Edited version of private advice

Authorisation Number: 1051887452407

Date of advice: 30 September 2021

Ruling

Subject: Small business restructure rollover

Question

Does the proposed transfer of land from the taxpayers to new discretionary trusts qualify for small business restructure relief under subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period periods:

Income year ended 30 June XX

Income year ended 30 June YY

The scheme commences on:

Xx xx xxxx

Relevant facts and circumstances

Individual 1 is an individual who owns several parcels of land totalling approximately xxx acres.

Individual 1 and spouse Individual 2 is a partnership who jointly own several parcels of land totalling approximately yyy acres.

Individual 2 is a small business entity operating a business as a sole trader.

The land is used in the conduct of a business by a related Family Trust.

Individual 1 and Individual 2 are the shareholders, and Individual 1 is the sole director, of the corporate trustee. Individual 1 and Individual 2 are the appointors of the Family Trust.

The taxpayers' asset ownership is considered sub-optimal in that the land is legally and beneficially held in individuals' names and is exposed in the event of personal liability.

The taxpayers are desirous of maximising the asset protection of their land and operations. In order to achieve this, it is proposed:

•         Individual 1 and Individual 2 will transfer all of their land to a newly settled discretionary trust (Land Trust) with a new company (New Trustee) as trustee.

•         Land Trust will have its class of beneficiaries limited to Individual 1 and Individual 2 and their present and future relatives, in order to comply with the Victorian stamp duty exemption in section the relevant state Duties Act; and

•         Land Trust will make a family trust election in accordance with Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) nominating Individual 1 as the test individual.

The Family Trust has made a distribution of at least 40% of its income to each of Individual 1 and Individual 2 in at least one of the past four income years.

The Family Trust had aggregated turnover under $XXm in the income years ended 30 June 20AA and 20BB.

It is intended that following the transaction, for a period of at least 3 years:

•         There will be no change to the ownership of the significant assets by Land Trust;

•         Those assets will be active assets; and

•         There will be no significant or material use of those assets for private purposes.

Individual 1 and Individual 2 are residents of Australia for taxation purposes.

The Family Trust is a resident trust for CGT purposes.

Both Individual 1 and Individual 2 (the transferors) and Land Trust (the transferee) will choose to apply the roll-over in relation to the Land transferred under the transactions.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 106-5

Income Tax Assessment Act 1997 - section 328-110

Income Tax Assessment Act 1997 - section 328-430

Income Tax Assessment Act 1997 - section 328-435

Income Tax Assessment Act 1997 - section 328-440

Reasons for decision

Summary

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

Detailed reasoning

Subdivision 328-G of the ITAA 1997 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 of the ITAA 1997 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 of the ITAA 1997 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 of the ITAA 1997 under the Proposed Transaction

A threshold of $10m applies to the turnover test for small business entities under Division 328 (section 328-110 of the ITAA 1997). To access the small business restructure roll-over an entity must satisfy this $XXm turnover threshold applying to small business entities.

Six conditions under section 328-430 of the ITAA 1997 need to be met in order for roll-over under Subdivision 328-G to be available:

1.    the transaction must be part of a genuine restructure of an ongoing business paragraph 328-430(1)(a) of the ITAA 1997

2.    the small business entity condition at paragraph 328-430(1)(b) of the ITAA 1997, including being connected with an entity that is a small business entity for that income year at sub paragraph (iii)

3.    there is no change in ultimate economic ownership of the assets paragraph 328-430(1)(c) of the ITAA 1997

4.    the asset being transferred is a CGT asset that is an active asset (paragraph 328-430(1)(d) of the ITAA 1997)

5.    both the transferor and each transferee must be residents of Australia (paragraph 328-430(1)(e) of the ITAA 1997)

6.    both the transferor and transferee must choose to apply the roll-over (paragraph 328-430(1)(f) of the ITAA 1997).

Condition 1: the transaction must be part of a genuine restructure of an ongoing business (paragraph 328-430(1)(a) of the ITAA 1997)

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 2016/3 explains 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 2016/3 contemplates 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 Individual 1 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.

Application to your circumstances

In respect to the land and the business conducted by the family trust:

a) the business will continue to be operated from the land

b) there is no intention to sell the land or wind up the business

c) the land will still be controlled by Individual 1 and Individual 2 as Individual 2 is the sole director of the trustee company of the family trust and both are the appointors of the family trust

d) the restructure will allow for the risks associated with the land 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) of the ITAA 1997.

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) of the ITAA 1997 is satisfied.

Condition 2: the small business entity condition paragraph 328-430(1)(b) of the ITAA 1997

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.

Section 328-110 of the ITAA 1997 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 $XX million;

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

Application to your circumstances

The family trust is a small business entity under section 328-110 of the ITAA 1997 as it carries on a business and its aggregated turnover in the income year ended 30 June 2021 was under $XXm.

In terms of paragraph 328-430(1)(b) of the ITAA 1997, the transferor Individual 1 is connected with the family trust as he controls the corporate trustee directly as the sole director of the corporate trustee so subparagraph 328-430(1)(b)(iii) is satisfied. In addition, the transferor Individual 2 is a small business entity in the income year the transfer so subparagraph 328-430(1)(b)(i) is satisfied.

In addition, the transferee (Land Trust) will be connected with the family trust as its corporate trustee will be controlled by Individual 2 directly as the sole director and by Individual 1, as an affiliate of Individual 2, and they control the family trust as Individual 1 controls the corporate trustee directly as the sole director of the corporate trustee and Individual 2 is an affiliate of Individual 1s. Therefore subparagraph 328-430(1)(b) of the ITAA 1997 is satisfied.

Condition 3: there is no material change in the ultimate economic ownership of the transferred assets paragraph 328-430(1)(c) of the ITAA 1997

Paragraph 328-430(1)(c) of the ITAA 1997 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) of the ITAA 1997.

Alternative ultimate economic ownership test for discretionary trusts

Section 328-440 of the ITAA 1997 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 of the ITAA 1997 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 of the ITAA 1997 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 paragraph 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.

Application to your circumstances

Section 328-440 is satisfied by the proposed transactions as:

•                just after the transactions, the land will be included in the property of Land Trust which will be a non-fixed trust that will be a family trust; and

•                Individual 1 and Individual 2, who have the ultimate economic ownership of the land assets just before the transfer are members of the family group (within the meaning of Schedule 2F to the ITAA 1936) relating to the family trust; and

•                Individual 1 and Individual 2 who, just after the transfer takes effect, will have the ultimate economic ownership of the land assets and will be members of the same family group.

As section 328-440 of the ITAA 1997 is satisfied, paragraph 328-430(1)(c) of the ITAA 1997 is also satisfied under the proposed arrangement.

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

For Individual 2, as subparagraph 328-430(1)(b)(i) of the ITAA 1997 applies, the assets will need to be active assets. Therefore, for the purposes of the rollover requirements, subparagraph 328-430(1)(d)(i) of the ITAA 1997 is satisfied.

For Individual 1, as subparagraph 328-430(1)(b)(iii) of the ITAA 1997 applies, the assets will need to be CGT assets (other than a depreciating asset) and an active asset in relation to which subsection 152-10(1A) is satisfied in that income year, or would be satisfied in that income year if paragraph 152-10(1AA)(b) were disregarded.

Paragraph 152-10(1AA)(b) of the ITAA 1997 serves to disregard the reduction in the turnover threshold to $2 million for the purposes of the small business restructure test requirements. For the purpose of this test the aggregated turnover threshold will be $XX million for the income year.

Subsection 152-10(1A) of the ITAA 1997 allows access to the small business conditions where passively held assets are held by taxpayers who are connected to a small business entity. The provision is set out as follows:

Subsection 152-10(1A)

The conditions in this subsection are satisfied in relation to the *CGT asset in the income year if:

(a) your *affiliate, or an entity that is *connected with you, is a *CGT small business entity for the income year; and

(b) you do not carry on a *business in the income year (other than in partnership); and

(c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d) in any case - the CGT small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b) ) in relation to the CGT asset.

Application to Individual 1's circumstances

For the proposed transactions section 152-10(1A) of the ITAA 1997 will be satisfied in relation to the CGT land assets, as, in the income year in which the transaction will occur:

•                an entity connected with Individual 1, the family trust, will be a small business entity for the income year; and

•                Individual 1 does not carry on a business in the income year (other than in partnership); and

•                the CGT asset (the land) is not an interest in an asset of a partnership business; and

•                the family trust will carry on the business in relation to the CGT assets (the land).

As subsection 152-10(1A) of the ITAA 1997 is satisfied, therefore for the purposes of the rollover requirements, subparagraph 328-430(1)(d)(ii) of the ITAA 1997 is satisfied for Individual 1.

Condition 5: both the transferor and each transferee must be residents of Australia (paragraph 328-430(1)(e) of the ITAA 1997)

Paragraph 328-430(1)(e) of the ITAA 1997 requires both the transferor and the transferees to meet the residency requirements outlined in section 328-445 of the ITAA 1997.

Section 328-445 of the ITAA 1997 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. As both Individual 1 and Individual 2are residents of Australia this requirement is satisfied in respect of the transferors.

If the entity is a trust, paragraph 328-445(b) of the ITAA 1997 requires the trust to be a resident trust for CGT purposes. Section 995-1 of the ITAA 1997 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. Land Trust will therefore be an Australian resident trust for CGT purposes.

The requirements of paragraph 328-430(1)(e) of the ITAA 1997 are satisfied as Individual 1 and Individual 2 and Land Trust are/will be Australian residents.

Condition 6: both the transferor and transferee must choose to apply the roll-over (paragraph 328-430(1)(f) of the ITAA 1997)

Paragraph 328-430(1)(f) of the ITAA 1997 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.

Individual 1 and Individual 2and Land 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 of the ITAA 1997 provides that if the transfer of an asset occurs under a transaction to which section 328-430 of the ITAA 1997 applies, the transfer of the asset has no direct consequences under the income tax law.