Edited version of private advice

Authorisation Number: 1051822763627

Date of advice: 19 April 2021

Ruling

Subject: Transfer of assets under a restructure of a small business

Question

Does the proposed transfer of land and water licences from the individual taxpayer to new discretionary trust(s) qualify for relief under subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

Financial year ending 30 June 20XX

Financial year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You do not carry on business individually but do so as a partner in a partnership (the Partnership).

You and the other partners of the Partnership are all members of the same family group.

The Partnership conducts a business (the Business).

The Business carried on by the Partnership is solely for the benefit of you, the other partners, and your respective families.

You hold an ownership interest in land (the Land), held as joint tenants with your spouse.

The Land has been used in a business since the date of purchase.

You own interests in commercial water licences that were acquired in XXXX.

The Partnership is financially dependent on the land parcel and the water licences.

You and the other partners are financially dependent on the Partnership business.

You act in affiliation with the other partners to ensure that the Partnership is run in a way to meet each of your financial requirements.

There is no formal lease agreement in place in respect to the use of the land and water licences with the Partnership. This is considered unnecessary due to the close intertwined relationship between the Partnership and the holders of the land and water licences.

The aggregated turnover of the Partnership was below $XX million for the previous financial year and is expected to be below $XX million for the current financial year.

The Partnership is a small business entity as per the meaning in 328-110 of the ITAA 1997.

Proposed restructure

The initial transaction will involve the transfer of the Business from the Partnership to a discretionary trading trust (Trading trust) with a corporate trustee.

The Trading trust will continue to carry on the same business.

Your spouse will be the appointor of the Trading trust and the sole director of the corporate trustee of the Trading trust.

You and other members of your family group will be beneficiaries of the new Trading trust.

The Trading trust will continue to use and be financially dependent on the land parcel and the water licences.

You and the other members of you family group will continue to be financially dependent on the Business after it is transferred to the Trading trust.

You will continue to act in affiliation with the other members of your family group to ensure that the Trading trust business is run in a way to meet each of your financial requirements.

The aggregated turnover of the Trading trust will be below $XX million for the income year the transactions will occur.

The Trading trust will be a small business entity as per the meaning in 328-110 of the ITAA 1997 in the income year the transactions will occur.

The land and water licences owned by you will be transferred to new discretionary trusts (Holding trusts) each with a corporate trustee.

Each new Holding trust established to hold the land and water licences will have a family trust election in place in accordance with section 272-80 of Schedule 2F to the ITAA 1936, with the family member X as the test individual.

Your spouse will be the sole director of the corporate trustee for the Holding trust holding the land.

You and your spouse will be the appointors of the Holding trust holding the land.

Your spouse and family member X will be the directors of the corporate trustee for the Holding trust that will hold the water licences.

You, your spouse and family members X and Y will be appointors of the Holding trust holding the water licences.

You and other members of your family group will be beneficiaries of the new Holding trusts.

All individuals and entities who are a party to this restructure are Australian Residents

for tax purposes.

The land and water licences will continue to be used by the Trading trust to undertake the core business.

The purpose of the restructure is to:

•         provide protection for assets that are integral to the running of the Business

•         enable improved financing availability to assist in growth of the Business

•         reflect a structure likely to have been adopted had the Taxpayers obtained appropriate professional advice when purchasing each parcel of land and each water licence.

You (transferor) and each discretionary trust(s)(transferees) will choose to apply the roll-over in relation to the land and water assets transferred under these transactions.

Relevant legislative provisions

Section 328-110 of the Income Tax Assessment Act 1997

Section 328-125 of the Income Tax Assessment Act 1997

Section 328-130 of the Income Tax Assessment Act 1997

Paragraph 152-10(1AA)(b) of the Income Tax Assessment Act 1997

Subsection 152-10(1A) of the Income Tax Assessment Act 1997

Section 328-430 of the Income Tax Assessment Act 1997

Section 328-440 of the Income Tax Assessment Act 1997

Section 328-460 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

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

Section 272-72 of Schedule 2F of the Income Tax Assessment Act 1936

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

Reasons for decision

Summary

The transfer of land and water licences from the individual taxpayer to the new discretionary trust(s) qualifies for relief under subdivision 328-G of the ITAA 1997 as the relevant requirements have been satisfied under the proposed transactions.

Detailed reasoning

The rollover under Subdivision 328-G of the ITAA 1997 is designed to facilitate flexibility for owners of small business entities to restructure their business, and the way their business assets are held, while disregarding the tax gains and losses that would otherwise arise.

To be eligible for the rollover several conditions under section 328-430 of the ITAA 1997 must be satisfied:

Section 328-430 of the ITAA 1997 When a roll-over is available

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.

Genuine restructure - 328-430(1)(a) of the ITAA 1997

Paragraph 328-430(1)(a) of the ITAA 1997 requires that the transaction is, or is part of, a genuine restructure of an ongoing business.

Whether a transaction is, or is 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.

Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3) provides guidance on whether a transaction will be part of a 'genuine restructure of an ongoing business'.

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.

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

•         it is a bona fide commercial arrangement undertaken to facilitate growth, innovation and diversification, to adapt to changed conditions, or to reduce administrative burdens and compliance costs

•         it is authentically restructuring the way the business is conducted, as opposed to a divestment or a 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, and

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

A restructure is likely to not be a genuine restructure of an ongoing business if:

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

•         it effects an extraction of wealth from the assets of the business for personal investment or consumption

•         it creates artificial losses or brings forward their recognition

•         it effects a permanent non-recognition of gain or creates artificial timing advantages, and/or

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

Application to your circumstances

The Commissioner considers that the proposed transactions are an authentic restructure of the Business that will improve asset protection and enhance financing options. The resultant structure would likely have been adopted had you obtained appropriate professional advice when setting up the Business. You and the other Business owners will continue to operate the Business, using the assets through a different legal structure.

As the transfers are considered to be part of a genuine restructure of an ongoing business, paragraph 328-430(1)(a) of the ITAA 1997 is satisfied.

Small business entities, affiliates or connected entities - 328-430(1)(b) of the ITAA 1997

Subparagraph 328-430(1)(b) of the ITAA 1997 requires that each party to the transfer is an entity to which 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.

Subsection 328-125(1) of the ITAA 1997 provides that an entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

An entity controls a discretionary trust if the trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its *affiliates, or the first entity together with its affiliates (subsection 328-125(3) of the ITAA 1997).

Subsection 328-130(1) of the ITAA 1997 provides that an individual or a company is an affiliate of yours if the individual or company acts, 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 of the individual or company.

However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share (subsection 328-130(2) of the ITAA 1997).

The Full High Court, in FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344, held that the phrase 'might reasonably be expected' requires more than a possibility.

An entity, the first entity, 'could reasonably be expected' to act in accordance with another entity's, the second entity's, wishes where the second entity has a relationship of control or influence over the first entity. Such a relationship can be evidenced by the entities' behaviours and the presence of any influential relationships, such as:

(a) family or other close personal relationships

(b) financial relationships and dependencies

(c) relationships created through links such as common directors, partners or shareholders.

Application to your circumstances

Due to the influential family relationships and financial dependencies that exist, for the purpose of applying the small business restructure under 328-G of the ITAA 1997, the Commissioner considers your spouse and family member X to be an affiliate of yours (subsection 328-130(1) of the ITAA 1997).

Under the proposed transactions your spouse will be the sole director of the corporate trustee for the Holding trust that will hold Jaensch Block and the Trading trust that will conduct the Business. Your spouse and family member X will be the directors of each corporate trustee for the Holding trusts that will hold the water licences. The Commissioner considers that it is reasonable to expect that the corporate trustees for the Holding trusts and Trading trust will act in accordance with the directions of your affiliates (your spouse and family member X). You will therefore control the Holding trusts and Trading trust (section 328-125(3) of the ITAA 1997) and be connected to them (paragraph 328-125(1)(a) of the ITAA 1997).

As both the Holding trusts and the Trading trust will be controlled by you and your affiliates, the Holding trusts will also be connected to the Trading trust (paragraph 328-125-125(1)(b) of the ITAA 1997).

As you (transferor) and each of the Holding trusts (transferees) will be connected to a small business entity (the Trading Trust) in the income year of the proposed transaction, subparagraph 328-430(1)(b)(iii) of the ITAA 1997 will be satisfied.

Ultimate economic ownership - 328-430(1)(c) of the ITAA 1997

Paragraph 328-430(1)(c) of the ITAA 1997 requires that the transaction does not materially change the ultimate economic ownership of the asset. The proposal does not meet this ultimate economic ownership test as the current ultimate economic ownership will not be maintained after the transfer to the discretionary trust(s).

An alternative economic test is available for discretionary trusts with family trust elections in place under section 328-440 of the ITAA 1997:

Section 328-440 Provides that Ultimate economic ownership - discretionary trusts

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:

(a) either or both of the following applies:

(i) just before the transaction took effect, the asset was included in the property of a *non-fixed trust that was a *family trust;

(ii) just after the transaction takes effect, the asset is included in the property of a non-fixed trust that is a family trust; and

(b) every individual who, just before the transfer took effect, had the ultimate economic ownership of the asset was a member of the family group (within the meaning of Schedule 2F to the Income Tax Assessment Act 1936 ) relating to the trust or trusts referred to in paragraph (a); and

(c) every individual who, just after the transfer takes effect, has the ultimate economic ownership of the asset is a member of that family group.

Application to your circumstances

Section 328-440 is satisfied by the proposed transactions as:

•         just after the transactions, the land and water right assets will be included in the property of the Holding trust which will be non-fixed trusts that will be family trusts; and

•         every individual who had the ultimate economic ownership of the asset just before the transfer is a member of the family group (within the meaning of Schedule 2F to the ITAA 1936) relating to the family trusts; and

•         every individual who, just after the transfer takes effect, will have the ultimate economic ownership of the land and water licences assets will be a member of the same family group.

As section 328-440 of the ITAA 1997 is satisfied, paragraph 328-430(1)(c) of the ITAA 1997 is also satisfied under the proposed arrangement.

Active asset - 328-430(1)(d) of the ITAA 1997

As subparagraph 328-430(1)(b)(iii) of the ITAA 1997 applies, the assets will need to be CGT assets (other than a depreciating asset) and 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.

Paragraph 152-10(1AA)(b) of the ITAA 1997 serves to disregard the reduction in the turnover threshold to $2 million for the purposes of the small business restructure test requirements. For the purpose of this test the aggregated turnover threshold will be $10 million for the income year.

Subsection 152-10(1A) of the ITAA 1997 allows access to the small business conditions where passively held assets are held by taxpayers who are connected to a small business entity. The provision is set out as follows:

Subsection 152-10(1A) The conditions in this subsection are satisfied in relation to the *CGT asset in the 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 a 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.

Application to your circumstances

For the proposed transactions section 152-10(1A) of the ITAA 1997 will be satisfied in relation to the CGT assets (land and water licences), as, in the income year:

•         an entity connected with you (the Trading trust) will be a small business entity for the income year; and

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

•         the CGT assets (land and water licences) were not an interest in an asset of the Partnership; and

•         the Trading trust will carry on the business in relation to the CGT assets (land and water licences).

As subsection 152-10(1A) of the ITAA 1997 is satisfied, therefor for the purposes of the rollover requirements subparagraph 328-430(1)(b)(ii) of the ITAA 1997 is satisfied.

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