Edited version of private advice

Authorisation Number: 1051802125692

Date of advice: 5 February 2021

Ruling

Subject: Small business restructure roll-over

Question 1

Will the proposed transfer of the Land from the Taxpayer to a new discretionary trust qualify for roll-over relief under Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will land subject to the proposed transfer and acquired before 20 September 1985 retain its pre-CGT status pursuant to section 328-460 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Relevant facts and circumstances

The Taxpayer is a partner in a partnership (the partnership) and an Australian resident for tax purposes. She has an interest in the partnership of 40%. The Taxpayer's spouse and son have a 40% and 20% interest in the partnership respectively.

The business activities of the partnership are livestock farming and cereal grain growing. The partnership has undertaken this primary production business for at least 20 years.

The Taxpayer owns parcels of land (collectively referred to as the Land) to the following extent:

•         Title 1 - 41.66% tenant in common

•         Title 2 - 50% tenant in common

•         Title 3 - 50% tenant in common

•         Title 4 - 50% tenant in common.

Titles 2 and Land 3 were purchased before 20 September 1985.

Title 4 was purchased as a crown lease in July 19XX. The crown lease was surrendered in 20XX and converted to a title partly owned by the Taxpayer.

The Land has been used by the partnership to carry on its primary production business since the date of its purchase. There is no formal lease in place in respect to the use of the Land by the partnership due to the close intertwined relationship between the owners of the Land and the partnership.

The other partners of the partnership act, or could reasonably be expected to act, in concert with the Taxpayer in relation to the affairs of the business of the other partners (which they carry on via their interest in the partnership), and therefore are an affiliate of the Taxpayer pursuant to subsection 328-130(1) of the ITAA 1997, on the basis that:

•         the Taxpayer has a very close family relationship with the other partners;

•         there is no formal agreement between the Taxpayer and the other partners dictating how they are to act in relation to each other;

•         there is a likelihood that the way the partners act, or could reasonably be expected to act, in relation to each other would be based on the relationship between them (rather than on formal agreements or legal or fiduciary obligations); and

•         the partners (the Taxpayer included) decide matters collectively.

The aggregated turnover for the partnership for the 20XX income year was greater than $XXX but less than $XXX. The partnership is consequently a 'small business entity' for the 20XX income year pursuant to subsection 328-110(1) of the ITAA 1997 but not a 'CGT small business entity' for the 20XX income year pursuant to subsection 152-10(1AA) of the ITAA 1997.

As part of a proposed restructure:

•         the primary production business being undertaken by the partnership is to be transferred to a newly established unit trust; and

•         the Land is proposed to be transferred to one or more newly established discretionary trusts (the proposed transfer).

A discretionary trust established to hold the Land:

•         will be a resident trust for tax purposes;

•         will have a corporate trustee in which the Taxpayer, her spouse and their daughter will be the directors and shareholders, each holding a 40%, 40% and 20% interest respectively;

•         will have a family trust election in place with either the Taxpayer or her spouse as the specified individual;

•         will have the Taxpayer as an appointor; and

•         will have the Taxpayer and her family as beneficiaries.

The benefits expected to result from the proposed transfer include:

•         Asset protection - the proposed transfer is designed to create an additional layer of protection for the core asset of the business, being the Land, which has appreciated considerably in value and could be at risk should any legal action be taken against the Taxpayer (or other partners). The primary production business being undertaken comes with significant risks in an increasing litigious environment and is at a heightened risk due to potential for fires to be ignited through operational practices. Additionally, the business has employees and the risks that come from such engagements in the industry.

•         Finance - the partnership is undertaking steps to refinance its core debt, as its relationship with its current financier has broken down, and apply for Regional Investment Corporation drought loans. Financiers are generally less favourable to lending funds and taking security provided by older individuals due the potential issues that may arise in the future with regards to succession and or estate planning. By transferring the Land out of an individual's name to that of a trust, continuity of the business is more likely to occur and future outcomes can be more certain should an event occur. It is expected that this structure will enable additional options with financiers to be negotiated over longer terms than that which is currently available to the individual partners, and the additional certainty that brings is anticipated to assist in growth of the business.

•         Reflect current land holding practices - if the Land were to be purchased today, it would be purchased in the proposed format of a discretionary trust rather than in the name of the Taxpayer (an individual). This is demonstrated by some of the more recent purchases of land by the Taxpayer's family.

The Land will continue to be used in the carrying on of the primary production business.

The proposed transfer is not proposed in the course of winding down the business or realising the Taxpayer's ownership interest in the business.

Both the Taxpayer (as transferor) and the discretionary trust (as transferee) will choose to apply a roll-over under Subdivision 328-G in relation to the Land transferred under the proposed transfer.

Assumption

The partnership will be a small business entity for the 20XX income year pursuant to section 328-110 of the ITAA 1997 and would be a CGT small business entity for the 20XX income year pursuant to subsection 152-10(1AA) of the ITAA 1997 if paragraph 152-10(1AA)(b) were disregarded.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 paragraph 152-10(1AA)(b)

Income Tax Assessment Act 1997 subsection 152-10(1A)

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 subparagraph 152-40(1)(a)(iii)

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 paragraph 328-125(1)(a)

Income Tax Assessment Act 1997 paragraph 328-125(1)(b)

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 subparagraph 328-125(2)(a)(ii)

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 subsection 328-130(1)

Income Tax Assessment Act 1997 Subdivision328-G

Income Tax Assessment Act 1997 section 328-430

Income Tax Assessment Act 1997 subsection 328-430(1)

Income Tax Assessment Act 1997 paragraph 328-430(1)(a)

Income Tax Assessment Act 1997 paragraph 328-430(1)(b)

Income Tax Assessment Act 1997 subparagraph 328-430(1)(b)(iii)

Income Tax Assessment Act 1997 paragraph 328-430(1)(c)

Income Tax Assessment Act 1997 paragraph 328-430(1)(d)

Income Tax Assessment Act 1997 subparagraph 328-430(1)(d)(ii)

Income Tax Assessment Act 1997 paragraph 328-430(1)(e)

Income Tax Assessment Act 1997 paragraph 328-430(1)(f)

Income Tax Assessment Act 1997 section 328-440

Income Tax Assessment Act 1997 section 328-445

Income Tax Assessment Act 1997 subsection 328-445(1)

Income Tax Assessment Act 1997 subsection 328-445(2)

Income Tax Assessment Act 1997 section 328-460

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 section 272-70 of Schedule 2F

Income Tax Assessment Act 1936 section 272-80 of Schedule 2F

Reasons for decision

Summary

The proposed transfer will meet the requirements under Subdivision 328-G of the ITAA 1997[1] and qualify for roll-over relief.

Detailed reasoning

Subdivision 328-G allows flexibility for owners of small business entities to restructure their businesses and the way their business assets are held while disregarding tax gains and losses that would otherwise arise.

Subsection 328-430(1) discusses when a roll-over is available. It provides as follows:

A roll-over under this Subdivision is available in relation to an asset that, under a transaction, an entity (the transferor) transfers to one or more other entities (transferees) if:

(a) the transaction is, or is a part of, a genuine restructure of an ongoing *business; and

(b) each party to the transfer is an entity to which any one or more of the following applies:

(i) it is a *small business entity for the income year during which the transfer occurred;

(ii) it has an *affiliate that is a small business entity for that income year;

(iii) it is *connected with an entity that is a small business entity for that income year;

(iv) it is a partner in a partnership that is a small business entity for that income year; and

(c) the transaction does not have the effect of materially changing:

(i) which individual has, or which individuals have, the ultimate economic ownership of the asset; and

(ii) if there is more than one such individual - each such individual's share of that ultimate economic ownership; and

(d) the asset is a *CGT asset (other than a *depreciating asset) that is, at the time the transfer takes effect:

(i) if subparagraph (b)(i) applies - an *active asset; or

(ii) if subparagraph (b)(ii) or (iii) applies - an active asset in relation to which subsection 152-10(1A) is satisfied in that income year, or would be satisfied in that income year if paragraph 152-10(1AA)(b) were disregarded; or

(iii) if subparagraph (b)(iv) applies - an active asset and an interest in an asset of the partnership referred to in that subparagraph; and

(e) the transferor and each transferee meet the residency requirement in section 328-445 for an entity; and

(f) the transferor and each transferee choose to apply a roll-over under this Subdivision in relation to the assets transferred under the transaction.

Paragraph 328-430(1)(a) - Genuine restructure of an ongoing business

Law Companion RulingLCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3) provides guidance on the meaning of the term 'genuine restructure of an ongoing business'.

Whether a transaction is, or is a part of, a genuine restructure of an ongoing business is a question of fact that is determined having regard to all of the circumstances surrounding the restructure (paragraph 5 of LCR 2016/3).

Paragraph 6 of LCR 2016/3 states that a genuine restructure of an ongoing business is one that could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business. It can encompass a restructure of the way in which business assets are held where that structure is likely to have been adopted had the business owners obtained appropriate professional advice when setting up the business.

Paragraph 7 of the LCR 2016/3 identifies the following features as ones which indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business':

•         It is a bona fide commercial arrangement undertaken in a real and honest sense to

- facilitate growth, innovation and diversification

- adapt to changed conditions, or

- reduce administrative burdens, compliance costs and/or cash flow impediments.

•         It is authentically restructuring the way in which the business is conducted as opposed to a 'divestment' or preliminary step to facilitate the economic realisation of assets.

•         The economic ownership of the business and its restructured assets is maintained.

•         The small business owners continue to operate the business through a different legal structure. For example, there is:

- continued use of the transferred assets as active assets of the business

- continuity of employment of key personnel, and

- continuity of production, supplies, sales or services.

•         It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business.

Factors which tend to indicate that a restructure is not a 'genuine restructure of an ongoing business' are listed in paragraph 10 of LCR 2016/3 to include:

•         where the restructure is a preliminary step to facilitate the economic realisation of assets, or takes place in the course of a winding down to transfer wealth between generations

•         where the restructure effects an extraction of wealth from the assets of the business (including accumulated profits) for personal investment or consumption or otherwise designed for use outside of the business

•         where artificial losses are created or there is a bringing forward of their recognition

•         the restructure effects a permanent non-recognition of gain or the creation of artificial timing advantages, and/or

•         there are other tax outcomes that do not reflect economic reality.

The proposed transfer is considered to be part of a 'genuine restructure of an ongoing business' on the basis that:

•         it is bona fide commercial arrangement undertaken in a real and honest sense to better protect a core asset of the business (i.e. the Land), and to ensure the partnership is able to refinance its core debt and negotiate finance over longer terms, thereby reducing potential cash flow impediments, achieving greater certainty and facilitating growth of the business;

•         it is not part of a divestment or preliminary step to facilitate the economic realisation of assets;

•         the economic ownership of the business and the Land will be maintained;

•         the Taxpayer and the other partners will continue to operate the business through a different legal structure (i.e. a unit trust);

•         the ownership of the Land by a discretionary trust is in keeping with the structure under which the Land would have been purchased today, as has been the case in respect of more recent purchases of land by the Taxpayer's family for use in the business; and

•         none of the factors listed in paragraph 10 of LCR 2016/3 which indicate that a restructure is not a genuine restructure of an ongoing business apply.

The requirement under paragraph 328-430(1)(a) will therefore be satisfied.

Paragraph 328-430(1)(b) - Small business entity

An entity is 'connected with' another entity pursuant to paragraph 328-125(1)(a) if either entity controls the other in a way described in section 328-125.

Relevantly, subparagraph 328-125(2)(a)(ii) states that an entity controls a partnership if the entity, its affiliates, or the entity together with its affiliates, own interests in the partnership that carry between them the right to receive a percentage that is at least 40% of the net income of the partnership.

The Taxpayer controls the partnership in a way described in subsection 328-125(2), and is therefore connected with the partnership in accordance with paragraph 328-125(1)(a), on the basis that either:

•         the Taxpayer owns an interest in the partnership that carries the right to receive 40% of the net income of the partnership; or

•         the Taxpayer together with her affiliates, own interests in the partnership that carry between them the right to receive 100% of the net income of the partnership.

An entity is 'connected with' another entity pursuant to paragraph 328-125(1)(b) if both entities are controlled in a way described in section 328-125 by the same third entity. Therefore, a discretionary trust to which the Land will be transferred will be connected with the partnership if, like the partnership, the discretionary trust is controlled in a way described in section 328-125 by the Taxpayer.

Relevantly, subsection 328-125(3) states that an entity controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the direction or wishes of the entity, its affiliates, or the entity together with its affiliates.

As the Taxpayer together with her spouse (an affiliate) will hold 80% of the shares of the corporate trustee (the other 20% being held by their daughter), and will be directors of the corporate trustee (together with their daughter), the trustee of the discretionary trust could reasonably be expected to act in accordance with the directions or wishes of the Taxpayer together with the Taxpayer's affiliates, and the Taxpayer will control the discretionary trust in a way described in subsection 328-125(2).

As a consequence, both the discretionary trust and the partnership will be controlled in a way described in section 328-125 by the Taxpayer, and the discretionary trust will be connected with the partnership pursuant to paragraph 328-125(1)(b).

Both the Taxpayer (as transferor) and the discretionary trust (as transferee) will therefore be connected with the partnership (a small business entity for the 20XX income year and, as assumed, for the 20XX income year), thereby constituting entities to which subparagraph 328-430(1)(b)(iii) applies and satisfying the requirement under paragraph 328-430(1)(b).

Paragraph 328-430(1)(c) - Ultimate economic ownership

The phrase 'ultimate economic ownership' is not defined in the ITAA 1997. However, the Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 states:

1.29 The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset.

1.30 Ultimate economic ownership of an asset can only be held by natural persons. Therefore, where a company, partnership or trust owns an asset it will be the natural person owners of the interests in these interposed entities that will ultimately benefit economically from that asset.

Where ownership passes to or from a discretionary trust, this requirement would generally not be able to be satisfied. Under ordinary legal concepts, a beneficiary of a discretionary trust is not entitled to income or capital of the trust until the trustee exercises their discretion to distribute income or to make an appointment of capital: Commissioner of Stamp Duties (NSW) v. Buckle (1998) 192 CLR 226.

A beneficiary of a discretionary trust only has a right to require the trustee to consider whether or not to exercise their discretion. Instead, a beneficiary of a discretionary trust generally has a 'mere expectancy' in the income or capital of a trust and does not have an interest in possession: Gartside v. Inland Revenue Commissioner [1968] AC 553.

However, section 328-440 contains an alternative ultimate economic ownership test designed to provide additional flexibility to small family businesses carried on through non-fixed trusts by allowing them to meet the requirement to maintain proportionate economic ownership of the transferred asset if the ultimate economic ownership of that asset remains within the family.

Section 328-440 states that for the purposes of paragraph 328-430(1)(c), a transaction does not have the effect of changing the ultimate economic ownership of an asset, or any individual's share of that ultimate economic ownership, if the requirements in that section are satisfied.

Section 328-440 is satisfied if:

•         the asset is included in the property of a family trust (as defined in Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)) either just before or just after the transaction takes/took effect; and

•         every individual who had the ultimate economic ownership of the asset just before and just after the transfer must be members of the family group (within the meaning of Schedule 2F to the ITAA 1936) relating to the family trust.

A discretionary trust established to hold the Land will be a 'non-fixed trust' as defined under

section 272-70 of Schedule 2F to the ITAA 1936 and, pursuant to section 272-80 of Schedule 2F to the ITAA 1936, will make a family trust election nominating either the taxpayer or the Taxpayer's spouse as the specified individual.

For the purposes of paragraph 328-430(1)(c), the proposed transfer will not have the effect of changing the ultimate economic ownership of the Land, or any individual's share of that ultimate economic ownership, as:

•         the Land will be included in the property of the discretionary trust (a non-fixed trust that is a family trust) just after the transaction takes effect;

•         every individual who, just before the proposed transfer takes effect, will have the ultimate economic ownership of the Land will be a member of the family group relating to the discretionary trust; and

•         every individual who, just after the proposed transfer takes effect, has the ultimate economic ownership of the Land will be a member of that family group.

The requirement under paragraph 328-430(1)(c) will therefore be satisfied.

Paragraph 328-430(1)(d) - Active assets

As the Taxpayer and the discretionary trust will be entities to which subparagraph 328-430(1)(b)(iii) applies, the requirement under subparagraph 328-430(1)(d)(ii) must be satisfied. To satisfy this condition, the asset subject to the proposed transfer must be a CGT asset (other than a depreciating asset) that is, at the time the transfer takes effect, an active asset in relation to which subsection 152-10(1A) is satisfied in that income year, or would be satisfied in that income year if paragraph 152-10(1AA)(b) were disregarded.

A CGT asset is defined in subsection 108-5(1) as any kind of property, or a legal or equitable right that is not property.

Subsection 152-40(1) provides the meaning of an active asset:

A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

...

The asset subject to the proposed transfer (i.e. the Land) is a CGT asset (other than a depreciating asset) that will, at the time the transfer takes effect, be an active asset pursuant to subparagraph 152-40(1)(a)(iii) on the basis that it will be owned by the Taxpayer and used in the course of carrying on a business by the partnership (an entity connected with the Taxpayer).

Subsection 152-10(1A) is satisfied in relation to an asset in an income year if:

(a)  your affiliate or an entity that is connected with you, is a CGT small business entity for the income year; and

(b)  you do not carry on a business in the income year (other than in partnership); and

(c)   if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership, and

(d)  in any case - the CGT small business entity referred to in paragraph (a) is the entity that, at the time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

At the time the proposed transfer takes effect, the Land will also be an asset to which subsection 152-10(1A) would be satisfied in that income year if paragraph 152-10(1AA)(b) were disregarded. This is because:

•         the partnership (being an entity connected with the Taxpayer) would be a CGT small business entity if paragraph 152-10(1AA)(b) were disregarded;

•         the Taxpayer doesn't carry on a business other than in partnership;

•         the CGT asset (i.e. the Land) is not an interest in an asset of the partnership; and

•         the partnership is the entity that carries on the business (as referred to in

•         subparagraph 152-40(1)(a)(iii)) in relation to the Land.

The relevant requirement under paragraph 328-430(1)(d) will therefore be satisfied.

Paragraph 328-430(1)(e) - Residency

As the Taxpayer is an Australian resident for tax purposes and the discretionary trust is a resident trust for CGT purposes (as required under section 328-445), the requirement under paragraph 328-430(1)(e) will be satisfied.

Paragraph 328-430(1)(f) - Roll-over choice

As both the Taxpayer and the discretionary trust will choose to apply the roll-over under Subdivision 328-G in relation to the Land transferred under the proposed transfer, the requirement under paragraph 328-430(1)(f) will be satisfied.

Conclusion

As each of the requirements under subsection 328-430(1) will be satisfied, the Taxpayer will be eligible to choose roll-over relief under Subdivision 328-G in relation to the proposed transfer.

Question 2

Summary

Land subject to the proposed transfer and acquired before 20 September 1985 will retain its pre-CGT status upon transfer to the discretionary trust pursuant to section 328-460.

Detailed reasoning

Where the transfer of an asset occurs under a transaction in relation to which section 328-430 applies and a roll-over under Subdivision 328-G is available in relation to that asset, subsection 328-455(1) provides that the income tax law applies in relation to the transfer as if it takes place for the asset's roll-over cost (as determined under subsection 328-455(2)).

Section 328-460 states that for the purposes of applying subsection 328-455(1) to the asset as a CGT asset (other than a revenue asset) that is a pre-CGT asset, a transferee is taken to have acquired the asset before 20 September 1985.

Therefore, for the purposes of applying subsection 328-455(1) to land subject to the proposed transfer and acquired before 20 September 1985, the discretionary trust will also be taken pursuant to section 328-460 to have acquired that land before that date.

[1] Unless otherwise indicated, all legislative references in this ruling are to the ITAA 1997.

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