If clients have claimed one or more small business CGT concessions in recent income tax returns, practitioners and clients may receive a letter from the ATO. The letter will ask to check clients’ claims and ensure that they meet the basic eligibility conditions and that they have records to substantiate their claim.  

Speaking to SMSF Adviser, DBA Lawyers director Daniel Butler said that the new ATO focus will have an impact on SMSFs involved with the CGT concessions.  

“What the ATO is seeing is that a number of people are not getting it correct, and as a result of that, they’re sending out a letter to those who have claimed the relief,” he said.

“This has been a heavily scrutinised area in the past, and the ATO is now going on an active campaign to send out letters to taxpayers who have claimed the relief and experience has shown that a lot of people stuff this up.”

Mr Butler warned it would be important for those SMSFs involved to have their position checked in case of any incorrect claim or uncertainty.

“The starting point is that the CGT small business concessions involve complex legislation,” he noted.

“To get the job done properly, you need to have a good tax expert look through and properly analyse the situation. A lot of people do not wish to incur that cost so a lot of people would not have documented advice and may not have a clear documented factual summary.

“If you don’t have that position covered like having a properly detailed opinion, which references the law along with supporting documents, then you’re open to a greater risk if the ATO do pursue their letter further.”

Practitioners should closely look at the list of situations that attract ATO attention. For example, expenditures that fail the small business entity test, such as failing to carry on a business or have an aggregated turnover greater than $2 million, entities that fail the maximum net asset value test – net assets of the entity, connected entities and affiliates exceeds $6 million, and if the asset disposed of does not meet the definition of an active asset.

Many funds can also easily run into risks when issues are identified with the CGT relief, as this can lead to flow-on impacts, such as excess contributions, according to Mr Butler.

“Let’s say the accountant has given advice, you qualify for the CGT relief, but then under closer inspection, they work out that [advice] was incorrect,” Mr Butler commented.

“It’s likely that the first thing that comes to mind is to rectify it straight away by withdrawing the money from super.

“But you cannot generally just simply withdraw the money from super; you have to ascertain whether you have a valid condition of release.

“Even if you have a valid condition of release, you will need to then get advice this time from a tax person who has appropriate superannuation experience to make sure you can manage any excess contribution. It’s quite likely that a member of a fund in this situation might be well over their total superannuation balance of $1.6 million after making a mistaken CGT contribution.”

This new focus by the ATO also emphasises the importance of getting proper advice upfront before claiming CGT relief, according to Mr Butler. It is strongly recommended to have it in writing, fully documented and fully supported.             

“Make sure that the people who do it are very familiar with the law, can reference the various sections and definitions and that they have properly analysed the material. You should then be a much sounder position,” Mr Butler continued.

“Make sure you also have that on your file, and if there is a mistake down the track, such as if the adviser is wrong, you can hold them accountable.”   

One good example involving the CGT small business concessions on the question of whether a piece of real estate used to store business equipment beside the family home was used in the course of carrying on a business illustrates the difficulty of winning in a tax dispute with the Commissioner.

In December 2016, the taxpayer applied to the ATO for a private ruling. The ATO ruled that the real estate was not used in the course of carrying on a business. The taxpayer objected. In July 2017, the ATO reaffirmed the ruling. The taxpayer appealed to the Administrative Appeals Tribunal, and in February 2019, the tribunal ruled that the real estate was used in the course of carrying on a business.

The ATO appealed to the Federal Court, and in December 2019, the Federal Court overturned the tribunal’s decision. The taxpayer then appealed to the Full Federal Court. In September 2020, the Full Federal Court ruled that the real estate was used in the course of carrying on a business (i.e. that the ATO had been wrong).

“This illustrates that even if a taxpayer is ultimately right, it can take years of fighting with the ATO to prove this,” Mr Butler explained.

“Also, if the taxpayer had lost the desire or ability to dispute the matter after, for example, the Federal Court decision but before the Full Federal Court decision, the taxpayer would have been ultimately wrong instead of being ultimately right. Losing the desire or ability to dispute a matter is a real possibility due to the extreme financial costs of a dispute with the ATO (at least several hundred thousand dollars can be possible, even before any litigation occurs).

“If a taxpayer loses a court case, the taxpayer typically has to also pay the other party’s legal fees (which of course can be significant). Even if a taxpayer ultimately wins a court case, the taxpayer is likely to still have significant out of pocket expenses. Furthermore, a dispute with the ATO can be tremendously stressful and time-consuming. The emotional toll of a protracted dispute with the ATO should not be underestimated.”