Edited version of private advice

Authorisation Number: 1051878196409

Date of advice: 3 August 2021

Ruling

Subject: Small business restructure rollover

Question 1

Is Entity A eligible to apply the small business restructure rollover relief under section 328-430 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the transfer of the Assets (other than depreciating assets)?

Answer

Yes.

Question 2

Is Entity A eligible to apply roll-over relief under item 8 in the table in subsection 40-340(1) of the ITAA 1997 in relation to the transfer of depreciating assets?

Answer

Yes.

This ruling applies for the following period:

For the income year ended 30 June 20XX

Relevant facts and circumstances

Entity A carries on the Business. In the income year ended 30 June 20XX, Entity A transferred certain Assets, which included goodwill, trading stock and plant and equipment, to Entity B. Entity B then continued to operate the Business using the transferred Assets. Entity B also continued with the same business processes, personnel, customers and services in the Business.

After the transfer of Assets to Entity B, Entity B decided to implement an employee equity incentive arrangement. Under this equity incentive arrangement, select key employees acquired minority interests in Entity B.

Entity A and Entity B are both small business entities under section 328-110 of the ITAA 1997 in the transfer income year. Entity A and Entity B are also Australian residents for tax purposes.

Relevant legislative provisions

Subsection 40-340(1) Income Tax Assessment Act 1997

Subsection 152-40(1) 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

Reasons for decision

Note: All legislative references in the 'Reasons for Decision' are references to the Income Tax Assessment Act 1997, unless otherwise indicated.

Question 1

Under subsection 328-430(1), a small business restructure roll-over (SBRR) 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)  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.

Genuine Restructure

Paragraph 328-430(1)(a) requires that the transaction to transfer an asset is, or is a part of, a genuine restructure of an ongoing business.

Law Companion Ruling LCR 2016/3 - Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3) provides guidance on what constitutes a "genuine restructure of an ongoing business".

As stated in paragraph 6 of LCR 2016/3, 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 does not extend to a restructure by a small business owner in the course of winding down to transfer wealth between generations or realising their ownership interests.

Paragraph 7 of LCR 2016/3 states that the features indicating a genuine restructure of an ongoing business include:

•         It is a bona fide commercial arrangement undertaken to facilitate growth, innovation and diversification, to adapt to changed conditions, or to reduce administrative burdens;

•         It is authentically restructuring the way the business is conducted, as opposed to a divestment or a 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.

Relevantly, Example 2 of LCR 2016/3 the Commissioner considers a restructure involving the issue of shares to essential employees, which occurred after the transfer of its active assets to another entity. These shares were issued in order to provide incentives for the employees' ongoing involvement in the business. It was concluded that the restructure was a 'genuine restructure of an ongoing business'.

In the present circumstances, Entity A's primary purpose for the restructure was to retain the skills of key employees in its business through an equity incentive arrangement. This arrangement would allow select key employees to acquire equity interests in its business which would increase employee commitment and involvement in the business, thereby leading to increased business profitability and growth.

Furthermore, whilst the restructure undertaken by Entity A changes the structure under which the business operates going forward, there is also continued use of the Business Assets in its business operations, employment of the same personnel in its business and continuity of the same business processes and services.

Given the above, and in line with Example 2 of LCR 2016/3, the restructure undertaken by Entity A is a 'genuine restructure of an ongoing business'. Consequently, the requirement in paragraph 328-430(1)(a) is satisfied.

Small business entity

Under paragraph 328-430(1)(b), SBRR will be available where each party to the transfer is a 'small business entity' in the income year in which the transfer occurred -see subparagraph 328-430(1)(b)(i).

Broadly, a small business entity is an entity that carries on a business and the combined annual turnover of the entity, and other entities that are affiliated or connected with it, is less than $10 million - see section 328-110.

Entity A and Entity B were both small business entities in the transfer income year. Consequently, the terms of paragraph 328-430(1)(b) is satisfied.

Ultimate economic ownership

Paragraph 328-430(1)(c) requires that the transaction for the transfer of the assets must not have the effect of materially changing the ultimate economic ownership of the assets. It must not materially change:

(a)  which individual has, or which individuals have, the ultimate economic ownership, and

(b)  if there is more than one such individual, each of those individuals ' share of the ultimate economic ownership.

It is accepted that in the present circumstances that the ultimate economic ownership of the Business Assets by the same owners will continue after the transfer of the assets to Entity B. Therefore, the requirement in paragraph 328-430(1)(c) is met.

Active asset

Where the transferor is a small business entity, at the time the transfer takes effect the transferred asset must be a CGT asset (other than a depreciating asset) that is also an active asset of the entity (paragraph 328-430(1)(d)).

A CGT asset (whether a tangible or intangible 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 you; your affiliate; or 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(1) of the ITAA 1997).

Although depreciating assets are specifically excluded from the SBRR, subsection 40-340(1) of the ITAA 1997 provides rollover relief for depreciating assets. The application of subsection 40-340(1) is discussed in Question 2 of this document.

In the present circumstances, the assets that were transferred to Entity B were goodwill, plant and equipment and trading stock. The application of paragraph 328-430(1)(d) to each of these assets is considered below:

Goodwill

The goodwill is an intangible CGT asset which was owned by Entity A. The notes to subsection 152-40(1) explain that an intangible asset need satisfy only paragraph (a) or paragraph (b) of the subsection and specifically refers to goodwill as an example. As the goodwill is inherently connected with Entity A, it is an active asset under subsection 152-40(1)(b). Paragraph 328-430(1)(d) is satisfied in relation to the goodwill.

Plant and equipment

The plant and equipment assets are CGT assets which are owned by Entity A and used in the course of carrying on its business. Therefore, the plant and equipment assets are 'active assets'.

However, as the plant and equipment assets are depreciating assets under section 40-30 of the ITAA 1997, these assets are specifically excluded from the SBRR and paragraph 328-430(1)(d) of the ITAA 1997 is not satisfied in relation to the plant and equipment assets.

Trading stock

The trading stock which was owned by Entity A is a CGT asset that was used by Entity A in the course of carrying on its business. Consequently, the trading stock is an active asset, as defined in subsection 152-40(1). As such, paragraph 328-430(1)(d) is satisfied in relation to the trading stock.

Residency requirement

Paragraph 328-430(1)(e) of the ITAA 1997 requires that the transferor and transferee must be an Australian resident (see paragraph 328-445(a)).

As both Entity A and Entity B are Australian residents for tax purposes, the requirement under paragraph 328-430(1)(e) will be satisfied.

Roll-over choice

Both Entity A and Entity B will choose to apply the roll-over under Subdivision 328-G in relation to the assets transferred under the restructure, and therefore, the requirement under paragraph 328-430(1)(f) is satisfied.

In conclusion, as all of the requirements in 328-430(1)(c) are met, Entity A is eligible to apply the SBRR to the transfer of its Business Assets (excluding depreciating assets) to Entity B.

Question 2

As explained previously in this document, under paragraph 328-30(1)(d) depreciating CGT assets are specifically excluded from SBRR. Consequently, the plant and equipment assets that are depreciating assets will be excluded from SBRR.

However, roll-over relief for these assets is effectively provided for in subsection 40-340(1).

Subsection 40-340(1) relevantly provides that there is roll-over relief if:

(a) there is a *balancing adjustment event because an entity (the transferor ) disposes of a *depreciating asset in an income year to another entity (the transferee ); and

(b) the disposal involves a *CGT event; and

(c) the conditions in an item in this table are satisfied.

Item 8 applies to a transfer of an asset under a small business restructure roll-over. The roll-over relief is subject to the condition that a roll-over under Subdivision 328-G would be available in relation to the asset if the asset were not a depreciating asset.

In the present case, a balancing adjustment event occurred in relation to the plant and equipment which are depreciating CGT assets upon the transfer of these assets to Entity B.

Under item 8, roll-over relief will be available for the plant and equipment assets where it can be demonstrated that a roll-over under Subdivision 328-G would be available if these assets were not depreciating assets.

To be eligible for roll-over relief under Subdivision 328-G in connection to the depreciating plant and equipment assets, the requirements in paragraphs 328-430(1)(a) to (e) must be satisfied. It was concluded earlier in this document that the requirements in paragraphs 328-430(1)(a) to (c) and paragraphs 328-430(1) (e) and (f) were met in respect of the assets (including plant and equipment) which were transferred from Entity A to Entity B under the restructure.

In respect of paragraph 328-430(1)(d) regarding whether a transferred CGT asset is an active asset, it was considered in Question 1 of this document that the plant and equipment was a CGT asset of Entity A that was also an active asset. Consequently, the requirement in paragraph 328-430(1)(d) is also met.

Accordingly, as a roll-over under Subdivision 328-G would be available for the plant and equipment but for these assets being depreciating assets, section 40-340(1) will apply to provide roll-over relief in respect of the plant and equipment.