Edited version of private advice

Authorisation Number: 1051951933926

Date of advice: 24 March 2022

Ruling

Subject: Small business restructure rollover

Question

Does the proposed transfer of land from the individual taxpayer to new discretionary trust qualify for relief under subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following periods:

Financial year ending 30 June 20XX

Financial year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Taxpayer owns two parcels of Land used in a primary production business undertaken by Trust X which is a discretionary trust.

The application states that the Taxpayer was formerly the sole operator of the primary production business prior to their child becoming involved. The Taxpayer continues to support and provide guidance to their child, although they are advancing in age.

The Taxpayer and the Taxpayer's child are appointers of Trust X.

The beneficiaries of Trust X are the Taxpayer, their spouse, their child, their child's spouse and children of their child and spouse. The Taxpayer has not received a distribution from Trust X in the last four years.

Discretionary Trust X has the corporate trustee Company X. The Taxpayer's child and the Taxpayer's child's spouse are the directors of Company X.

Trust X financially benefits from using the two land parcels.

The Taxpayer was formerly the sole operator of the farming enterprise prior to his son becoming involved continues to support and provide guidance to his son. the Taxpayer is over 70 years of age.

There is no formal lease agreement in place with respect to the use of the land.

The aggregated turnover of Trust X was below $10 million for the 20XX income year and is expected to below $10 million for the current and future income years.

All major decision for each entity (Company X and Trust X) are made by the shareholders of the company and the beneficiaries of the trust who hold regular informal meetings.

The two land parcels will be transferred to a new discretionary trust with a corporate trustee.

The Taxpayer and the Taxpayer's child will be the appointers of the new discretionary trust.

The new discretionary trust established to hold the two land parcels will have a family trust election in place with Taxpayer as the test individual.

The Taxpayer and members of his family group (within the meaning of Schedule 2F to the Income Tax Assessment Act 1936) will be the beneficiaries of the new discretionary trust.

The new discretionary trust will be Australian resident trusts under section 328-445 of the ITAA 1997.

The Taxpayer will hold 33.3% of the shares in the corporate trustee company for the new discretionary trust.

The Taxpayer and the Taxpayer's son will be the directors of the corporate trustee company for the discretionary trust.

The Taxpayer is an Australian resident under section 328-445 of the ITAA 1997.

The two land parcels will continue to be used by the family to undertake their primary production business.

Other land used by Trust X is held by other discretionary trusts.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 328-G

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Subsection 328-125(1)

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

Income Tax Assessment Act 1997 Subsection 328-125(4)

Income Tax Assessment Act 1997 Subsection 328-130(1)

Income Tax Assessment Act 1997 Section 328-430

Reasons for decision

Summary

The rollover is not available in relation to the transfer of the land. The requirement that each party (to the transfer) is either a small business entity (or affiliate of, or connected with a small business entity), or a partner in a partnership that is a small business entity is not met.

Detailed reasoning

The small business restructure rollover in Subdivision 328-G allows small businesses to transfer active assets from one entity (the transferor) to one or more other entities (transferees), on or after 1 July 2016, without incurring an income tax liability.

Subsection 328-430(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that roll-over relief is available if the following conditions are met:

1. The transfer of the asset is, or is part of, a genuine restructure of an ongoing business.

2.    Each party to the transfer is either a small business entity (or affiliate of or connected with a small business entity) or a partner in a partnership that is a small business entity.

3.    There is no material change in the ultimate economic ownership of the transferred asset.

4.    The asset being transferred is a CGT asset (other than a depreciating asset) that is an active asset, and for a partnership, is also an interest in an asset of the partnership.

5.    Both the transferor and each transferee are residents of Australia.

6.    Both the transferor and each transferee choose to apply the roll-over.

Small business entities, affiliates, connected entities, or partners of a partnership - 328-430(1)(b) of the ITAA 1997

An entity is a small business entity if it carries on business and its aggregated turnover for the previous income year is less than $10 million or is likely to be less than $10 million for the current income year (section 328-110 of the ITAA 1997).

Paragraph 328-430(1)(b) of the ITAA 1997 requires that each party to the transfer is an entity to which 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.

328-130(1) of the ITAA 1997 provides that an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

Subsection 328-125(1) of the ITAA 1997 provides that an entity is connected with another entity if:

(a)  either entity controls the other entity in a way described in this section; or

(b)  both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(3) of the ITAA 1997 states that an entity controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the direction or wishes of the entity, its affiliates, or the entity together with its affiliates, this is referred to as the influence test.

An entity also controls a discretionary trust for an income year under subsection 328-125(4) of the ITAA 1997 if, for any of the 4 income years before that year:

(a)  the trustee paid to, or applied for the benefit of, the entity and/or its affiliates any of the income or capital of the trust, and

(b)  the percentage (control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year

Application to your circumstances

The relevant parties to the proposed transfer are the Taxpayer as transferor of the land (being allotment 578 and 579), and the transferee (the new discretionary trust set up to hold the land). Both the transferor and the transferee will each need to meet one of the tests listed in paragraph 328-430(1)(b) of the ITAA 1997 in the income year the proposed transfer occurs. We will firstly consider the tests in relation to the transferor (the Taxpayer).

Trust X is the entity undertaking the farming activities set out in this case. From the trading information provided, it meets the small business entity requirements under section 328-110 of the ITAA 1997, given its income is under $10 million per year. It is the relevant entity to consider for the purposes of applying the rollover tests in paragraph 328-430(1)(b) of the ITAA 1997 in this case.

Subparagraph 328-430(1)(b)(i) of the ITAA 1997 would require the transferor to be carrying on the business. It is Trust X that is carrying on the small business in this case, and this entity is not a party to the proposed land transfer, therefore this test is not satisfied.

Affiliates must be either individuals or companies (subsection 328-125(1) of the ITAA 1997. As the small business entity in this case Trust X is not an individual or a company it cannot therefor be an affiliate of Taxpayer and the test in subparagraph 328-430(1)(b)(ii) of the ITAA 1997 is not satisfied.

The Taxpayer is not a partner in a partnership carrying on a small business, and therefor subparagraph 328-430(1)(b)(iv) of the ITAA 1997 is also not satisfied.

The remaining test, subparagraph 328-430(1)(b)(iii) of the ITAA 1997 requires the Taxpayer to be connected to the small business entity Trust X in the income year of the proposed transfer.

Paragraph 328-125(1)(a) of the ITAA 1997 provides that the Taxpayer will be connected to Trust X if they control it. As Trust X is a discretionary trust, the relevant tests to consider in order to determine control are the influence test in 328-125(3) of the ITAA 1997 or the distribution test in 328-125(4) of the ITAA 1997. The Taxpayer will be taken to control and therefore be connected to Trust X if either of these tests are met in the income year of the proposed transfer.

Both 328-125(3) or 328-125(4) of the ITAA 1997 make reference to affiliates for the purposes of determining the control of a discretionary trust. An affiliate relationship requires conduct of the parties in relation to the business affairs of the other entity being either individuals or companies as previously discussed (subsection 325-130(1) of the ITAA 1997). As none of the entities involved with the control of Trust X, are carrying on businesses in their own right, they cannot be affiliates of each other.

The Taxpayer cannot therefore rely on working together with other potentially controllers to influence Trust X for the purposes of subsection 328-125(3) of the ITAA 1997. The Taxpayer, acting alone, will need to be the one to influence the trustee (Company X), so that it acts, or could reasonably expected to act in accordance with their wishes.

You have stated that all major decisions for each entity (Company X and Trust X) are made by the shareholders of the company and the beneficiaries of the trust who hold regular informal meetings. However, this does not settle who would have ultimate control the Trust X for the purposes of the influence test. It is appropriate to consider who would have the final say, if for example, there was a disagreement between the individuals who potentially controlled the trust.

You have further contended that the Taxpayer provides land that is used by Trust X, the trustee is more likely to act in accordance with their wishes. It is accepted that this may provide some influence over the Trust. However, other land held within the family group is also used in the Trust's operation, providing some amount of counter influence.

The Taxpayer's child is a director of Company X, along with their spouse. As the Taxpayer is not a director of Company X, it is difficult to conclude that he would be controlling this entity.

Voting rights in Company X are shared equally one third each by the Taxpayer, the Taxpayer's child, and the Taxpayer's child's spouse. Due to their relationship, it is considered the spousal couple would vote together if a conflict situation arouse between the Taxpayer and their child.

The Taxpayer and the Taxpayer's child are joint appointors of Trust X, they could both potentially assert influence over the Trustee, having the power to replace the trustee. This leads to a conclusion that it is unlikely that Taxpayer's child's spouse would be controlling the trust. It does not however, assist with drawing a conclusion as to whether either the Taxpayer or their child is controlling the Trust.

When compared with their child, the Taxpayer's advancing age and diminishing distributions lead to a conclusion that their child now has a greater influence over Trust X.

After considering all the information available, the Commissioner's view is that the Taxpayer's child is controlling Trust X according to subsection 328-125(3) of the ITAA 1997. It is more likely that, in the event of a conflict arising within the family group, that Company X (the trustee) would act, or would reasonably be expected to act, in accordance with the direction or wishes of the Taxpayer's child rather than the Taxpayer. The Taxpayer also does not have an affiliate with whom he can control Trust X.

For the purposes of subsection 328-125(1) of the ITAA 1997, the Taxpayer does not control Trust X under either subsection 328-125(3) or 328-125(4) of the ITAA 1997. It follows that he is not connected to the small business entity Trust X per paragraph 328-125(1) of the ITAA 1997 for the purposes of subparagraph 328-430(1)(b)(iii) of the ITAA 1997.

It will therefore not be possible for both parties (transferor and transferee) to meet the tests as required in this case regardless of whether the transferee meets the tests. The rollover is not available for the proposed transfer of allotments 578 and 579 from the Taxpayer to the discretionary trust under section 328-430 of the ITAA 1997.