Edited version of private advice

Authorisation Number: 1051765552602

Date of advice: 16 October 2020

Ruling

Subject: Small business restructure rollover relief

Question

Does the proposed transfer of assets from Unit Trust to Company X Pty Ltd qualify for rollover relief under Subdivision 328-G of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following period:

For the income year xxxxx

Relevant facts and circumstances

The Unit Trust is an Australian resident unit trust. Company A owns xx% of the units in the Unit Trust. Trust B, which is a discretionary trust owns the remaining yy% of units in the Unit Trust.

The corporate trustee of the Unit Trust is Company X, an Australian resident company.

The shareholders of Company X are Company A and Trust B. Company A holds xx% of the shareholding and Trust B holds yy% of the shareholding in Company X.

The sole shareholder and director of Company A is Individual A.

The Unit Trust operates a business.

The Unit Trust is a small business entity (SBE) and all the connected entities are currently SBEs.

Transfer of assets

In xxxx income year, the Unit Trust intends to transfer its trading stock, revenue assets and depreciating assets to Company X. Company X will then operate the business. These assets will be transferred from the Unit Trust to Company X.

To account for the transfer of the net transferred assets, a commercial loan will be provided by the Unit Trust to Company X. The interest rate for the loan will be set in accordance with the benchmark interest rate for loans under Division 7A of the ITAA 1936.

Reasons for Restructure

The reasons provided for the restructure of the business from a current unit trust to a proprietary company are as follows:

·         the business is expanding and adapting their systems to change with market demands.

·         The recent relocation of the business to new premises has enabled the business to increase production capacity and to expand its product range.

·         The relocation of the business and projected growth of the business will continue to require more bank funding. In this regard, issues were encountered with financiers in obtaining finance due to its current structure.

·         The current structure does not assist the business's funding applications due to security of assets and the Unit Trust's flow of income outside the business affecting working capital. The current structure is looked at as too complex and considered an administrative burden.

Both the Unit Trust and Company X will choose to apply rollover relief under Subdivision 328-G.

Trust B - Terms of Deed

The trustee of Trust B is recorded as Company Z. Company Z is controlled by Individual A. The Appointor of the Trust B is Individual A. The relevant terms of Trust B provide the following:

·         The settlor wishes to establish a trust to make certain provisions for the benefit of the beneficiaries.

·         Subject to the trustee's power of accumulation under the deed, the trustee in its absolute discretion shall determine the proportion or amount of the trust income to be distributed to the beneficiaries or any one or more of them to the exclusion of any others.

·         The trustee is permitted under the deed to distribute income to any beneficiary in such amount as it determines at any time during an income year.

·         The trustee may at any time prior to the vesting date distribute capital or any part of it to any beneficiary in such amount as it decides.

·         On vesting date or upon early termination of the trust, the trustee shall distribute the whole of the capital of the trust to the beneficiaries in any such proportions at the discretion of the trustee.

·         The trustee has the power to alter, modify or amend any provision of the trust deed. It can also in its absolute discretion add or remove a person as a beneficiary. The trustee may, at any time, with the Appointor's consent, remove a beneficiary or a class of beneficiaries

·         The beneficiaries of Trust B are specified to include, amongst others, Individual A, their immediate family, relatives, related companies and trusts, and also income tax exempt charities and associations.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 section 328-440

Income Tax Assessment Act 1997 Subdivision 328-G

Reasons for decision

All the legislative references that follow are to the Income Tax Assessment Act 1997.

Subsection 328-430(1) states that a restructure roll-over under Subdivision 328-G 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

(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 the transferee meet the residency requirements in section 328-445 for an entity; and

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

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

For the restructure roll-over provided for by Subdivision 328-G to be available, there is a requirement in paragraph 328-430(1)(c)) that the restructure does not have the effect of materially changing which individual has, or which individuals have, the ultimate economic ownership of the business assets.

If there is more than one individual who is an ultimate economic owner of an asset, there is an additional requirement that each of those individual's share of that ultimate economic ownership be materially unchanged, maintaining the same proportionate ownership in the asset.

The term 'ultimate economic ownership' is not defined in the income tax provisions. The Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 (the EM) explains at paragraph 1.29 that the ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset.

Further at paragraph 1.30, the EM states that

'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.'

In the present case, the assets are currently owned by the Unit Trust. Company A and a trust, Trust B own xx% and yy% respectively of the units in the Unit Trust. After the transfer of the assets to Company X, Company A and Trust B will each own shares in this company in the same proportions.

The interests in Company A are, in turn, owned by Individual A who is the sole shareholder of this company. Therefore, Individual A as the sole shareholder of this company will benefit economically from the assets owned by the Unit Trust (pre- asset transfer) and Company X (post- asset transfer) through their interests held in Company A. Individual A's share of the economic ownership of those assets will be in proportion to Company A's xx% ownership interests in the Unit Trust and Company X.

The remaining share of the units /shares (as the case may be) in the Unit Trust / Company X are held by Trust B, which is a discretionary trust. Broadly, under the terms of the instrument of trust for Trust B, the trustee at its discretion shall distribute the trust's income to any beneficiary in such amount as it determines. The beneficiaries of Trust B as specified in the trust deed include, amongst others, Individual A, family members and relatives. It also includes any related company and trust, and also income tax exempt charities and associations.

In relation to the application of the ultimate ownership test to discretionary trusts, the Commissioner's view is that a purely discretionary trust could not satisfy the ultimate economic ownership test without relying on the special rule in section 328-440. This is because the economic interests that the objects of such a trust have in an asset are not fixed in proportion, and would depend on the trustee exercising their discretion.

Under ordinary legal concepts, a beneficiary of a discretionary trust does not have any beneficial interest in any trust property prior to a distribution or appointment of income or capital. Instead, 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.

In the present case, there are a number of potential beneficiaries of Trust B as described in the trust deed. The terms of the deed permit any one of these beneficiaries to economically benefit from the assets of this Trust depending on the exercise of the trustee's discretion in their favour. The assets of Trust B include its interest in the assets of the Unit Trust or Company X.

Consequently, it is not possible to determine or fix a beneficiary's proportionate economic ownership of Trust B's assets, including its interests in the assets of Unit Trust/ Company X. As mentioned above a beneficiary's right to benefit economically from the assets of Trust B will always depend on the exercise of the trustee's discretion in their favour.

Accordingly, as there is no beneficiary of Trust B which has ultimate economic ownership of the assets of the Unit Trust / Company X that are held through Trust B, the ultimate economic ownership test in paragraph 328-430(1)(c) cannot be met

Consequently, it is necessary to consider whether the proposed restructure would meet the alternative ultimate economic ownership test provided in section 328-440 in order for the restructure rollover to be available.

For section 328-440 to apply the assets in question must be included in the property of a non-fixed trust that is a family trust either before the asset transfer transaction or just after; or both before and after the transaction. This is not the case here, as the assets in question are the property of a Unit Trust, and just after the transaction the assets will be included in the property of a company, namely Company X. Please refer to examples 12 and 13 of Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters, in this regard.

Accordingly, the proposed restructure would not satisfy the alternative ultimate economic ownership test under section 328-440.

As the restructure rollover is not available due to neither the ultimate economic ownership test in paragraph 328-430(1)(c) or the alternative test in section 328-440 being met, it is not necessary to consider whether the other requirements in subsection 328-430(1) are met.