Edited version of private advice

Authorisation Number: 1052013569370

Date of advice: 17 November 2022

Ruling

Subject: CGT - small business restructure rollover

Question

Will the proposed transfer of the shares in TradingCo from HoldCo to the Family Trust be part of a genuine restructure of an ongoing business for the purpose of paragraph 328-430(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

HoldCo is an Australian resident private company that was incorporated for the purpose of investing in TradingCo in order to derive dividend income.

Since incorporation, Individual A has owned nine shares in HoldCo. Individual B has owned one share. There is and has been no other shareholders in HoldCo

Individual A is the sole director of HoldCo.

HoldCo holds less than 40% of the issued share capital in TradingCo. The remaining shares in TradingCo are owned by entities not associated with HoldCo or Individual A.

HoldCo received a fully franked dividend in a recent year and although no other dividends have been paid there is an expectation of dividends being paid in the future.

It was originally intended that a discretionary trust acquire the shareholding in TradingCo so as Individual A and B could both receive dividends by way of trust distribution. However, the financial institution being dealt with at the time would not provide finance for the share purchase via a trust structure and as such, and HoldCo was used to acquire the shareholding.

It is now apparent that having the TradingCo shares held by HoldCo is not the desired structure and it is proposed these shares be transferred to the Family Trust.

The Family Trust was settled recently as a discretionary trust. The Family Trust is not carrying on a business.

At the time of the proposed transfer of the shares in TradingCo, the Family Trust will have in place a family trust election with Individual A as the specified individual.

HoldCo and the Family Trust are connected entities under section 328-125 of the ITAA 1997, both entities being controlled by Individual A.

The market value of the active assets of TradingCo exceeds 80% of the total market value of all its assets, such that the shares in TradingCo held by HoldCo are active assets under subsection 152-40(3) of the ITAA 1997.

The aggregated turnover of HoldCo was below $XX million in the 20XX-XX financial year and is expected to be below $XX million in the 20XX-XX financial year.

Both HoldCo and the Family Trust meet the residency requirements in section 328-445 of the ITAA 1997.

Both HoldCo and the Family Trust will choose to apply the roll-over under Subdivision 328-G of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 152-40(3)

Income Tax Assessment Act 1997 Subdivision 328-G

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

Income Tax Assessment Act 1997 paragraph 328-430(1)(a)

Income Tax Assessment Act 1997 section 328-435

Income Tax Assessment Act 1997 section 328-445

Reasons for Decision

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

Question 1

Subdivision 328-G allows for tax-neutral consequences for a small business that restructures the ownership of the assets of the business without changing their ultimate economic ownership.

Subsection 328-430(1) outlines the conditions to be met for the roll-over relief to be available. The first condition of the rollover requires that the transfer of the asset is, or is part of, a genuine restructure of an ongoing business (paragraph 328-430(1)(a)).

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.

Asset protection

Example 1 in LCR 2016/3 (paragraph 17 to 23), involves an individual (Mark) who is expanding his sole trader bookkeeping business into the riskier operations of financial advice. After being sued by a client for negligent financial advice, Mark has decided he is not prepared to conduct his business on his own account.

Mark is transferring assets from the original entity (himself) to quarantine his business from his personal assets. This is a benefit to Mark in terms of his ability to grow the riskier operations and enhance its profits. The restructure is a response to his business needs, facilitates further growth and is not unduly tax driven. The economic ownership of the business is maintained. Accordingly, the 'genuine restructure of an ongoing business' condition is satisfied.

Application to your circumstances

The private ruling application states that the proposed restructure is preferred as it will allow both Individual A and B to receive dividends by way of distribution from the discretionary trust. Having the shares held by the discretionary trust being the originally preferred structure, however, financiers required the acquisition to be done through the company structure.

Despite the benefits to the owners with regard dividend distributions, our view is that the transfer of shares from the company structure to a discretionary trust, does not deliver benefits in respect of the efficient conduct of the business. The proposed structure is also not considered conducive to growth, as evidenced by the limitations on financing at the time of the original acquisition.

Providing asset protection for the main shareholder, Individual A, was also provided as a reason for the proposed restructure, in a meeting held with HoldCo's tax agent and legal advisors.

The circumstances in this case are clearly distinguishable from those in example 1 of LCR 2016/3. There being no change or increased litigation risk arising from the way the business is being conducted. The business activity undertaken by HoldCo, that of holding shares in TradingCo for the derivation of dividend income, is also not considered to carry significant risks to the owner's personal assets.

After consideration of the full circumstances of this case against the factors outline in LCR 2016/3, our view is that the proposed transfer does not satisfy the genuine restructure of an ongoing business requirement in paragraph 328-430(1)(a) for the following reasons:

•         The proposed restructure is not reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business, per paragraph 6 of LCR 2016/3.

•         None of the features outlined in paragraph 7 of LCR 2016/3 apply as the proposed transfer does not:

• facilitate growth, innovation and diversification
• allow for adaption to changed conditions
• reduce administrative burdens, compliance costs and/or cash flow impediments.

•         None of the examples in LCR 2016/3 on what is a genuine restructure apply, that is there is no advantages by way of asset protection, maintaining essential employees, raising new capital, or simplifying the affairs of the business.

Further, the proposed transfer will provide a number of tax advantages including the discretionary distribution of dividends and access to the general discount. Based on the information provided, and the absence of a genuine restructure, we cannot establish that the proposed restructure is not unduly tax driven per paragraph 9 of LCR 2016/3.