Maximum net asset value test under the microscope again! Bell v Federal Commissioner of Taxation
Warning for Taxpayers
For CGT events that happen in the 2007-08 or later income year, it is not necessary to satisfy the maximum net asset value (‘MNAV’) test to access the small business CGT concessions in Division 152 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 97’) if the alternative small business entity test is satisfied. For taxpayers who are not small business entities, satisfying the MNAV test is vital.
The MNAV test is an “all or nothing” test in that even $1 in excess of the threshold means failing the test and denial of all of the four small business CGT concessions. This means that exceeding the threshold can lead to massively different tax outcomes. The Commissioner is all too aware of this, and it is no coincidence that the MNAV test has been the subject of litigation in recent years. The recent case of Bell v The Federal Commissioner of Taxation  FCA 1042 (‘Bell’) is the latest in a string of cases where the Commissioner has argued that the small business CGT concessions were not available to the taxpayer because the MNAV test was not met.
Bell v FCT
The Bell decision provides guidance on what liabilities can be taken into account in the MNAV test calculation in section 152-15 of ITAA 97.
In Bell, the taxpayer was a beneficiary of the Bell Family Trust (‘Trust’). In March 2007, the trustee of the Trust made a capital gain exceeding $6 million for selling the units held in two associated unit trusts. The taxpayer was presently entitled to 100% of the income the Trust for the 2007 income year and, therefore, the Commissioner assessed the taxpayer on all of the net (taxable) income of the Trust, including the net capital gain, and imposed a penalty of 50% for recklessness.
The Taxpayer argued that two of the small business concessions were available to the Trust to reduce the taxable amount of the capital gain that flowed through to him. However, the Commissioner considered that the MNAV test (with the then applicable threshold of $5 million) had not been met and therefore that none of the concessions were available.
At issue was the calculation of the assets and liabilities to be taken into account in determining whether the MNAV test was satisfied.
The hearing of the appeal to the Federal Court of Australia from a decision of the Administrative Appeals Tribunal (‘AAT’) was essentially confined to the following two issues:
Whether a borrowing by the Trust to fund a distribution of capital to the taxpayer “related to” the assets of the Trust (‘Issue 1’); and
Whether, for another individual (the taxpayer’s wife) whose net value of CGT assets was to be taken into account in the Trust’s MNAV test calculation, a loan account and an offset account should be regarded as a single CGT asset and, if not, whether the debit balance in the loan account “related to” the offset account (‘Issue 2’).
Issue 1 – The borrowing by the Trust
The debt owing by the Trust arose as a result of the Trust borrowing money to fund a capital distribution made to the taxpayer to enable him to discharge a mortgage over his wife’s home (an excluded asset) and to fund a superannuation contribution.
The AAT held that the debt was too remote for the relationship necessary between a liability and an asset under section 152-20 to exist and therefore the liability did not “relate to” the CGT assets of the Trust as required by section 152-20. The Federal Court disagreed.
The Federal Court held that the debt was a liability “related to” the CGT assets of the Trust as contemplated by section 152-20. The liability did not exist independently. The purpose of the debt was to meet the Trust’s obligation to distribute capital, namely a portion of the corpus of the Trust, to the taxpayer. The trust deed provided for that obligation to be met by the Trust borrowing and that is in fact what did occur. The debt was necessary to meet the obligation and thereby protect or maintain the CGT assets of the Trust. Absent the debt, the Trust’s obligation to make the capital distribution was an encumbrance over its CGT assets which would have had to be met by the sale or distribution of those assets. There was and remained a direct relationship or connection between the CGT assets of the Trust and the debt of the Trust. The relationship was real and substantial, and not remote. Accordingly, the taxpayer won on this issue.
Issue 2 – The Wife’s Loan and Offset Account
The wife’s debt was a bank loan used to fund the purchase of a home. The taxpayer contended that the loan reduced the balance of her other bank account, an interest offset account. The AAT found that the loan account and offset account were separate accounts and the loan related not to the offset account but to the home, an excluded asset. The Federal Court agreed. Accordingly, the taxpayer lost on this issue.
Even though the taxpayer won on Issue 1, this did not mean that the small business CGT concessions were available because failure on Issue 2 meant that the MNAV test was not met.
Before the AAT, the Commissioner sought to support his decision to impose an administrative penalty of 50% for “recklessness”. The AAT held that the appropriate penalty was for a failure to take reasonable care (i.e. 25%). The Federal Court held that it was open for the AAT to impose a 25% penalty for failure to take reasonable care.
The taxpayer has lodged an appeal to the Full Federal Court of Australia from the decision of Justice Gordon.
As mentioned at the start of this article, the Bell decision is the latest in a string of cases where the Commissioner has argued that the small business CGT concessions were not available to the taxpayer because the MNAV test was not met.
The following issues have been the subject of contention in recent cases concerning the MNAV test:
Can expenses incurred after a sale be included in the MNAV test?
Is the market value of an active asset the sale price in the contract?
When are the net assets of a “connected entity” taken into account?
Is a ‘kerbside’ valuation acceptable to value assets?
Should you have any questions about the small business CGT concessions please contact Richard Norton, Chris Smailes, Daniel Fry or Alan Krawitz.
Disclaimer: This articie is in summary form and should not be relied on as a subsitute for detailed advice.
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