Tax Laws Amendment (Small Business) Act 2007

The Tax Laws Amendment (Small Business) Act 2007 is a Commonwealth tax amending Act. It did not create a single stand-alone code for small business. Instead, it amended multiple tax laws and inserted a central small business entity framework into the Income Tax Assessment Act 1997, then linked that framework into other tax rules.

The Act's schedules show how broad the changes were. They cover small business entities, amendments relating to GST turnover thresholds, STS taxpayers, capital gains tax small business concessions, fringe benefits tax car parking exemption, PAYG instalments, roll-over relief and miscellaneous amendments. That means this Act is relevant well beyond income tax alone.

At the centre of the changes is Subdivision 328-C of the Income Tax Assessment Act 1997. That Subdivision explains the meaning of small business entity, annual turnover, aggregated turnover, connected with and affiliate. Those concepts are the starting point for working out whether a business can access a range of concessions, but they are not a substitute for checking the detailed rule for the specific concession you want to use.

The small business entity rules apply to an entity that carries on a business and satisfies the turnover test in the legislation. The Act is relevant to sole traders, companies, partnerships and trusts, but the practical analysis does not stop with the legal form of the entity. You also need to consider whether other entities are connected with you or are your affiliates, because their turnover may need to be counted as part of your aggregated turnover.

This is especially important for family groups, businesses with subsidiaries, businesses owned through trusts, and structures where individuals hold voting rights or income rights across multiple entities. The rules are also relevant for businesses that start during the year, stop during the year, or are winding up.

Some businesses will be outside the small business entity rules because they do not carry on a business. Even then, parts of the Act may still matter. The GST amendments in Schedule 2 include provisions that apply where an entity does not carry on a business and instead looks to GST turnover thresholds. So the first check is not just whether you are small. It is which concession you are looking at, and which eligibility test that concession actually uses.

Section 328-110 inserted by the Act sets out when an entity is a small business entity for an income year. The basic requirement is that the entity carries on a business in the current year and satisfies one of the turnover tests.

The general rule works in two main ways. A business can qualify if it carried on a business in the previous income year and its aggregated turnover for that previous year was less than $2 million. Alternatively, it can qualify if its aggregated turnover for the current year is likely to be less than $2 million. The legislation says that current year estimate is worked out as at the first day of the current year, or if the business starts during the year, as at the day the business starts.

There is also an exception to the estimate pathway. If the entity carried on a business in each of the two previous income years and its aggregated turnover for each of those years was $2 million or more, it cannot qualify under the current year estimate rule.

The Act also includes an additional year-end rule. An entity is also a small business entity for the current year if it carries on a business in that year and its aggregated turnover for the current year, worked out at the end of that year, is less than $2 million.

That year-end rule is useful, but it has limits. The Act expressly notes that if you are a small business entity only because of that year-end rule, you cannot choose certain concessions. The listed examples are paying PAYG instalments based on GDP-adjusted notional tax, accounting for GST on a cash basis, making an annual apportionment of input tax credits, and paying GST by quarterly instalments.

So the less than $2 million aggregated turnover threshold is central to the small business entity rules inserted by this Act, but it is not a universal answer for every tax issue. Businesses still need to check the exact concession provision they are relying on.

Aggregated turnover is defined in section 328-115. It is the sum of the relevant annual turnovers for the income year. Those relevant annual turnovers are your own annual turnover, the annual turnover of any entity connected with you at any time during the income year, and the annual turnover of any entity that is your affiliate at any time during the income year.

The Act also tells you what not to include. Aggregated turnover excludes amounts derived from dealings between you and a relevant entity while that entity is connected with you or is your affiliate. It also excludes amounts derived from dealings between relevant entities while each relevant entity is connected with you or is your affiliate. It further excludes amounts derived by a relevant entity while that entity is not connected with you and is not your affiliate.

Annual turnover is defined in section 328-120 as the total ordinary income an entity derives in the income year in the ordinary course of carrying on a business. The legislation excludes GST amounts that are non-assessable non-exempt income under section 17-5, and excludes ordinary income from sales of retail fuel. It also says that income from dealings with associates must be worked out on an arm's length basis.

If the business was carried on for only part of the income year, annual turnover must be worked out using a reasonable estimate of what the annual turnover would have been if the business had been carried on for the whole year. That is a practical point for start-ups, businesses sold mid-year, and businesses that ceased trading.

For many groups, this is the hardest part of the analysis. The turnover figure is not just a bookkeeping total. It depends on legal relationships between entities, the timing of those relationships during the year, and whether amounts should be excluded because they are internal dealings. For groups involving trusts, companies and individuals, the grouping and turnover calculation are central to eligibility and can be complex.

The Act does not use connected with and affiliate as loose commercial labels. They are technical concepts set out in the legislation and should be read that way.

Under section 328-125, an entity is connected with another entity if either entity controls the other in a way described in the section, or both are controlled in that way by the same third entity. The section then sets out detailed control rules. For entities other than discretionary trusts, control can arise where an entity, its affiliates, or the entity together with its affiliates beneficially own, or have rights to acquire, interests carrying at least 40% of income or capital rights, or in the case of a company, at least 40% of voting power.

For discretionary trusts, the rules are different. Control can arise if the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates, or the entity together with its affiliates. Control can also arise for an income year if, in any of the four income years before that year, the trustee paid or applied at least 40% of the trust's income or capital to or for the benefit of the entity, its affiliates, or both.

The Act also gives the Commissioner a discretion in some 40% to less than 50% cases. If the relevant control percentage is at least 40% but less than 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks the other entity is controlled by someone else.

Section 328-125 also deals with indirect control, subject to exceptions for certain listed and widely held entities. This means grouping can extend through chains of ownership or control, not just direct holdings.

Affiliate is defined separately in section 328-130. An individual or company is an affiliate if they act, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business. But the Act is clear that a person or company is not your affiliate merely because of the nature of the business relationship you share. The example in the legislation says one partner is not automatically an affiliate of another partner merely because of the partnership relationship. Directors of the same company and trustees of the same trust are given as similar examples.

For businesses with trusts, companies and individuals in the same group, these rules are often the key issue. A turnover calculation is only as accurate as the grouping analysis behind it.

The Act amended several tax regimes. The schedules show that the changes were not confined to one concession or one Act. They include amendments relating to GST turnover thresholds, STS taxpayers, CGT small business concessions, fringe benefits tax car parking exemption, PAYG instalments, roll-over relief and miscellaneous amendments.

Schedule 2 is a good example of the practical detail. It amended the GST Act so that a number of provisions refer to GST turnover rather than annual turnover. It also amended the GST cash accounting, annual apportionment and GST instalment rules so that certain choices are available where you are a small business entity other than because of subsection 328-110(4), or where you do not carry on a business and your GST turnover does not exceed the relevant threshold.

That distinction matters. A business may be a small business entity at year end under subsection 328-110(4), but still be unable to choose some GST and PAYG concessions because the specific provision excludes entities that qualify only that way.

The practical point is simple. Do not stop once you conclude that the entity is a small business entity. You should also check the specific concession provision, the threshold it uses, and the timing rule it applies.

If a business is relying on these rules, it should be able to show how it worked out both its turnover and its grouping position. The legislation makes ownership rights, voting rights, trust distributions, affiliate relationships and the timing of those relationships relevant to eligibility. That means the supporting material is often just as important as the final number.

Useful records can include ownership registers, shareholder and unit holder details, trust deeds, distribution records, partnership arrangements, documents showing rights to acquire interests, and working papers showing how internal dealings were excluded from aggregated turnover. If the business only operated for part of the year, it should also keep the basis for its reasonable estimate of annual turnover.

Where the structure includes discretionary trusts, multiple companies, family members or changing ownership during the year, the grouping analysis can be technical. In those cases, businesses should check the legislation carefully before relying on a simplified summary.

The Act received Royal Assent on 21 June 2007 and commenced on that day. Schedule 1 states that the small business entity amendments apply in relation to the 2007-08 income year and later income years.

The compiled version referenced in the legislation text was prepared on 4 March 2010 and notes amendments made by Act No. 8 of 2010. Businesses should therefore treat this Act as part of an ongoing legislative framework and check the current consolidated text and the current concession provisions when checking the current position.

The Act also notes that transitional provisions affect the operation of some rules for early income years, including the 2007-08 and 2008-09 income years, and in some cases later years for discretionary trust control rules. If you are reviewing a historical position, those transitional rules need to be checked directly.

Before relying on the small business entity rules for any concession, check the current law for the specific concession you want to use. This Act introduced and linked key concepts, but the practical answer often depends on the detailed provision in the relevant tax law.

You should confirm whether the entity carries on a business, whether the relevant threshold is aggregated turnover or GST turnover, whether the threshold is the less than $2 million test used in the small business entity rules inserted by this Act or a different threshold under the specific concession, and whether the concession excludes entities that qualify only under the year-end rule. You should also review all entities and individuals that may be connected with the business or may be affiliates, including through discretionary trust distributions, voting rights, ownership rights and indirect control chains.

Where the structure includes trusts, multiple companies, family members or changing ownership during the year, the grouping analysis can be technical. In those cases, the safest approach is to work from the legislation itself and the current ATO position for the concession in question.