Edited version of private advice

Authorisation Number: 1052345887896

Date of advice: 29 January 2025

Ruling

Subject: Small business restructure roll-over

Question 1

Will the Trust be eligible to access the small business restructure rollover relief concession under Subdivision 328-G of the Income Tax Assessment Act (ITAA 1997)?

Answer 1

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Trust is a Discretionary Trust established on XXX.

The Trust conducts business activities.

The applicant would like to restructure the business and rollover the assets to a newly created company with the shareholding being owned by the Trust.

Current structure

The trustee of the Trust is the Company.

Primary beneficiaries of the Trust include individuals, being family members.

A Revised Deed was prepared in XX to nominate a charity.

XXX is the significant individual of the business and is the sole director of the Company.

Aggregate turnover of the Trust is less than $X.

All entities involved in the proposed restructure are Australian residents for tax purposes.

Proposed restructure

A new company will be incorporated and a total of XX ordinary shares in the new company will be issued to the Trust. All the shares will have equal rights.

The Trust receiving shares will not pay any consideration for the shares.

The Trust will transfer its business assets to the newly created company.

The business assets to be transferred include motor vehicles, plant & equipment, the software developed by the business and intellectual property used in the business.

The newly created company will continue to conduct business in the same manner as the Trust.

The newly created company currently has no plans to sell the business or its assets to a third party or to cease the business.

A Family Trust Election will be completed prior to the business rollover.

Reasons for the restructure

The intention of the applicant is to retain essential employees.

The current key employee is only considering staying with the business with the provision that he will receive an equity shareholding (post restructure rollover).

The business has software development projects in which the key employee has been heavily involved. Other essential personnel have already left the business, and the applicant does not wish to lose other key employees.

In addition, the intention is to issue shares to family members (post restructure rollover), who are currently general beneficiaries of the Trust and were also involved in the business in the past.

Moreover, the proposed structure may be beneficial in the future in order to attract potential investors.

Further steps - post rollover issuance of shares

After the restructure, the additional X ordinary shares will be issued to the individuals involved in the business for a number of years.

One of the individuals is a key employee of the company.

The additional ordinary shares will carry the same rights as the shares issued to the Trust.

No consideration will be paid by the above individuals for the shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 40- 30

Income Tax Assessment Act 1997 section 40-340

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Income Tax Assessment Act 1997 subdivision 328-G

Income Tax Assessment Act 1936 Schedule 2F

Reasons for decision

All references - ITAA 1997 unless otherwise stated.

Subdivision 328-G provides an optional small business restructure roll-over where a small business entity transfers an active asset of the business to another small business entity as part of a genuine business restructure without changing the ultimate economic ownership of the asset.

A roll-over under Subdivision 328-G is available in relation to a transferred asset if the following criteria set out in section 328-430 are satisfied:

•                the transfer of the asset is, or is part of, a genuine restructure of an ongoing business

•                each party to the transfer is one of the entities listed in section 328-430(1)(b)

•                there is no material change in the ultimate economic ownership of the transferred asset

•                the asset being transferred is a CGT asset that is an active asset

•                both the transferor and each transferee are residents of Australia, and

•                both the transferor and each transferee choose to apply the roll-over.

A roll-over under Subdivision 328-G is not available if the transferor and any transferee is an exempt entity or a complying superannuation entity (subsection 328-430(2)).

The application of the indicators from section 328-430 of ITAA 1997 presented above to your circumstances is outlined below.

1. The transfer of the asset is, or is part of, a genuine restructure of an ongoing business (paragraph 328-430(1)(a)).

The first criterion for eligibility for the roll-over is that the transfer of the asset is, or is part of, a genuine restructure of an ongoing business. This requirement distinguishes genuine restructures from artificial or inappropriately tax-driven schemes, and acknowledges that, while tax considerations are significant in small business structuring, taxpayers should not be allowed to manipulate the tax law to achieve an inappropriate or uneconomic tax outcome.

Law Companion Ruling 2016/3 Small Business Restructure Roll-over: genuine restructure of an on-going business and related matters (LCR 2016/3) explains that whether a transaction is or is part of a 'genuine restructure' will be a question of fact, determined having regard to all of the circumstances surrounding the restructure. In particular, paragraph 7 of LCR 2016/3 outlines the following features are indicative of a genuine restructure:

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

o        facilitate growth, innovation and diversification

o        adapt to changed conditions, or

o        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:

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

o        continuity of employment of key personnel, and

o        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.

Paragraph 11 of LCR 2016/3 provides that the small business restructure rollover contemplates restructures to or from more than one entity. Accordingly, there may be circumstances where not all business assets that are necessary for the continued operation of an 'ongoing business' are transferred. For example, small business owners may decide to transfer plant and equipment to a new entity but leave real property in the original entity. On its own, this is not a factor that is inconsistent with the conclusion that a restructure is a 'genuine restructure of an ongoing business'.

However, the restructure of an ongoing business by a business owner is not genuine if it is done in the course of winding down to transfer wealth between generations or realising their ownership interests. 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.

Relevantly, Example 2 of LCR 2016/3 the Commissioner considers a restructure involving the issue of shares to essential employees, which occurred after the transfer of its active assets to another entity. These shares were issued in order to provide incentives for the employees' ongoing involvement in the business. It was concluded that the restructure was a 'genuine restructure of an ongoing business'.

Application to your circumstances

In the present circumstances, the Trustee's primary objective for the restructuring was to retain the key employee's skills in the business by issuing additional shares in the new company. This will increase the employee's commitment and involvement in the business, leading to increased profitability and growth of the new company.

Furthermore, whilst the restructure undertaken by the Trustee changes the structure under which the business operates going forward, there is also continued use of the Business Assets in its business operations, employment of the same personnel in its business and continuity of the same business processes and services.

Given the above, and in line with Example 2 of LCR 2016/3, the restructure undertaken by the Trustee is a 'genuine restructure of an ongoing business'. Consequently, the requirement in paragraph 328-430(1)(a) is satisfied.

2. Each party to the transfer is one of the entities listed in paragraph 328-430(1)(b).

The roll-over is only available if each party to the transfer of the assets is one or more of the following:

(i) it is a "small business entity" for the income year during which the transfer occurs

(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, or

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

"Small business entity" has the meaning given by section 328-110, which, broadly, requires that the entity carry on a business and that the combined annual turnover of the entity, and other entities that are affiliated or connected with it, is less than $10m.

"Affiliate" has the meaning given by section 328-130, which basically states that an individual or company is an "affiliate" of another entity if the individual or company acts, or could reasonably be expected to act, in accordance with the entity' s directions or wishes, or in concert with the entity, in relation to the affairs of the business of the individual or company.

"Connected with" has the meaning given by section 328-125, under which an entity is "connected with" another entity if either entity controls the other entity, or both entities are controlled by the same third entity.

The roll-over is available not only to a small business entity but also to certain entities that hold assets that are used by another entity in a small business. An entity that is carrying on small business may, for example, put its significant assets in the hands of another entity in order to protect the assets from legal action commenced against the entity carrying on business. Eligibility to the roll-over extends to these passive entities (covered by (ii), (iii) and (iv) above) holding assets used by another entity in a small business.

Application to your circumstances

As both parties of the rollover are small business entities within the meaning of section 328-110, this condition is satisfied.

3. There is no material change in the ultimate economic ownership of the transferred assets (paragraph 328-430(1)(c)).

The transaction for the transfer of the assets must not have the effect of materially changing the ultimate economic ownership of the assets. It must not materially change:

•                which individual has, or which individuals have, the ultimate economic ownership, and

•                if there is more than one such individual, each of those individuals ' share of the ultimate economic ownership.

The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own the asset. Where a company, partnership or trust owns an asset, it is the individual owners of the interests in these interposed entities that ultimately benefit economically from the asset. For a roll-over to be available, the individuals must maintain the same proportionate ownership in the asset after a transfer as they did before the transfer.

An alternative ultimate economic ownership test may be applied where a transaction for the transfer of assets involves a non-fixed trust that is a family trust.

As per paragraph 107 of LCR 2016/3:

107. A transfer of assets from or to a discretionary trust will generally not meet the requirements for ultimate economic ownership on their facts. Where it is not possible to demonstrate that ultimate economic ownership of the assets has been maintained, an alternative ultimate economic ownership test is available.

108. The alternative ultimate economic ownership test provides additional flexibility to small family businesses carried on through non-fixed trusts by allowing them to meet the requirement to maintain proportionate ultimate economic ownership of the transferred assets if the ultimate economic ownership of those assets remains within the family.

109. The alternative test is only available when assets are included in the property of a non-fixed trust that is a family trust, that is, a non-fixed trust for which there is a family trust election in force.

Section 328-440 provides for an alternate ultimate economic ownership test intended to facilitate the roll-over for non-fixed discretionary trusts. It allows small family businesses carried on through non-fixed trusts to satisfy the test in paragraph 328-430(1)(c) as long as the ultimate economic ownership of the transferred assets remains within the family.

The alternative test is satisfied if:

(a) either or both of the following applies:

(i) just before the transaction transferring the assets 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) just before the transfer took effect, every individual who 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) just after the transfer takes effect, every individual who has the ultimate economic ownership of the asset is a member of that family group.

You advised us, that just before the proposed restructure a family trust election will be completed. The main provisions regarding family trust elections relevant to your circumstances are discussed below.

Family trust election

If the trustee makes a family trust election the trust will be a family trust for the purposes of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936). The election needs to specify an income year from which it is to take effect.

If the election is to be made, it must be made by the trustee in the trust's return of income for the specified income year. If the trust is not required to lodge a return in the year that the trust wants to make the family trust election, the trustee must make the election in writing to the Commissioner in an approved form. The election must be given either within 2 months after the end of the income year or such later time as the Commissioner allows.

The family trust election must specify an individual as the individual whose family group is the subject of the election. This would be the same person as the test individual referred to in section 272-95 of Schedule 2F to the ITAA 1936. In addition to specifying an individual the election must also specify such other information as the Commissioner requires. This information would include:

•                the name of the trust;

•                the address of the trust including its country of residence;

•                the beneficiaries of the trust at the time the election takes effect; and

•                any other particulars that the Commissioner may require.

A trust cannot make a family trust election unless it is controlled by the relevant family from the time the election comes into effect. To this end the trustee cannot make a family trust election if the trust does not pass the 'family control test' at least at the end of the income year.

The family control test for trusts is set out in subsections 272-87(1) and (2) of Schedule 2F to the ITAA 1936.

In technical terms, it might accordingly be said that "family control" will be established where the requirements of "group control" have been met.

For these purposes, a "group" may ordinarily consist of:

•                the primary individual

•                family members, as defined in section 272-95 of Schedule 2F to the ITAA 1936 to include persons related in specified degrees to the primary individual

•                the primary individual and one or more members of that individual ' s family, or

•                any of the above persons and one or more legal or financial advisors to the primary individual or a member of his or her family.

Certain charities and tax-exempt bodies can also be included in the family group in accordance with subsections 272-90(7) and 272-90(8) of Schedule 2F to the ITAA 1936.

A group constituted in this way will have the requisite control, for the purposes of making a family trust election, if (broadly speaking) it has the power, directly or indirectly, and whether by virtue of the exercise of a power of appointment or revocation or otherwise, to control or obtain the beneficial enjoyment of the capital or income of the trust or to remove or appoint the trustee of the trust (subsection 272-87(2) of Schedule 2F to the ITAA 1936).

Application to your circumstances

Relevantly, for the purposes of the 'ultimate economic ownership' test for discretionary trusts contained in section 328-440 only the "individuals" (natural persons) just before the transfer took effect and just after the transfer takes effect should be considered.

The charity can be included in the family group. However, its presence in the family group is not required in relation to the proposed restructure, because for the purposes of the 'ultimate economic ownership' test for discretionary trusts, only the individuals should be considered.

As the proposed restructure will result in issuing shares in the newly incorporated company to the Trust, the above beneficiaries will retain their ultimate economic ownership after the restructure. Therefore, the conditions from section 328-440 are satisfied.

4. The asset being transferred is a CGT asset that is an active asset (paragraph 328-430(1)(d)).

To access the roll-over under Subdivision 328-G, the asset being transferred must be a " CGT asset " as defined in section 108-5 (other than a " depreciating asset ") that is at the time of the transfer:

(i) if a party to the transfer is itself a small business entity - an " active asset " as defined in section 152-40, broadly an asset used in the business

(ii) if a party to the transaction is not a small business entity but is either an entity that has an affiliate that is a small business entity or an entity that is connected with a small business entity - an active asset that satisfies section 152-10(1A) which, among other things, requires that the relevant small business entity carries on business in relation to the asset, and

(iii) if a party to the transaction is not a small business entity but is a partner in a partnership that is a small business entity - an active asset and an interest in the asset of the partnership.

Under subsection 152-40(1), a CGT asset is an active asset at a particular time if, at that time, it is owned and used (or held ready for use) by a taxpayer or certain related entities in the course of carrying on a business or is an intangible asset that is inherently connected with a business that the taxpayer carries on.

The application of paragraph 328-430(1)(d) to the assets of the Trust is set out below.

Application to your circumstances

Depreciating assets

In accordance with the provided documentation, the business assets to be transferred include motor vehicles, plant & equipment, the software developed by the business and intellectual property used in the business.

All these assets are depreciating assets within the meaning of section 40-30.

Under the SBRR, the statutory mechanism for delivering the roll-over differs depending on the type of assets being transferred. CGT assets, trading stock and revenue assets are subject to a general rule in section 328-450 that, except as provided in Subdivision 328-G, 'the transfer of an asset has no direct consequences under the income tax law'. However, the relief for the tax consequences for the transfer of depreciating assets, as provided under section 40-340, is more limited.

As a result, for the purposes of the small business restructure rollover, the eligibility of the above assets as a trading stock of the current business must be considered.

Depreciating assets - trading stock

"Trading stock" has the meaning given by section 70-10, presented below:

(1) Trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

(2) Trading stock does not include:

(a) a Division 230 financial arrangement; or

(b) a CGT asset covered by section 275 - 105 that:

(i) is owned by a complying superannuation entity; or

(ii) is a complying superannuation asset of a life insurance company.

Relevantly, subsection 40-30(2), states as follows:

2) These intangible assets are depreciating assets if they are not trading stock:

(a) mining, quarrying or prospecting rights;

(b) mining, quarrying or prospecting information;

(c) items of intellectual property;

(d) in - house software;

(e) IRUs;

(f) spectrum licences;

(h) telecommunications site access rights.

Only items of intellectual property and in-house software should be considered as a trading stock of the current business. These assets are treated as active assets within the meaning of paragraph 328-430(1)(d) and are active assets of the current business.

Depreciating assets - not trading stock

Item 8 of the table in subsection 40-340(1) outlines that roll-over relief is available under section 40-340 if a roll-over under Subdivision 328-G would be available in relation to the asset if the asset were not a depreciating asset.

Note that the Commissioner has exercised his remedial power in section 370-5 of Schedule 1 to Taxation Administration Act 1953 to modify the operation of section 40-340.

The modification is contained in Legislative Instrument CRP 2017/2 (F2017L01687). The effect of this instrument is to ensure that, where the restructure otherwise satisfies the conditions for roll-over under Subdivision 328-G, the transfer of depreciating assets will have no 'direct income tax consequences'. This will align the treatment of depreciating assets with the treatment of CGT assets, trading stock and revenue assets. This modification will most commonly apply where the restructure involves the transfers of depreciating assets by the trustees of trusts to beneficiaries, by companies to shareholders, and other associated persons. In the absence of the modification, such transfers could give rise to assessable income in the hands of the transferee.

As a result, if all the conditions of the rollover are satisfied, motor vehicles and other plant & equipment owned by the current business can be transferred to the new company without income tax consequences for the transferee company.

Bank accounts

A bank account is a debt (owed by the bank) and is a CGT asset under section 108-5.

However, under paragraph 152-40(4)(d) an asset that is a financial instrument cannot be an active asset.

A bank account represents a contractual arrangement between the depositor and the bank. The depositor in effect lends their money to a bank by depositing money into an account. A savings or deposit account is in law a loan to the banker (Tyree, A. 1995, Banking Law in Australia, 2nd edition, Butterworths, p.44; Pearce v. Creswick (1983) 2 Hare 286; 12 LJ Ch 251; Dixon v. Bank of New South Wales (1896) 12 WN (NSW) 101; Akbar Khan v Attar Singh [1936] 2 All ER 545.

A loan is listed as a financial instrument in paragraph 152-40(4)(d). A bank account is therefore a financial instrument and accordingly, not an active asset under section 152-40.

A bank account may also be excluded from being an active asset under paragraph 151-40(4)(e) if its main use is to derive interest.

Consequently, bank accounts held by the Trust are not considered as active assets and cannot be transferred to the new company.

5. Both the transferor and each transferee must be residents of Australia (paragraph 328-430(1)(e)).

Both the transferor and each transferee must, according to the type of entity they are, meet the appropriate residency test as set out in section 328-445.

Basically:

(a) if the entity is an individual or a company--the entity is an Australian resident; or

(b) if the entity is a trust--it is a resident trust for CGT purposes; or

(c) if the entity is a partnership (other than a corporate limited partnership) - at least one of the partners is an Australian resident; or

(d) if the entity is a corporate limited partnership--it is, under section 94T of the Income Tax Assessment Act 1936, a resident for the purposes of the * income tax law.

Application to your circumstances

All entities involved in the proposed rollover are and will be Australian tax residents. Therefore, this condition is satisfied.

6. Both the transferor and each transferee must choose to apply the roll-over (paragraph 328-430(1)(f)).

Finally, as the roll-over is optional, both the transferor and each transferee must choose to apply the roll-over in relation to the assets transferred, and the choice affects the tax consequences for both the transferor and each transferee.

Application to your circumstances

All entities involved in the proposed rollover choose to apply the rollover to the assets transferred. Therefore, this condition is satisfied.

Conclusion

The above presented conditions in Subdivision 328-G of the ITAA 1997 have been satisfied and therefore the entities are entitled to apply the small business restructure roll-over.

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