Edited version of private advice

Authorisation Number: 1051779960518

Date of advice: 13 November 2020

Ruling

Subject: Income tax - capital gains tax - rollovers

Question 1

Will the transfer of the Property be part of a genuine restructure of an ongoing business for the purposes of section 328-430 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the answer to Question 1 is yes

Will a roll-over under Subdivision 328-G of the ITAA 1997 be available in relation to the Property which is transferred under the proposed transaction?

Answer

Yes

This ruling applies for the following period

Financial year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

Partnership

The Partnership operates the Business from the Property.

Husband and Wife each have a 50% interest in the Partnership.

The Partnership's aggregated turnover for the relevant income year was less than $10 million.

All relevant individuals and/or entities are Australian residents.

The Partnership will continue to operate the Business.

Husband and Wife are looking at transferring the Property so that assets (other than the Property) which are accumulated can be protected from contractual risks.

Trust

The Partners have established a discretionary trust (the Trust).

The Trust is a non-fixed trust (within the meaning of Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936).

The Trust deed was provided and forms part of the scheme for the purposes of this private ruling application.

Relevantly:

A company incorporated in Australia, is the trustee of the Trust (the Trustee).

Husband, Wife and Child are each directors and equal shareholders of the Trustee.

Husband and Wife are the primary beneficiaries of the Trust.

Wife has the power to appoint a new trustee of the Trust.

The class of discretionary beneficiaries will be limited to the 'Family Group' as defined in section 272-90 of schedule 2F to the ITAA 1936; and the Trust will make a Family Trust Election (FTE) in accordance with section 272-80 of schedule 2F to the ITAA 1936. The test individual will be either Husband or Wife.

By making the FTE the Trust will be a 'family trust' (within the meaning of Schedule 2F of the ITAA 1936).

Husband and Wife will be part of Husband's or Wife's (as the case may be) family group (within the meaning of Schedule 2F of the ITAA 1936).

Proposed transaction

The Partners propose:

•         transferring the Property to the Trust, and

•         to continue to operate the Business from the Property.

If the roll-over under Subdivision 328-G is available:

•         the Partners and Trust will choose to apply the roll-over under Subdivision 328-G, and

•         the Trust will make an FTE in relation to either Husband or Wife when it lodges its first income tax return.

There are no further proposed transactions, transfers or restructures of the business under contemplation

Relevant legislative provisions

Income Tax Assessment Act 1936 schedule 2F

Income Tax Assessment Act 1936 section 272-80

Income Tax Assessment Act 1936 section 272-90

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 paragraph 152-40(1)(a)

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

Income Tax Assessment Act 1997 section 152-47

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 paragraph 328-125(1)(b)

Income Tax Assessment Act 1997 subparagraph 328-125(2)(a)(ii)

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 subdivision 328-G

Income Tax Assessment Act 1997 section 328-430

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)(b)

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

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

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

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

Income Tax Assessment Act 1997 subsection 328-430(2)

Income Tax Assessment Act 1997 section 328-435

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

Income Tax Assessment Act 1997 section 328-440

Income Tax Assessment Act 1997 subparagraph 328-440(a)(ii)

Income Tax Assessment Act 1997 section 328-445

Income Tax Assessment Act 1997 subsection 328-445(a)

Income Tax Assessment Act 1997 subsection 328-445(b)

Income Tax Assessment Act 1997 subsection 328-445(c)

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

Reasons for decision

Question 1

Summary

The transfer of the Property will be part of a genuine restructure of an ongoing business for the purposes of section 328-430 of the ITAA 1997.

Question 2

Summary

The disposal of the Property pursuant to the proposed transaction will satisfy the conditions for roll-over under subdivision 328-G of the ITAA 1997.

Detailed reasoning for questions 1 and 2

Legislative references are to the ITAA 1997 unless otherwise stated.

Subdivision 328-G provides an option for small business restructure roll-over to be available where an active asset of the business is transferred to another small business entity as part of a genuine business restructure without changing the ultimate economic ownership of the asset. Entities are able to restructure their businesses, and the way their business assets are held, while disregarding tax gains and losses that would otherwise arise.

Section 328-430 applies to transfers of assets on or after 1 July 2016 and may apply whether operating as a sole trader, a partnership, a trust or a company where a small business determines a change of structure is appropriate.

Section 106-5 states that any capital gain or capital loss made from a CGT event happening in relation to a partnership or one of its CGT assets is made by the partners individually. Each partner's gain or loss is calculated by reference to the partnership agreement, or partnership law if there is no agreement. Accordingly, the partners will each be the transferors for the purposes of section 328-430 under the Proposed Transaction

While a $2m aggregated turnover test is used to assess eligibility for CGT small business entities under Division 152 (subsection 152-10(1AA)), a threshold of $10m applies to the turnover test for small business entities under Division 328 (section 328-110). To access the small business restructure roll-over an entity must satisfy this higher $10m turnover threshold applying to small business entities.

Six conditions need to be met in order for roll-over under Subdivision 328-G to be available (section 328-430):

a)    condition 1: the transaction must be part of a genuine restructure of an ongoing business paragraph 328-430(1)(a)

b)    condition 2: the small business entity condition at paragraph 328-430(1)(b), including being a partner in a partnership that is a small business entity for that income year at sub paragraph (iv)

c)    condition 3: there is no change in ultimate economic ownership of the assets paragraph 328-430(1)(c)

d)    condition 4: the asset being transferred is a CGT asset that is an active asset (paragraph 328-430(1)(d))

e)    condition 5: both the transferor and each transferee must be residents of Australia (paragraph 328-430(1)(e))

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

Condition 1: the transaction must be part of a genuine restructure of an ongoing business (paragraph 328-430(1)(a))

The Explanatory Memorandum to the Tax laws amendment (small business restructure roll-over) Bill 2016 (SBRR EM) states at paragraph 1.20:

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 advisers may try to manipulate the operation of a 'black letter' provision of the tax law to achieve an inappropriate or uneconomic tax outcome.

The SBRR EM provides the following factors that would indicate a genuine restructure at paragraph 1.22:

•         It is a bona fide commercial arrangement undertaken to enhance business efficiency.

•         The business continues to operate following the transfer, through a different entity structure but under the same ultimate economic ownership.

•         The transferred assets continue to be used in the business.

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

•         The restructure is not artificial or unduly tax driven.

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

Law Companion Ruling LCR 2016/3 Small Business Restructure Roll over: genuine restructure of an ongoing business and related matters, lists at paragraph 7 a number of features which would indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business'. These are as follows:

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

-   facilitate growth, innovation and diversification

-   adapt to changed conditions, or

-   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:

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

-   continuity of employment of key personnel, and

-   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.

LCR 2016/3explains the meaning of the term 'genuine restructure of an ongoing business' in Subdivision 328-G. It discusses the features that indicate if a restructure falls within scope.

In this case only the land is being transferred. Paragraph 11 of LCR 2016/3contemplates restructures where not all business assets that are necessary for the continued operation of an 'ongoing business' are transferred. It outlines that, 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'.

Paragraphs 17-23 of LCR 2016/3 provide an example where Mark has been operating a small business and transfers his active assets used to carry on his business into a discretionary family trust. He and his wife are the beneficiaries and Mark is the primary individual specified in the FTE in force in respect of the trust.

A corporate trustee is appointed and the trustee employs staff to service the client base. The trustee pays Mark and the other employees a salary commensurate to the services they provide to the business. Mark and the trustee of the discretionary family trust choose to apply the SBRR. The economic ownership of the business is maintained. Asset protection was a major factor and the evidence available supports Mark's claim of asset protection. For this and other factors explained in the LCR the 'genuine restructure of an ongoing business' condition is satisfied.

In respect to the Property and the Business:

a)    the Business will continue to be operated from the Property

b)    there is no intention to sell the Property or wind up the Business

c)    the Property will still be controlled by Husband and Wife as they will control the board of the directors of the trustee company of the Trust and Wife is the appointor of the Trust

d)    the restructure will allow for the risks associated with the Property to be separated from other assets.

It is clear that the business is intended to be carried on after the Proposed Transaction has been implemented. This satisfies the 'ongoing business' requirement of paragraph 328-430(1)(a).

Further, all of these factors in combination indicate that the proposed restructure is a genuine restructure of an ongoing business. The requirement in paragraph 328-430(1)(a) is satisfied.

Condition 2: the small business entity condition paragraph 328-430(1)(b)

To satisfy this condition, both the transferor and transferee must be one or more of the following:

a)    be a small business entity for the income year during which the transfer occurred

b)    an entity which has an affiliate that is a small business entity for the year in which the transfer occurred

c)    an entity which is connected with an entity that is a small business entity for the year in which the transfer occurred, or

d)    be a partner in a partnership that is a small business entity for the year in which the transfer occurred.

As the partners are partners in a partnership, they can satisfy subparagraph 328-430(1)(b)(iv) if the partnership is a small business entity in the income year the proposed restructure occurs.

Section 328-110 provides that you are a small business entity for an income year if:

(a) you carry on a business in the current year; and

(b) one or both of the following applies:

(i) you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $10 million;

(ii) your aggregated turnover for the current year is likely to be less than $10 million.

The term 'business' is defined in section 995-1 to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Do the transferors satisfy this condition?

As the Partnership is carrying on the business, this satisfies the requirement of paragraph 328-110(1)(a).

Therefore, it has to be determined if the aggregated turnover of the partnership is less than $10 million in the relevant income year. The Partnership's aggregated turnover for the 20XX income year was less than $10 million. The partnership is a small business entity as defined by section 328-110.

The transferors satisfy this condition as:

•         they are each partners in the Partnership

•         the Partnership is a small business entity for the 20XX year as it carried on business in the 20XX year and carried on business in the 20XX year

•         the Partnership had an aggregated turnover of less than $10 million in the 20XX year

Will the transferee satisfy this condition?

The Trust will be connected with the Partnership for the following reasons:

a)    Husband and Wife each control the Partnership as they each own rights to at least 40% of the net income of the Partnership (subparagraph 328-125(2)(a)(ii))

b)    Husband and Wife each control the Trust under subsection 328-125(3) as they will be taken to be affiliates of each (under section 152-47) and together control the trustee company of the Trust - the Trustee will act, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates

c)    as the Partnership and Trust are both controlled by Husband and Wife, they will be connected entities (paragraph 328-125(1)(b)).

The transferee (being the Trust) therefore satisfies this condition as it is connected with the Partnership and the Partnership is a small business entity for the 20XX year.

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

Paragraph 328-430(1)(c) requires the transaction to not have the effect of materially changing which individual has, or which individuals have, the ultimate economic ownership of the assets. Additionally, where more than one individual holds the ultimate economic ownership of the asset, each individual's share of that ownership must not materially change.

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.

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 328-430(1)(c).

Alternative ultimate economic ownership test for discretionary trusts

Section 328-440 contains an alternative ultimate economic ownership test for discretionary trusts. Section 328-440 states that 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 the requirements in that section are satisfied.

Section 328-440 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 takes effect, has the ultimate economic ownership of the asset is a member of that family group.

Section 328-440 is satisfied if the assets are included in the property of a family trust (as defined in Schedule 2F to the ITAA 1936) either just before or just after the transaction took effect. Additionally, every individual who had the ultimate economic ownership of the asset just before and just after the transfer must be members of the family group (as defined in by Schedule 2F to the ITAA 1936) relating to the family trust.

LCR 2016/3 at paragraphs 108 - 109 describes that 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.

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 an FTE in force.

The Commissioner provides the following example in paragraphs 112 to 119 of LCR 2016/3:

Facts

112. Steven operates a business of providing golf instruction and equipment sales through a company structure. Steven and his wife, Vicki are the directors. Steven and Vicki hold 100 ordinary shares in the company. Daniel, their son, holds 100 A class shares while Courtney, their daughter, holds 100 B class shares.

113. Steven and Vicki, in their capacity as directors, may resolve to pay dividends to holders of one class of shares to the exclusion of any other.

114. The company transfers the business' active assets to a trust where he and his family members are beneficiaries. The FTE is made and Steven is the primary individual specified in the election.

Relevant considerations

115. The SBRR is restricted to circumstances where there has been no material change in the ultimate economic ownership of assets as a result of the transfer of the assets.

116. The transfer of assets to a non-fixed trust means that the proportionate ultimate economic ownership of the assets of the trust has changed materially. However, the alternative ultimate economic ownership test must be considered.

117. To meet this alternative test, every individual who had ultimate economic ownership of the transferred asset before the transfer, and every individual who has ultimate economic ownership of the transferred asset after the transfer, must be members of the family group relating to the family trust.

118. In this example, Steven, Vicki, Daniel and Courtney are all members of Steven's family group.

Conclusion

119. The ultimate economic test in paragraph 328-430(1)(c) is satisfied because of the alternative test in section 328-440.

As in the above example:

a)    Husband and Wife are currently the ultimate economic owners of the Property that will be transferred to Trust, and

b)    the Trust will make an FTE so that Husband and Wife will be members of Husband's or Wife's (as the case may be) family group.

The farming land asset will be included in the property of a family trust so as to satisfy subparagraph 328-440(a)(ii).

The ultimate economic ownership condition is satisfied.

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

Paragraph 328-430(1)(d) requires that the asset being transferred is a CGT asset that is an active asset, other than a depreciating asset, at the time of the transfer.

Additionally, where subparagraph 328-430(1)(b)(iv) is satisfied, as the partners are partners in the partnership that is a small business entity for the income year, subparagraph 328-430(1)(d)(iii) also requires the asset to be an active asset and an interest in an asset of the partnership.

Paragraph 152-40(1)(a) provides that a tangible or intangible CGT asset is an active asset if you own the asset and it is used, or held ready for use, in a business carried on (whether alone or in partnership) by you, your affiliate or another entity that is connected with you.

However, certain types of CGT assets are excluded from being active assets under subsection 152-40(4). The types of excluded assets that are relevant to this situation include certain financial instruments such as loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, and a right or option in respect of a share, security, loan or contract, as well as shares in a company and interests in trusts in certain conditions.

The asset being transferred by the partners is an asset that is used in carrying on the business by the Partnership.

At the time the transfer takes effect, the CGT asset (being the Property) is an active asset of the Partnership as:

a)    prior to the transfer, Husband and Wife (transferees) are partners in the Partnership and the Property is an interest in the asset of the Partnership, and

b)    after the transfer, Partnership is a connected entity of the Trust (transferor).

This condition will be satisfied as the Property will be an active asset of the Partnership just prior to and after the transfer as it will continue to be used by the Partnership in the course of carrying on the Business.

Condition 5: both the transferor and each transferee must be residents of Australia (paragraph 328-430(1)(e))

Paragraph 328-430(1)(e) requires both the transferor and the transferees to meet the residency requirements outlined in section 328-445.

Section 328-445 contains different types of residency tests for different types of entities. If the entity is an individual paragraph 328-445(a) requires the individual to be an Australian resident. If the entity is a partnership (other than a corporate limited partnership) 328-445(c) requires at least one of the partners to be an Australian resident. As both Husband and Wife are residents of Australia this requirement is satisfied in respect of the transferors.

If the entity is a trust, paragraph 328-445(b) requires the trust to be a resident trust for CGT purposes. Section 995-1 contains the definition of a resident trust for CGT purposes. If the trust is not a unit trust, it will be a resident trust for CGT purposes if at any time during the income year, the trustee is an Australian resident, or the central management and control of the trust is in Australia.

The Trustee will be a company that is incorporated in Australia and is an Australian resident. The Trust will therefore be an Australian resident trust for CGT purposes.

The requirements of paragraph 328-430(1)(e) are satisfied as Husband, Wife and the Trust are Australian residents.

Condition 6: both the transferor and transferee must choose to apply the roll-over (paragraph 328-430(1)(f))

Paragraph 328-430(1)(f) requires that both the transferor and the transferees choose to apply the roll-over under Subdivision 328-G in relation to the assets transferred under the transaction.

Husband, Wife and the Trust will each choose to apply the roll-over under Subdivision 328-G, so this requirement is satisfied.

Consequences of the roll-over

Section 328-450 provides that if the transfer of an asset occurs under a transaction to which section 328-430 applies, the transfer of the asset has no direct consequences under the income tax law.