Edited version of private advice

Authorisation Number: 1051963964322

Date of advice: 20 June 2022

Ruling

Subject: CGT - small business concessions

Question 1

Will the proposed transfer of the Land from the Taxpayer (an individual) to the new discretionary trust(s) qualify for Capital Gains Tax (CGT) small business restructure roll-over under subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, provided the requirements of section 328-435 of the ITAA 1997 continue to be met for the three years following the restructure.

Question 2

Will the land purchased by the Taxpayer prior to 20 September 1985 retain its pre-CGT status post the proposed transfer of the Land?

Answer

Yes, provided all the requirements of section 328-435 of the ITAA 1997 continue to be met for the three years following the restructure.

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 is an individual who solely owns the following three parcels of pre- and post-CGT land (the Land).

Each parcel of the Land has been used in a primary production business since their respective purchase dates

The Taxpayer, who is of retirement age does not carry on a business individually.

The Taxpayer has an interest in the primary production entity Trust A, that uses the Land.

Trust A is a discretionary trading trust. The Taxpayer's association with Trust A is summarised as follows:

•         The Taxpayer along with their spouse are the appointors of the trust.

•         The Taxpayer and the Taxpayer's spouse are each a specified beneficiary.

Company A is the corporate trustee of Trust A. The control and ownership of Company A is summarised as follows:

•         The Taxpayer and their spouse each hold 25% of the ordinary shares and voting rights, with the remaining shares and voting rights held by the Taxpayers spouse and two children.

•         The Taxpayer is a director along with their spouse and two children.

Company A is solely a trustee company.

The aggregated turnover of Trust A was below $XX million in the 20XX income year and is expected to be well below $XX million for the current and future income years.

There is no formal lease agreement in place for the use of the Land by Trust A. You have stated that this is due to the close intertwined relationship between the Taxpayer and Trust A.

You have stated that Trust A is financially dependent on the Land and the Taxpayer is financially dependent on Trust A.

You have stated that all major decisions of Trust A are made by the directors of Company A.

You have stated that the Taxpayer as managing director of Company A continues to support and provide guidance to the other directors with regard to the control of Trust A.

It is proposed that the land will be transferred to new discretionary trust(s) each with a corporate trustee.

The Taxpayer will be an appointor of the new discretionary trust(s).

Each new discretionary trust established to hold the Land will have a family trust election in place with the Taxpayer as the test individual.

The Taxpayer and members of their family group will be beneficiaries of the new discretionary trust(s).

The Taxpayer will be the sole shareholder and director of each new company established as the corporate trustee(s) of the new discretionary trust(s).

The new discretionary trust(s) will be a resident trust for CGT purposes.

The Taxpayer is an Australian Tax Resident.

The Land will continue to be used by the family to undertake their core primary production business.

You have stated that the purpose of the proposed transfer of the Land to the new discretionary trust(s) will be to:

•         Enable additional options with financiers of loans to be negotiated over longer terms to assist in growth of the business

•         Provide additional asset protection to the taxpayer whose land is integral to the running of the primary production business.

You have stated that the proposed ownership of the Land will reflect a structure likely to have been adopted had the Taxpayer purchased the land within the past decade.

Both the Taxpayer and the new discretionary trust(s) established to hold the Land will choose to apply the roll-over in relation to the Land transferred under these transactions.

Assumptions

For the three years following the transfer of the Land:

•         The ownership of the Land remains with the discretionary trust(s)

•         The Land will continue to be an active asset of Trust A, and

•         There is no significant or material use of the Land for private purposes.

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1997 Subsection 152-10(1A)

Income Tax Assessment Act 1997 Subsection 152(1AA)(b)

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

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

Income Tax Assessment Act 1997 Subsection 328-430(1)

Income Tax Assessment Act 1997 Section 328-435

Income Tax Assessment Act 1997 Section 328-450

Income Tax Assessment Act 1997 Section 328-460

Reasons for decision

Unless specified all subsequent legislative references are to the ITAA 1997.

Summary

The proposed transfer will meet the requirements under Subdivision 328-G and qualify for CGT small business restructure roll-over, provided all the requirements of section 328-435 continue to be met for the three years following the restructure.

Detailed reasoning

The CGT small business restructure roll-over 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) 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 (paragraph 328-430(1)(a)).

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 (paragraph 328-430(1)(b)).

3.    There is no material change in the ultimate economic ownership of the transferred asset (paragraph 328-430(1)(c)).

4.    The asset being transferred is an active asset (paragraph 328-430(1)(d)).

5.    Both the transferor and each transferee are residents of Australia (paragraph 328-430(1)(e)).

6.    Both the transferor and each transferee choose to apply the roll-over (paragraph 328-430(1)(f))

Condition 1. Genuine restructure

Law Companion Ruling 2016/3 Small Business Restructure Roll-over: genuine restructure of an on-going business and related matters (LCR 2016/3) explains that whether a transaction is or is part of a 'genuine restructure' will be a question of fact, determined having regard to all of the circumstances surrounding the restructure. In particular, the following features are indicative of a genuine restructure:

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

o   facilitate growth, innovation and diversification

o   adapt to changed conditions, or

o   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:

o   continued use of the transferred assets as active assets of the business,

o   continuity of employment of key personnel, and

o   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.

However, as discussed in LCR 2016/3, a transaction that is a part of a process of winding down to transfer wealth between generations is not considered by the Commissioner to be a genuine business restructure.

Section 328-435 provides a safe harbour rule whereby, a transaction will be, or will be part of, a genuine restructure if, for a period of three years after the transaction occurs:

•         There is no change in ultimate economic ownership of any of the significant assets of the business that were transferred under the transaction; and

•         Those significant assets continue to be active assets; and

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

In circumstances where the safe harbour rule is satisfied, it is not necessary to consider whether the restructure would otherwise be a 'genuine restructure of an ongoing business' under paragraph 328-430(1)(a).

Application to your circumstances

You have stated that the purpose of the proposed transfer of the Land to the new discretionary trust(s) will be to:

•         Enable additional options with financiers to be negotiated over longer terms to assist in growth of the business.

•         Provide additional asset protection to the taxpayer whose land is integral to the running of each entities business.

Also, that the proposed ownership of the land reflects a structure likely to have been adopted had the Taxpayer purchased the land within the past decade.

However, a significant portion of the Land proposed to be transferred to the new discretionary trusts(s) is pre-CGT land. Under section 328-460 the new discretionary trust(s) will be taken to have acquired the asset prior to 20 September 1985 if the roll-over is applied. The roll-over therefore will provide some tax advantage to the Taxpayer's family in addition to the advantages you have outlined. The Commissioner considers there is some concern about the reason for the restructure to conclude what is proposed is a "genuine restructure".

However, if for the three years following the restructure, all the requirements of section 328-435 are met, the safe harbour rule in that section can be applied. The Taxpayer and the discretionary trust(s) can choose to apply the CGT small business restructure roll-over relief of subdivision 328-G for the Transfer of the Land, if, for a three-year period following the transfer of the Land:

•         The ownership of the Land remains with the discretionary trust(s).

•         The Land continues to be an active asset of Trust A.

•         There is no significant or material use of the Land for private purposes.

Condition 2. The small business entity condition

Paragraph 328-430(1)(b) 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.

Subsection 328-125(1) 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.

An entity controls a discretionary trust if the trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates, or the first entity together with its affiliates (subsection 328-125(3)).

Application to your circumstances

The relevant parties to the proposed transfer are the Taxpayer as transferor of the land, and the new discretionary trust(s) as transferees. Both the transferor and the transferee will each need to meet one of the tests listed in Paragraph 328-430(1)(b) in the income year the proposed transfer occurs.

Trust A 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, given its income is under $10 million per year. It is the relevant entity to consider for the purposes of applying the roll-over tests in paragraph 328-430(1)(b).

You have contended that subparagraph 328-430(1)(b)(iii) is satisfied for both the transferee and the transferor as the Taxpayer is connected with both Trust A and the new discretionary trust(s) holding the land.

Given the Taxpayer is:

•         the joint appointor of discretionary trust Trust A with their spouse,

•         a director of the corporate trustee with their spouse and two children,

•         and the Land is used in Trust A's business,

the Commissioner accepts that the Taxpayer controls Trust A under section 328-125(3) as the corporate Trustee (Company A) could reasonably be expected to act in accordance with the Taxpayer's wishes.

As the Taxpayer controls Trust A, they will be connected with this entity (a small business entity) under paragraph 328-125(1)(a) in the income year of transfer.

With respect to the new discretionary trust to be established to hold the Land, given the Taxpayer will be:

•         a joint appointer of the trust(s),

•         a beneficiary of the trust(s),

•         the sole shareholder and director of the corporate trustee(s) of the trust(s),

•         the test individual with regard to the family trust election for the trust(s),

the Commissioner accepts that the Taxpayer will control the new discretionary trust(s) under section 328-125(3) of the ITTA 1997. Given the proposed structure, it will be reasonable to conclude that the new corporate trustee(s) of the new discretionary trust(s) will act in accordance with the Taxpayer's wishes.

The Taxpayer will control both Trust A and the new discretionary trust(s). Therefore, the new discretionary trust(s) will be connected with Trust A (a small business entity) under paragraph 328-125(1)(b) in the income year of the transfer.

As both parties to the transfer (the Taxpayer and the new discretionary trust(s)) will be connected with the small business entity (Trust A) in the income year of the transfer, the small business entity condition in subparagraph 328-430(1)(b)(iii) is satisfied.

Condition 3: Ultimate economic ownership

The transfer must not have the effect of materially changing the ultimate economic ownership of the transferred assets (sub paragraph 328-430(1)(c)(i)). Where there is more than one ultimate economic owner, each individual share of that ultimate economic ownership must not be materially changed (subparagraph 328-430(1)(c)(ii)).

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 such, beneficiaries of a discretionary trust cannot have ultimate economic ownership of the assets held by the trust.

However, section 328-440 contains an alternative ultimate economic ownership test for discretionary trusts for the purposes of paragraph 328-430(1)(c). Section 328-440 will be satisfied if:

•         just after the transaction takes effect, the asset is included in the property of a non-fixed trust that is a family trust; and

•         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 (ITAA 1936)) relating to the family trust; and

•         every individual who, just after the transfer takes effect, has the ultimate economic ownership of the asset is a member of that family group.

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 the new discretionary trust(s) trusts which will be a non-fixed trust that will be family trusts; and

•         The Taxpayer who had the ultimate economic ownership of the Land just before the transfer is a member of the family group (within the meaning of Schedule 2F to the ITAA 1936) relating to the family trust; and

•         The beneficiaries of the new discretionary trust(s) who will have the ultimate economic ownership of the Land just after the transfer will all be members of the same family group.

As section 328-440 is satisfied, the ultimate economic ownership condition in paragraph 328-430(1)(c) is also satisfied under the proposed arrangement.

Condition 4: Active assets

Subparagraph 328-430(1)(d) provides that as subparagraph 328-430(1)(b)(iii) applies in this case, 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 328-430(1)(d)(ii) serves to disregard the reduction in the turnover threshold to $2 million under paragraph 152-10(1AA)(b) for the purposes of the small business restructure test requirements. For the purpose of this test the aggregated turnover threshold will be $10 million for the income year.

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 the 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 your circumstances

Section 152-10(1A) will be satisfied in relation to the Land, as, in the income year in which the transaction will occur:

•         an entity connected with The Taxpayer, Trust A will be a small business entity for the income year if paragraph 152-10(1AA)(b) were disregarded; and

•         The Taxpayer does not carry on a business in the income year either alone or in partnership; and

•         Trust A will carry on the business in relation to the CGT asset (the Land).

As subsection 152-10(1A) is satisfied, therefore for the purposes of the roll-over requirements subparagraph 328-430(1)(b)(ii) is satisfied.

Condition 5. Residency

As the Taxpayer is an Australian resident for tax purposes and the discretionary trust(s) will be resident trust(s) for CGT purposes at the time of the proposed transfer, the residency requirements under section 328-440 and paragraph 328-430(1)(e) will be satisfied.

Condition 6. Roll-over choice

As both The Taxpayer and the discretionary trust(s) will choose to apply the roll-over under Subdivision 328-G in relation to the Land transferred under the proposed transfer, the requirement under paragraph 328-430(1)(f) will be 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.

In this case, provided the requirements of section 328-435 (genuine restructures - safe harbour rule) continue to be met for the three years following the restructure, the transfer of the Land from the Taxpayer to the discretionary trust(s) will have no direct consequences under income tax law.

Question 2

Section 328-460 provides that for a transfer of a pre-CGT asset, where the transfer meets the requirements of section 328-430 a transferee is taken to have acquired the asset before 20 September 1985.

In this case if the proposed transactions proceed, provided the requirements of section 328-435 (genuine restructures - safe harbour rule) continue to be met for the three years following the restructure, the parcels of the Land acquired by the Taxpayer prior to 20 September 1985 will retain their pre-CGT status when transferred to the discretionary trust(s).