Edited version of your written advice

Authorisation Number: 7920126593966

Date of advice: 14 January 2019

Ruling

Subject: Income tax: capital gains tax: rollovers: small business restructuring rollover: Subdivision 328-G

Question 1(a)

Does the client satisfy the safe harbour rule under section 328-435 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 1(b)

Will the roll-over outlined under section 328-430 of the ITAA 1997 be available in relation to the proposed restructure from a partnership of individuals to a family trust?

Answer:

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

XX January 20XX

Relevant facts and circumstances

Overview

1. In January 20XX, three individuals A, B and C registered a partnership.

2. The partners own in equal shares as tenants-in-common of a property (the Property).

3. The Property is a pre-CGT asset, on which the partnership carries on a business.

4. The Business Trust also conducts a separate business on the Property.

5. For the income year ending 30 June 20XX, the aggregated turnover of the partnership and associates (including the Business Trust) is less than $10m.

Proposed restructure

6. For the income year ending 30 June 20XX, the partners intend to transfer the Property and the business into a newly established trust (the New Trust). The New Trust will be a discretionary trust settled by Deed (the Deed)

7. The trustee of the New Trust is Company A.

8. Individual B is the sole director, secretary and beneficiary of Company A.

9. A family trust election is proposed to be made for the New Trust. Individual B is intended to be the test individual of the New Trust.

10. A relative of Individuals A, B and C will be the Primary Beneficiary.

11. The trustee will not exercise its discretion to vary the beneficiaries’ interests in the trust assets or vest or dispose of the assets of the trust that are the subject of the restructure.

12. All parties to the proposed transaction are Australian residents.

13. The partners propose that:

(a) the restructure will be undertaken to facilitate the growth of the business;

(b) the restructure will provide asset protection to the current owners of the Property (ie the partners);

and,

(c) The Property will continue to be used as an active asset of the business conducted by the Business Trust through a formal lease arrangement.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

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

Income Tax Assessment Act 1997 Subdivision 328-G

Income Tax Assessment Act 1997 section 328-425

Income Tax Assessment Act 1997 section 328-430

Income Tax Assessment Act 1997 section 328-435

Income Tax Assessment Act 1997 section 328-440

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or DPT tax benefit in connection with an arrangement.

If Part IVA applies the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter ‘part iva general’ in the search box on the top right of the page, then select: ‘Part IVA: the general anti-avoidance rule for income tax’.

Reasons for decision

Question 1(a)

Does the client satisfy the safe harbour rule under section 328-435 of the ITAA 1997?

Summary

Yes. The client satisfies the safe harbour rule under section 328-435 of the ITAA 1997.

Detailed reasoning

Overview

1. Section 328-435 of the ITAA 1997 provides that:

For the purposes of paragraph 328-430(1)(a) (but without limiting that paragraph), a transaction is, or is a part of, a genuine restructure of an ongoing *business if, in the three year period after the transaction takes effect:

(a) there is no change in ultimate economic ownership of any of the significant assets of the business (other than *trading stock) that were transferred under the transaction; and

(b) those significant assets continue to be *active assets; and

(c) there is no significant or material use of those significant assets for private purposes.

2. As highlighted in paragraph 78 of the Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3):

Where the safe harbour rule is satisfied, it is not necessary to consider whether the arrangement would otherwise be a ‘genuine restructure of an ongoing business’ under paragraph 328-430(1)(a).

3. Further, at paragraph 79 of the LCR 2016/3:

The safe harbour rule does not limit or expand what would otherwise be considered a ‘genuine restructure of an ongoing business’ within its ordinary meaning.

Meaning of ‘ultimate economic ownership’ and ‘active assets’

‘Ultimate economic ownership’

4. The phrase ‘ultimate economic ownership’ is not defined in the ITAA 1997.

5. Higgins J in Amalgamated Society of Engineers v. Adelaide Steamship Co Ltd (1920) 28 CLR 129 at 161 to 162 states that:

…a statute is to be expounded according to the intent of the Parliament that made it; and that intention has to be found by an examination of the language used in the statute…when we find what the language means, in its ordinary and natural sense, it is our duty to obey that meaning, even if we think the result to be inconvenient, impolitic or improbable.

6. The Macquarie Dictionary defines:

(a) ‘ultimate’ as ‘forming the final aim or object’ or being the ‘last, as in a series’,

(b) ‘economic’ as ‘relating to the production, distribution, and use of income and wealth’, and

(c) ‘ownership’ as ‘the state or fact of being an owner’ or the ‘legal right of possession; proprietorship’.

7. Further, extrinsic material to the ITAA 1997 can be consulted to resolve ambiguity or confirm the ordinary meaning conveyed by the text of the provision pursuant to section 15AB of the Acts Interpretation Act 1901 (AIA).

8. The Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 (the EM) states at paragraph 1.29 that

[t]he ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset.

9. At paragraph 1.30, the EM also provides that the

[u]ltimate 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. [emphasis added]

10. The Commissioner is satisfied that the definition provided in the EM reflects the ordinary meaning of the phrase ‘ultimate economic ownership’.

11. The definition of ‘ultimate economic ownership’ under section 328-440 of the ITAA 1997 provides an alternative test for discretionary trusts. However, the Commissioner queries the application of that definition for purposes other than paragraph 328-430(1)(c) of the ITAA 1997.

12. For the purposes of section 328-440 of the ITAA 1997 (outlined further in question two), we have formed the view that the transactions and the proposed family trust election satisfy this alternative test for discretionary trusts.

13. Therefore, it must be determined which natural persons directly or indirectly (through any interposed entities) beneficially own the significant assets after the transaction.

Nature of interests held by beneficiaries of a discretionary trust

14. 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.

15. A beneficiary of a discretionary trust only has a right to require the trustee to consider whether or not to exercise their discretion: Gartside v. Inland Revenue Commissioner [1968] AC 553. Further, a property interest will only arise if the discretion is exercised in that beneficiary’s favour or the trust vests.

16. 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.

17. As a beneficiary of a discretionary trust does not hold an interest in any asset of the trust, it cannot be said that any beneficiary of a discretionary trust will have ultimate economic ownership for the purpose of paragraph 328-435(a) of the ITAA 1997.

18. There is no analogous administrative concession for section 328-435 of the ITAA 1997 and discretionary trusts as is the case with Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (IT 2340) for the interpretation of ‘majority underlying ownership’ with respect to discretionary trusts and former section 160ZZS of the ITAA 1936.

‘Active asset’ test

19. An ‘active asset’ is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 152-40 of the ITAA 1997.

20. Subsection 152-40(1) of the ITAA 1997 provides that:

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

(b) if the asset is an intangible asset – you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

21. Subsection 152-40(4) of the ITAA 1997 contains a list of exceptions to the active asset definition.

Application to your circumstances

Overview

22. The partners of the partnership propose to transfer the Property and the business into the New Trust (which will be the “transaction” for the purposes of Section 328-435 of the ITAA 1997).

23. Therefore, in the three (3) year period after the transaction, it must be determined whether:

(a) there will be a change in the ultimate economic ownership of any significant assets of the business transferred under the transaction; and

(b) those significant assets will continue to be active assets; and

(c) there will be no significant or material use of those significant assets for private purposes.

Significant assets

24. The Commissioner is satisfied that the Property and the business will be the significant assets of the transaction.

No change to ultimate economic ownership

25. The Commissioner is satisfied that the New Trust is a discretionary trust.

26. Due to the reasoning above, we are satisfied that based on the case law referred to in paragraphs 14 to 16, none of the beneficiaries of the New Trust will be ultimate economic owners of the significant assets. However, this is subject to a more specific reading of section 328-435 of the ITAA 1997 in the context of Subdivision 328-G of the ITAA 1997.

27. While there may be several possible readings of the phrase ‘no change in ultimate economic ownership’, the Commissioner is satisfied that (in this instance on the facts of the scheme) no change should occur to the ultimate economic ownership of any of the significant assets of the business transferred under the transaction.

Significant assets continue to be active assets

28. The Commissioner is satisfied that the significant assets will be active assets for the three year period following the transaction.

No significant or material use for private purposes

29. The Commissioner is satisfied that the significant assets will not be used for private purposes for the three year period following the transaction.

Conclusion

30. The Commissioner will rule favourably on this issue.

Question 1(b)

Will the roll-over outlined under section 328-430 of the ITAA 1997 be available in relation to the proposed restructure from a partnership of individuals to a family trust?

Summary

The taxpayer may rely on the safe harbour provision under section 328-435 of the ITAA 1997. As a result, the roll-over under Subdivision 328-G of the ITAA 1997 will be available to the client.

Detailed reasoning

Overview

31. Subdivision 328-G of the ITAA 1997 provides tax neutral consequences for small business entities that restructure the ownership of the assets of their business, without changing the ultimate economic ownership of the assets.

32. Section 328-425 of the ITAA 1997 provides that the purpose of Subdivision 328-G of the ITAA 1997 is to:

…facilitate flexibility for owners of small business entities to restructure their business, and the way their business assets are held, while disregarding tax gains and losses that would otherwise arise.

Small business restructure roll-over

33. Specifically, section 328-430 of the ITAA 1997 states that:

(1) A rollover 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) …

(iii) …

(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…that is, at the time the transfer takes effect:

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

(ii) …

(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.

(2) However, a roll-over under this Subdivision is not available if the transferor, or any transferee, is either an *exempt entity or a *complying superannuation entity.

34. The safe harbour rule, as provided under section 328-435 of the ITAA 1997, for the purpose of question (1)(a) of the ruling will be available based on the facts of the scheme that we have been asked to rule on.

‘Genuine restructure of an ongoing business’ under paragraph 328-430(1)(a) of ITAA 1997

35. The phrase ‘genuine restructure of an ongoing business’ for the purpose of paragraph 328-430(1)(a) of the ITAA 1997 is not defined in the ITAA 1997.

36. The Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 (the EM) discusses the ‘genuine restructure’ principle from paragraphs 1.19 to 1.22.

37. Specifically, paragraph 1.20 of the EM states that:

The genuine restructure principle distinguishes genuine restructures from artificial or inappropriately tax-driven schemes. This acknowledges that while tax considerations are significant factors in small business structuring, a minority of taxpayers and advisors may try to manipulate the operation of a ‘black letter’ provision of the tax law to achieve an inappropriate or uneconomic tax outcome.

38. Paragraph 1.21 of the EM continues to state that:

Whether a restructure is ‘genuine’ is a question of fact that is determined having regard to all of the facts and circumstances surrounding the restructure.

39. Paragraph 1.22 of the EM outlines examples of factors that indicate whether a restructure is genuine:

(a) It is a bona fide commercial arrangement undertaken to enhance business efficiency;

(b) The business continues to operate following the transfer, through a different entity structure but under the same ultimate economic ownership;

(c) The transferred assets continue to be used in the business;

(d) The restructure results in a structure likely to have been adopted had the business owners obtained appropriate professional advice when setting up the business;

(e) The structure is not artificial or unduly tax driven; and

(f) It is not a divestment or preliminary step to facilitate the economic realisation of assets.

40. The Commissioner’s view on the meaning of ‘genuine restructure of an ongoing business’ is outlined in Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3).

41. As highlighted by paragraph 2 of LCR 2016/3, the ruling discusses the features of a restructure that fall within the scope of paragraph 328-430(1)(a) of the ITAA 1997 and those features that indicate that a restructure falls outside that scope.

42. 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. However, it is a composite phrase emphasising that the SBRR is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests.

43. Paragraph 7 of LCR 2016/3 expands on the factors outlined in paragraph 1.22 of the EM.

44. As highlighted in paragraphs 8 and 9 of LCR 2016/3, the Commissioner considers that tax considerations can be taken into account under a genuine small business restructure, but:

There are concerns where the restructure is contrived or unduly tax driven in the sense that it achieves a tax outcome that does not reflect the economic reality or creates an outcome that would, but for the SBRR, ordinarily attract other integrity measures in the law. For example, a restructure directed at eliminating an impending or existing tax liability, would indicate that a restructure is not a ‘genuine restructure of an ongoing business’.

45. Other factors that tend to indicate that a restructure is not a ‘genuine restructure of an ongoing business’ are included at paragraph 10 of LCR 2016/3:

● where a 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

● …

● …

● …

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

‘Ultimate economic ownership’ under paragraph 328-430(1)(c) of ITAA 1997

46. Under subparagraph 328-430(1)(c)(ii) of the ITAA 1997, the proposed transaction should not have the effect of materially changing each individual’s share of the original ultimate economic ownership of the assets.

47. For the purpose of paragraph 328-430(1)(c) of the ITAA 1997, an alternative test may apply for discretionary trusts as provided in section 328-440 of the ITAA 1997.

48. Section 328-440 of the ITAA 1997 states:

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) …

(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 took effect, has the ultimate economic ownership of the asset is a member of that family group.

49. As highlighted by paragraphs 14 to 16, beneficiaries of a discretionary trust cannot have ultimate economic ownership of the assets of the trust.

50. While there are several readings of section 328-440 of the ITAA 1997, the Commissioner is satisfied that section 328-440 of the ITAA 1997 was established to ascribe ‘ultimate economic ownership’ to individuals for the purpose of paragraph 328-430(1)(c) of the ITAA 1997.

Application to your circumstances

Overview

51. The Commissioner is satisfied that:

(a) For the purpose of subsection 328-430(1)(b) of the ITAA 1997, each party to the transfer is an entity to which one or more of the following subparagraphs apply:

(i) Under subparagraph 328-430(1)(b)(i) of the ITAA 1997 – the New Trust is a small business

(ii) Under subparagraph 328-430(1)(b)(iii) of the ITAA 1997 – each transferor is a partner of a partnership which will be a small business entity for the income year ending 30 June 201X.

(b) For the purpose of subsection 328-430(1)(c) of the ITAA 1997, the Commissioner is satisfied that the client satisfies the alternative test for ultimate economic ownership as provided for in section 328-440 of the ITAA 1997.

(c) For the purpose of subsection 328-430(1)(d) of the ITAA 1997, the relevant assets will be active assets at the time when the transfer will occur.

(d) For the purpose of subsection 328-430(1)(e) of the ITAA 1997, all parties to the transfer meet the residency requirement in section 328-445 of the ITAA 1997.

(e) For the purpose of subsection 328-430(1)(f) of the ITAA 1997, all parties have chosen to apply the roll-over under this Subdivision 328-G in relation to the transfer of the Property and the business.

Paragraph 328-430(1)(a) of ITAA 1997 – ‘genuine restructure of an ongoing business’

52. The client has indicated that they wish to rely on the safe harbour rule under section 328-435 of the ITAA 1997 to meet the requirements of Section 328-430(1).

Conclusion

53. The taxpayer may rely on the safe harbour provision under section 328-435 of the ITAA 1997. As a result, the roll-over under Subdivision 328-G of the ITAA 1997 will be available to the client.

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