Edited version of private advice

Authorisation Number: 1051850681298

Date of advice: 10 June 2021

Ruling

Subject: CGT roll-over relief

Question 1

Is rollover relief available under Subdivision 124-N of the ITAA 1997 for the proposed restructure?

Answer

Yes

Question 2

Will the Trust disregard capital gains (or capital losses) in relation to the transfer of its assets (except trading stock) to the Company under section 124-875 of the ITAA 1997?

Answer

Yes

Question 3

Will depreciation rollover relief be available under subsection 40-340(1) item 2A and section 40-345 of the ITAA 1997 in relation to the depreciating assets transferred under the restructure such that no balancing adjustment arises for the Trust?

Answer

Yes

Question 4

Will the Commissioner accept that 70-90 ITAA 1997 will not apply to the transfer of the trading stock from the Trust to the Company?

Answer

Yes

Question 5

Will the Commissioner accept that the Trust should include the book value of its stock in its assessable income under section 6-5 of the ITAA 1997 on the transfer of the trading stock from the Trust to the Company?

Answer

Yes

Question 6

Does any provision within Part IVA of the ITAA 1936 apply?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20YY

The scheme commences on:

1 July 20ZZ

Relevant facts and circumstances

The Trust is an unlisted unit trust that operates a business with the Company as its corporate trustee.

The Trust has less than XX unitholders and has never offered these units to the public. No unit holders are exempt entities.

The Trust has a major unitholder, holding over 75% of all units on issue. The unitholders include both residents and non-residents for tax purposes.

The Trust is not a public trading trust for the purposes of section 102P and Division 6C ITAA 1936.

The Trust is not taxed as a company.

The Trust does not own land in Australia.

The Trust records it's trading stock at cost.

The unitholders would like the business to be conducted via the medium of a company.

The proposed transaction seeks to employ the CGT roll-over contained in Subdivision 124-N of the ITAA 1997. The steps of this proposed transaction are:

1. The Company is currently a dormant company (and is the trustee of the Trust) with nominal share capital (founder shares) and it would agree to become the trading entity.
2. The Trust would create a present entitlement in the unitholders equal to the value of its current year earnings and any retained earnings.
3. The Trust would transfer all of the assets of the Trust to the Company (reduced by assets which are needed to pay out the unitholders' present entitlements) and also the Company would assume all of the Trust's liabilities and the value of the Trust's unit capital (i.e. its paid up capital).
4. In consideration for the Company acquiring the business from the Trust and assuming its liabilities and the value of its paid up capital, the Company would also cancel its founder shares and issue non-redeemable shares in the Company to the unitholders in proportion to their unit holdings (additional shares).
5. The Trust would pay out its current year earnings (and any retained earnings as well).
6. Rollover choices would be made by the Trust, the Company and eligible unit holders.
7. The Trust would be wound up within 6 months.

All leases, customer contracts, employment agreements, supply contracts etc and other transactions are already in the name of the Company in their capacity as trustee of the Trust.

The replacement shares in the Company will be issued to the unit holders of the Trust on a one to one basis.

The trust deed of the Trust and company constitution of the Company allow for this restructure to occur.

The transaction would be done with legal agreements and appropriate resolutions from unitholders etc. These will be drafted in due course.

No disposals have been planned for the interests in the company after the proposed restructure.

Assumption

Any valuations required under the roll-over will be done in accordance with ATO market valuation guidelines.

Relevant legislative provisions

Income Tax Assessment Act 1936

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 subsection 177C(1)

Income Tax Assessment Act 1936 paragraph 177C(1)(a)

Income Tax Assessment Act 1936 subsection 177C(2)

Income Tax Assessment Act 1936 paragraph 177C(2)(a)

Income Tax Assessment Act 1936 subparagraph 177C(2)(a)(i)

Income Tax Assessment Act 1936 subsection 177C(3)

Income Tax Assessment Act 1936 subsection 177C(4)

Income Tax Assessment Act 1936 section 177CB

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1997

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 40-285

Income Tax Assessment Act 1997 section 40-340

Income Tax Assessment Act 1997 subsection 40-340(1) Item 2A

Income Tax Assessment Act 1997 section 40-345

Income Tax Assessment Act 1997 section 40-345(2)

Income Tax Assessment Act 1997 section 40-360

Income Tax Assessment Act 1997 section 70-90

Income Tax Assessment Act 1997 section 70-95

Income Tax Assessment Act 1997 section 104-195

Income Tax Assessment Act 1997 subsection 104-195(1)

Income Tax Assessment Act 1997 Subdivision 124-N

Income Tax Assessment Act 1997 section 124-10

Income Tax Assessment Act 1997 subsection 124-10(3)

Income Tax Assessment Act 1997 section 124-15

Income Tax Assessment Act 1997 section 124-855

Income Tax Assessment Act 1997 section 124-860

Income Tax Assessment Act 1997 subsection 124-860(3)

Income Tax Assessment Act 1997 subsection 124-860(4)

Income Tax Assessment Act 1997 subsection 124-860(5)

Income Tax Assessment Act 1997 subsection 124-860(6)

Income Tax Assessment Act 1997 section 124-865

Income Tax Assessment Act 1997 section 124-875

Income Tax Assessment Act 1997 subsection 124-875(2)

Reasons for decision

Question 1

Detailed reasoning

Broadly, Subdivision 124-N of the ITAA 1997 allows for capital gains and losses to be disregarded where a unit trust disposes of CGT assets to a company as part of a business restructure where certain requirements are met.

Under section 124-855 of the ITAA 1997, a roll-over may be available for a restructure where a trust disposes of all of their CGT assets to a company limited by shares, CGT event E4 is capable of applying to all of the units in the trust, and the additional requirements under section 124-860 of the ITAA 1997 are met.

Section 124-860 of the ITAA 1997 further requires that all CGT assets be disposed of to the transferee during the trust restructuring period that comprises the period beginning just before the first CGT asset is disposed of to the transferee under the restructure and ends when the last CGT asset of the transferor is disposed of to the transferee. Additionally, the transferee must not be an exempt entity in accordance with subsection 124-860(3) of the ITAA 1997.

As the transferee is the trustee of the transferor, subsection 124-860(5) provides that the additional requirements under subsection 124-860(4) of the ITAA 1997 do not apply.

Under subsection 124-860(6) of the ITAA 1997, the proportion of interests each entity owned in the transferor must be the same as their ownership proportion in the transferee. This proportion must have substantially the same market value as their original interests.

Under the proposed steps of the restructure, the Trust will dispose of all of their assets and liabilities, except those needed to pay the unitholders' present entitlements, to the Company within the trust restructuring period. The founder shares in the trustee will be cancelled just after the trust restructuring period with non-redeemable shares being issued in the same proportion to the original unit holders. The new shares in the Company issued to the unitholders are replacement interests and will be issued in the same proportion as the units held in the Trust, as such the shares issued will have substantially the same market value as the unit holders original interests. All requirements of section 124-860 of the ITAA 1997 are met.

Both entities will choose the roll-over in accordance with section 214-865 of the ITAA 1997. Therefore, rollover relief under subdivision 124-N of the ITAA 1997 is available.

Question 2

Detailed reasoning

Roll-over relief under Subdivision 124-N of the ITAA 1997 is only available where both the transferee and transferor choose to obtain it in accordance with section 124-865 of the ITAA 1997.

As both entities will choose to obtain the roll-over the Trust will be capable of disregarding the capital gains in relation to the transfer of assets in accordance with subdivision 124-N of the ITAA 1997 and the effects provided for under section 124-875 of the ITAA 1997.

In particular, subsection 124-875(1) of the ITAA 1997 provides that any capital gain or any capital loss from CGT event A1 happening to the transferor under the trust restructure is disregarded (even if CGT event J4 applies).

Question 3

Detailed reasoning

Under item 2A of the table in subsection 40-340(1) of the ITA 1997 there is automatic roll-over relief for the balancing adjustment where the balancing adjustment event occurs because an entity disposes of a depreciating asset, that involves a CGT event, in an income year to another entity and both entities are able to choose a roll-over under Subdivision 124-N of the ITAA 1997.

As the conditions of Subdivision 124-N of the ITAA 1997 have been satisfied and both are able to choose the roll-over, the Trust will be entitled to automatic roll over relief under section 40-340 of the ITAA 1997. The rollover relief is outlined under section 40-345 of the ITAA 1997, which provides that section 40-285 of the ITAA 1997 does not apply to the balancing adjustment event for the transferor, and the transferee can deduct the decline in value of the depreciating asset using the same method and effective life that was being used by the transferor.

Question 4

Detailed reasoning

Under section 70-90 the disposal of trading stock outside the ordinary course of business will result in the entity's ordinary income including the market value of the item on the day of the disposal.

The word 'dispose' is not defined in the ITAA 1997. Taxation Determination TD 96/2 Income tax: can section 36A of the Income Tax Assessment Act 1936 apply if a sole trader who owns trading assets declares himself or herself to be a trustee of a discretionary trust over the assets? (TD 96/2) considers the meaning of disposed in the context of the now repealed subsection 36(1) of the Income Tax Assessment Act 1936 following the ruling from the High Court of Australia in Rose v Federal Commissioner of Taxation (1951) 84 CLR 118. TD 96/2 noted that section 36 of the ITAA 1936 only applied where there is a disposal of the entirety of the ownership of the trading asset. The view in TD 96/2 is presently relevant to the treatment of the trading stock in this ruling and will be adopted.

Under the current arrangement the Company holds the legal title of the trading stock on behalf of the trust, with the unit holders of the Trust holding beneficial ownership. The transfer of trading stock to the Company as outlined will not change the legal ownership.

Therefore, as a disposal of trading stock requires the disposal of the entirety of the ownership interest, not just a single aspect of that ownership, there is no disposal under the trust restructure under subdivision 124-N and as such section 70-90 of the ITAA 1997 does not apply to the trading stock.

Question 5

Detailed reasoning

As there is no disposal of trading stock outside of the ordinary course of business pursuant with section 70-90 of the ITAA 1997, there is no requirement to record the transfer of stock to the Company at market value.

The Trust currently records its trading stock at cost in its books. The transfer of stock at cost will result in an assessable amount by the Trust identical to the deduction they incurred when the stock was acquired. The Company will incur a deduction of the same value when they acquire the trading stock. This will result in a net tax outcome of nil to the Trust and provide the Company with the same outcome when calculating the profit from the sale of the stock.

The Commissioner accepts the use of book value when transferring the trading stock from the Trust to the Company.

Question 6

Detailed reasoning

The Commissioner is empowered under subsection 177F(1) of Part IVA of the ITAA 1936 to cancel a 'tax benefit' that has been obtained by a taxpayer.

For the Commissioner to exercise this power, the following requirements under Part IVA must be satisfied:

1. A 'tax benefit' as identified in section 177C, was or would but for subsection 177F(1), have been obtained;
2. The tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A; and
3. Having regard to section 177D, the scheme is one to which Part IVA applies.

The general anti-avoidance provisions can only apply where a taxpayer has obtained a tax benefit in connection with a scheme identified by the commissioner. To identify the scheme, regard must be had for its definition under subsection 177A(1) of the ITAA 1936.

Scheme

A scheme is broadly defined under subsection 177A(1) of the ITAA 1936 to mean:

a)    any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

b)    any scheme, plan, proposal, action, course of action or course of conduct.

The relevant scheme identified for this ruling begins when the first CGT asset is transferred to the Company and ends when the Trust vests and ceases to exist.

Tax Benefit

Amounts not being included in assessable income that would otherwise have been included would constitute a tax benefit under subsection 177C(1) of the ITAA 1936.

Under subparagraph 177C(2)(a)(i), the non-inclusion of an amount in assessable income that arises from a choice made under the Act, where this choice was not made purely as a result of steps taken to purposefully enable the choice, will not constitute a tax benefit for the purpose of Part IVA.

Therefore, the tax benefit will not be excluded under subsection 177C(2) of the ITAA 1936 if it was obtained in connection with a scheme that was entered into or carried out by any person for the sole of dominant purpose of enabling that person or any other person to make the choice.

The transaction was entered into with the purpose of enabling the business to operate in a company structure to facilitate its growth strategy. Under the reconstruction approach, the same outcome could have been achieved had the CGT roll-overs not been chosen when undertaking the restructure.

Under the proposed transaction, The Trust and the Australian resident unit holders obtain roll-overs for the capital gains that will be incurred as a result of the assets transferring from the Trust to the Company, and the unit holders disposal of interests in the Trust in exchange for shares in the company. The roll-over results in an amount of assessable income not being included in the income year the transfer occurs.

This exclusion amounts to a tax benefit for the purposes of 177C(1)(a) and more broadly, Part IVA of the ITAA 1936.

The eight factors under 177D of Part IVA of the ITAA 1936 must be explored to examine whether the steps taken were done purely to enable the choice to be made. Where the dominate purpose for a tax benefit is established, the exclusion of a tax benefit gained from a choice made under the Act as provided for in subsection 177C(2)(a) of the ITAA 1936 will not apply.

Dominant Purpose

The objective factors under 177D of Part IVA of the ITAA 1936 must be examined when determining the existence of a tax benefit.

These factors are:

(a) the manner in which the scheme was entered into or carried out;

(b) the form and substance of the scheme;

(c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Manner

The first factor enables the identification of contrivance and artificiality in the proposed scheme by examining the manner in which the scheme was entered into or carried out compared to the manner in which the counterfactual would have been implemented.

The transaction proposes to transfer all assets and liabilities, net those required to pay out the present entitlement of unit holders, to the trustee. The Company would then cancel its founder shares and issue non-redeemable shares to the unit holders of the Trust.

The same substantive outcome could have been achieved had the assets been transferred without the benefit of roll-over relief. Additionally, there is no evidence of any preparatory steps taken to facilitate this transaction.

Form and substance

The second factor directs attention to whether there is a discrepancy between the form of the scheme and its substance. There may be an indication a scheme has been implemented in a particular form as the means to obtain a tax benefit where there is a discrepancy between the business and practical effect of a scheme. This may be evident where the substance of the scheme may be achieved by a more straightforward or commercial transaction.

The transaction takes the shape of a restructure to facilitate growth of the business through a company structure. There is no evidence of any additional or unnecessary steps to facilitate this restructure.

Timing

The timing aspects of the manner in which the scheme was entered into are examined in the third factor. Consideration must be had for the time the scheme was entered into and the length of period in which it was carried out.

The proposed transaction will occur shortly after the issuance of this ruling and is expected to be completed within six months from the date the first CGT asset is transferred to the Company. This time frame is necessitated by the particular CGT roll-over being applied to the transaction.

The third factor does not support a conclusion that the requisite purpose is present.

Tax effects

The tax effect of this scheme is to defer a taxing point through the roll-over of the CGT implications of the transfer of assets from the Trust to the Company, and the cancellation of the Australian resident unit holders interests in the Trust in exchange for shares in the Company. The non-resident unit holders will not be entitled to roll over relief and will pay tax in the same proportion had the roll over not been applied.

This effect arises from the operation of the CGT roll-over relief applied to the transaction. It is considered this factor is neutral towards the requisite purpose.

Financial effects

The fifth, sixth and seventh factors move to focus on changes in financial position or any other consequence reasonably expected to result from the scheme for the relevant taxpayer and connected parties.

The transaction resulted in the assets from the Trust being transferred to the Company with the benefit of a CGT roll-over for the Trust and the Australian resident unit holders. The non-resident unit holders in the Trust do not benefit from this CGT roll-over relief. However, all parties would be liable for CGT should the roll-over relief not be applied.

There is no immediate sell down of ownership interests expected to occur. Therefore, the most significant financial outcome of this transaction is the deferment of tax for the Trust and the Australian resident unitholders, such that there is no outgoing of funds to meet a tax liability on an internal restructure.

Connection

The eighth factor examines the nature of connection between the taxpayer and any other person whose financial position is reasonably expected to change as a result of the scheme.

Apart from the Trust and the Company the other affected parties include the unit holders. As the unit holders will cease to have interests in the Trust, they will acquire shares in the Company as a result. The market value and proportion ownership of shares in the Company will substantially match those the shareholders held in the Trust.

Conclusion

Upon examination of the factors above, the Commissioner is of the view that the sole or dominate purpose of the scheme was not to obtain a tax benefit. The Trust had operated as a trust from inception of the business and now wishes to operate in a corporate structure to help facilitate its growth strategy. The steps taken have not predominantly been taken to enable the roll over choice to be made. Part IVA of the ITAA 1936 will not apply to the proposed restructure.