Small business CGT concessions – professional fees and the $6 million net value test

The small business CGT concession are only available to taxpayers who can satisfy one of two alternative tests:

  •      a $2 million maximum turnover test for small business entities
  •      a $6 million maximum net asset value test.

Both are “drop dead” tests – $1 over and you fail to qualify for relief, $1 under and you qualify.

In the case of the $6 million maximum net asset value test, the question of whether certain professional fees relating to the sale of a relevant CGT asset are “liabilities” which can be deducted from the value of the taxpayer’s assets can be critical.

However the relevant statutory time at which that test must be satisfied is just before the relevant CGT event “happens”. In the case of a sale of property, the relevant CGT event “happens” at the time of entering into the contract of sale – not at the date of settlement.

This timing issue can pose problems in the case of professional fees associated with the sale. In some cases, the question of whether those fees can be taken into account in satisfying the $6 million test can mean the difference between “just falling in” or “just missing out”.

This issue recently came before the Full Federal in Commissioner of Taxation v Byrne Hotels Qld Pty Ltd [2011] FCAFC  in relation to the sale of the Byrne family’s hotel in the 2004 tax year (when the maximum net asset value test threshold was $5 million). The case was an appeal from a decision of the Administrative Appeals Tribunal (AAT).

In that case, the Commissioner argued that some of the professional fees associated with the sale did not crystalise as liabilities until after the contract of sale had been signed and therefore could not be deducted from the value of assets at the relevant time. He characterised those fees as being only “contingent liabilities” at that time.

The argument ultimately came down to whether the following professional fees could be deducted for the purposes of the maximum net asset value test”:

  •        the estate agent’s commission on sale of the hotel; and
  •        some of the legal fees payable on the sale.

Estate agent’s commission

The estate agent’s commission was $353,125 and was therefore particularly important as a deduction.

At first instance, the AAT had considered that it would be “entirely artificial” to exclude the agent’s commission and found in favour of the taxpayer.

However the Commissioner’s relentless zeal to protect the public’s money compelled him to spend large amounts of it in taking the matter on appeal.

Before the Full Court, the Byrne family was completely successful on the question of the agent’s commission.

The majority of the Court took the view that the words “contingent liability” did not appropriately describe the effect of the contractual obligation of the vendor to the estate agent at the time just  before the contract of sale was signed.

The majority held that the taxpayer’s contractual obligation to pay the agent’s commission was better described as being a “provisional burden” which was borne by the taxpayer just before it signed the sale contract and therefore reduced the total value of the taxpayer’s assets at that time.

To apply the accounting term “contingent liability” was to misunderstand the statutory test as it applied to a reduction of the value of a taxpayer’s assets at the relevant time.

Legal fees

The legal fees were treated in a different fashion. The court took the view that the liability for the legal services in question effectively accrued progressively as the legal services were performed. As a result, fees for work performed prior to the date of signing the contract of sale were able to be deducted from the vendor’s net assets. However fees for work performed  after that date could not be deducted.

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