Edited version of private advice

Authorisation Number: 1051604135383

Date of advice: 1 November 2019

Ruling

Subject: Restructure of small businesses

Question

Is a roll-over available under subsection 328-430(1) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the proposed restructure?

Answer

Yes.

This ruling applies for the following period:

1 July 2018 - 30 June 2020

The scheme commences on:

The date the transfer of the land and the business is signed.

Relevant facts and circumstances

The taxpayer is a discretionary trust which owns substantial investment properties, farming land and owns and operates a farming business from the farming lands.

The farming lands comprise of both pre and post CGT property.

The taxpayer's class of beneficiaries is limited to the main individual and his relatives, as well as trusts nominated by the trustee and companies in which any of these beneficiaries have an interest. To date no trusts have been nominated as beneficiaries.

The taxpayer's asset ownership is considered sub-optimal in that the investment properties are exposed to the risks of the farming operations. In addition, the farming land is also exposed to the risks of the farming business.

In order to separate the ownership of investment assets and farming lands from the farming business, the taxpayer proposes:

·        transferring the farming lands to two newly settled discretionary trusts (Trust 1 and Trust 2) with each trust to own a discrete parcel of farming land;

·        transferring the farming business to two further newly settled discretionary trusts (Trust 3 and Trust 4), with each trust to own a discrete farming business ("the proposed restructure").

Each of the taxpayer, Trust 1, Trust 2, Trust 3, and Trust 4 will make a family trust election (FTE) in accordance with section 272-80 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) nominating the main individual as the test individual.

Assumptions

Following the transaction, for a period of at least three years:

·        there will be no change to the ownership of the significant assets by Trust 1, Trust 2, Trust 3, and Trust 4;

·        those assets will be active assets; and

·        there will be no significant or material use of those assets for private purposes.

Distributions and conferrals by the taxpayer, Trust 1, Trust 2, Trust 3, and Trust 4 will only be made to members of the Family Group (as defined in section 272-90 of Schedule 2F to the ITAA 1936) of the main individual.

Assume the requirements of paragraphs 328-430(1)(b), (1)(d), (1)(e), and (1)(f) and subsection 328-430(2) of the ITAA 1997 are satisfied.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 272-80

Income Tax Assessment Act 1936 section 272-90

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

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 subdivision 328-G

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)(c)

Income Tax Assessment Act 1997 section 328-430

Income Tax Assessment Act 1997 section 328-435

Income Tax Assessment Act 1997 paragraph 328-435(a)

Income Tax Assessment Act 1997 section 328-440

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

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.

Section 328-425 of the ITAA 1997 provides that the purpose of Subdivision 328-G 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

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)   ...

(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)   ...

(e)   ...

(f)     ...

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

As highlighted in paragraph 78 of 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).

The 'Safe Harbour Rule' under section 328-435 of the ITAA 1997

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 3 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.

'Ultimate economic ownership'

The phrase 'ultimate economic ownership' is not defined in the ITAA 1997.

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.

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'.

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.

At paragraph 1.30, the EM also provides that the

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. [emphasis added]

The definition of 'ultimate economic ownership' under section 328-440 of the ITAA 1997 provides an alternative test for discretionary trusts and is considered below under the section 'Ultimate economic ownership' under paragraph 328-430(1)(c) of ITAA 1997'. That section concludes that the proposed restructure will not cause a change of the ultimate economic ownership of an asset or any individual's share of the ultimate economic ownership.

An assumption has been included in this ruling that there will be no change to the ownership of the significant assets by Trust 1, Trust 2, Trust 3, and trust 4. As there will be no change to the ownership of the assets of the trusts or to those that can benefit from the conferrals and distributions of the income and capital under the trusts, it is considered that subsection 328-435(a) is satisfied.

Active asset' test

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.

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.

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

It is considered the farming land and the farming business are active assets and will continue to remain active assets for a minimum period of three years following the transactions.

No significant or material use for private purposes

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

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

Beneficiaries of a discretionary trust cannot have ultimate economic ownership of the assets of the trust.

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: 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.

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.

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.

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.

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.

Alternative test for discretionary trusts under section 328-440 of the ITAA 1997

Section 328-440 of the ITAA 1997 contains an alternative ultimate economic ownership test for discretionary trusts. It states:

Section 328-440 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; or

(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 above; 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.

(a) (i) Will the asset be included in the property of a non-fixed trust that was a Family Trust just before the proposed transaction takes place?

The taxpayer is a non-fixed trust for the purposes of section 272-70 of Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936). The taxpayer will make a family trust election under section 272-80 of Schedule 2F to the ITAA 1936 before the proposed restructure. Therefore, the Farming land and Farming business Assets are, and will be owned by the trustees of the taxpayer, a Family Trust, immediately before the proposed restructure takes place. Therefore, paragraph 328-440(a)(i) of the ITAA 1997 is satisfied.

(a) (ii) Will the asset be included in the property of a non-fixed trust that was a Family Trust just after the proposed transaction takes place?

The Farming land asset will be included in the property of Trust 1 and Trust 2, which will be a Family Trust so as to satisfy paragraph 328-440(a)(ii) of the ITAA 1997.

The Farming business asset will be included in the property of Trust 3 and Trust 4 which will be a Family Trust so as to satisfy paragraph 328-440(a)(ii) of the ITAA 1997.

(b) Will every individual who, just before the proposed transfer takes effect, has the ultimate economic ownership of the asset be 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 above?

The alternative test is available when assets are included in the property of a non-fixed trust that is a family trust (i.e. a non-fixed trust for which there is an FTE in force). An assumption is included in this ruling that distributions and conferrals by the taxpayer, Trust 1, Trust 2, Trust 3 and Trust 4 will only be made to members of the Family Group (as defined in section 272-90 of Schedule 2F to the ITAA 1936) of the main individual. Therefore, although the class of beneficiaries contained in the respective trust deeds are wider than the main individual's Family Group the economic owners of the income and capital of each trust will be members of the main individual's Family Group. As such, section 328-440(b) of the ITAA 1997 will be satisfied.

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

As mentioned above, an assumption is included in this ruling that distributions and conferrals by the taxpayer, Trust 1, Trust 2, Trust 3, and Trust 4 will only be made to members of the Family Group (as defined in section 272-90 of Schedule 2F to the ITAA 1936) of the main individual. Therefore, although the class of beneficiaries contained in the respective trust deeds are wider than the main individual's Family Group the economic owners of the income and capital of each trust will be members of the main individual's Family Group. As such, section 328-440(c) of the ITAA 1997 will be satisfied.