Edited version of private advice

Authorisation Number: 1052059470261

Date of advice: 24 November 2022

Ruling

Subject: Small business restructure roll-over

Question 1

Does the proposed subdivision and transfer of land from the Company to New Family Trust 1 and New Family Trust 2 qualify for roll-over relief under Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does section 328-450 of the ITAA 1997 apply to the transfer of the land to stop the application of section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.         The Company owns land upon which it conducts businesses.

2.         The Company has a sole shareholder.

3.         The Company's aggregated turnover for the 20XX income year is likely to be less than $10 million.

4.         The Company is a resident trust for capital gains tax purposes.

The Proposed Transaction

5.         The Company proposes to transfer the land to two newly settled discretionary trusts - New Family Trust 1 and New Family Trust 2.

6.         New Family Trust 1 will own a section of the land and will assume a portion of the running of one of the businesses.

7.         New Family Trust 2 will own the other section of the land and will assume a portion of the running of one of the businesses and the entirety of the other business.

8.         Prior to the transfer of the land, each of New Family Trust 1 and New Family Trust 2 will make a family trust election in accordance with Schedule 2F of the ITAA 1936 nominating the sole shareholder of the Company as the test individual.

9.         The aggregated turnover of New Family Trust 1 and New Family Trust 2 (including connected entities and affiliates) is not likely to exceed $10 million in the 20XX income years.

10.      The proposed arrangement is being considered for the following reasons:

•                     to enable legal segregation of separate business activities and assets, reducing the risk of litigation against one of the operations impacting the other sections of the land used for different purposes. A predominant reason for the proposed restructure is to ensure that should there be a claim against any one of the businesses conducted arising from their infrastructure or lease activities, the exposure of assets to any such claim is limited.

•                     to enable businesses of vastly different natures to be run and managed separately. Splitting the ownership of the land into separate entities allows for operational and financial independence of activities in accordance with the separate operations conducted.

•                     to enable flexibility with capital and debt restructuring. Having separate asset ownership creates a segregation of assets available for security to financiers.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 section 272-70 of Schedule 2F

Income Tax Assessment Act 1936 section 272-80 of Schedule 2F

Income Tax Assessment Act 1997 paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Assessment Act 1997 paragraph 328-110(1)(a)

Income Tax Assessment Act 1997 paragraph 328-110(1)(b)

Income Tax Assessment Act 1997 subsection 328-115(1)

Income Tax Assessment Act 1997 subsection 328-115(2)

Income Tax Assessment Act 1997 subsection 328-115(3)

Income Tax Assessment Act 1997 Subdivision 328-G

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 subparagraph 328-430(1)(b)(i)

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 subparagraph 328-430(1)(d)(ii)

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 subsection 328-430(2)

Income Tax Assessment Act 1997 section 328-440

Income Tax Assessment Act 1997 subparagraph 328-440(a)

Income Tax Assessment Act 1997 subparagraph 328-440(a)(ii)

Income Tax Assessment Act 1997 subsection 328-440(b)

Income Tax Assessment Act 1997 subsection 328-440(c)

Income Tax Assessment Act 1997 section 328-445

Income Tax Assessment Act 1997 section 328-450

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Summary

The disposal of the Property by the Company to the New Family Trust 1 and New Family Trust 2 in accordance with the Proposed Transaction will satisfy the conditions for roll-over under section 328-430.

Detailed reasoning

1.         Subdivision 328-G allows flexibility for owners of small business entities to restructure their businesses and the way their business assets are held while disregarding tax gains and losses that would otherwise arise.

2.         Section 328-430 discusses when a roll-over is available. There are 6 basic conditions in subsection 328-430(1) that must be met and they are as follows:

A roll-over under this Subdivision 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)          the 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 each transferee meet the residency requirement in section 328-445 for an entity; and

(f)            the transferor and each transferee choose to apply a roll-over under this Subdivision in relation to the assets transferred under the transaction.

Note: The roll-over of a depreciating asset transferred in the restructuring of a small business is addressed in item 8 of the table in subsection 40-340(1).

3.         The transferor is the Company who will be subdividing and transferring a section of the land to each of the transferees, New Family Trust 1 and New Family Trust 2.

4.         In addition, subsection 328-430(2) provides that roll-over is not available under Subdivision 328-G if the transferor or any transferee is either an exempt entity or a complying superannuation entity. As all the parties to the Proposed Transaction are not either of these types of entities, subsection 328-430(2) does not prevent roll-over being available in this situation.

5.         Each requirement in subsection 328-430(1) will now be considered in detail.

Paragraph 328-430(1)(a) - genuine restructure

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

7.         Whether a transaction is or is part of a 'genuine restructure of an ongoing business' is a question of fact that is determined having regard to all of the circumstances surrounding the restructure.

8.         Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters provides guidance on whether a transaction will be part of a 'genuine restructure of an ongoing business'.

9.         LCR 2016/3 states that 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 can encompass a restructure of the way in which business assets are held where that structure is likely to have been adopted had the business owners obtained appropriate professional advice when setting up the business.

10.       Paragraph 7 of LCR 2016/3 outlines the following features that indicate a transaction is, or is part of, a genuine restructure of an ongoing business:

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

•                     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, and

•                     it results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business.

11.       However, the restructure of an ongoing business by a business owner is not genuine if it is done in the course of winding down to transfer wealth between generations or realising their ownership interests. A restructure is likely to not be a genuine restructure of an ongoing business if:

•                     it is a preliminary step to facilitate the economic realisation of assets, or takes place in the course of winding down to transfer wealth between generations

•                     it effects an extraction of wealth from the assets of the business for personal investment or consumption

•                     it creates artificial losses or brings forward their recognition

•                     it effects a permanent non-recognition of gain or creates artificial timing advantages, and/or

•                     there are other tax outcomes that do not reflect economic reality.

12.       The businesses will continue to be carried on after the Proposed Transaction has been implemented. You have stated that there are 3 main reasons for its implementation:

•                     to enable legal segregation of separate business activities and assets, reducing the risk of litigation against one of the operations impacting the other sections of the Property used for different purposes,

•                     to enable businesses of vastly different natures to be run and managed separately, allowing for operational and financial independence of activities in accordance with the separate operations conducted, and

•                     to enable flexibility with capital and debt restructuring.

13.       As per paragraph 7 of LCR 2016/3 these are features that indicate a genuine restructure of an ongoing business is taking place. That is, it is a bona fide commercial arrangement undertaken to facilitate diversification. Moreover it is an authentic restructuring of the way the businesses are conducted. There is no indication that the Proposed Transaction is occurring in the course of winding down to transfer wealth between generations or realising their ownership interests.

14.       It is accepted that the Proposed Transaction is a genuine restructure for the purposes of paragraph 328-430(1)(a).

Paragraph 328-430(1)(b) - small business or related entity

15.       Paragraph 328-430(1)(b) requires both the transferor and the transferee to be one or more of the following entities in the income year the Proposed Transaction occurs:

(i)            a small business entity

(ii)           an affiliate of a small business entity

(iii)          connected with a small business entity

(iv)          a partner in a partnership that is a small business entity.

Small business entity

16.       Subsection 328-110(1) 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 $10 million;

(ii) your aggregated turnover for the current year is likely to be less than $10 million.

17.       The term 'business' is defined in subsection 995-1(1) to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The Company

18.       The Company is currently conducting the businesses and therefore satisfies the requirement in paragraph 328-110(1)(a).

19.       The next requirement is to determine if the aggregated turnover of the taxpayer is less than $10 million in the relevant income year. 'Aggregated turnover' for an income year is defined in subsection 328-115(1) as the sum of the relevant annual turnovers excluding any amounts covered by subsection (3).

20.       The 'relevant annual turnovers' are defined in subsection 328-115(2) as:

(a)          your *annual turnover for the income year; and

(b)          the annual turnover for the income year of any entity (a relevant entity) that is *connected with you at any time during the income year; and

(c)           the annual turnover for the income year of any entity (a relevant entity) that is an *affiliate of yours at any time during the income year.

21.       The amounts excluded under subsection 328-115(3) are amounts derived from dealings between you and any entities that are connected with you or are your affiliates, or amounts derived from dealings between those entities.

22.       You advised that the aggregated turnover for the Company was less than $10 million in the 20XX income year.Consequently the requirement in paragraph 328-110(1)(b) is satisfied.

23.       Since paragraphs 328-110(1)(a) and (b) are both satisfied, the Company is a small business entity in accordance with subsection 328-110(1).

New Family Trust 1 and New Family Trust 2

24.       As a result of the proposed restructure New Family Trust 1 and New Family Trust 2 will carry on the businesses from the time immediately after the transfer takes place. New Family Trust 1 and New Family Trust 2 will therefore satisfy the requirement in paragraph 328-110(1)(a).

25.       You have stated that the aggregated turnover of New Family Trust 1 and New Family Trust 2 in the current income year (20XX) is likely to be less than $10 million. Consequently, the requirement in subparagraph 328-110(1)(b)(i) should be satisfied.

26.       Since paragraphs 328-110(1)(a) and (b) should be both satisfied, New Family Trust 1 and New Family Trust 2 are expected to be small business entities in accordance with subsection 328-110(1).

27.       The Company along with New Family Trust 1 and New Family Trust 2 are expected to be small business entities in accordance with subsection 328-110(1). Thus, the requirement in paragraph 328-430(1)(b) are expected to be satisfied.

Paragraph 328-430(1)(c) - ultimate economic owner

28.       Paragraph 328-430(1)(c) 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.

29.       Where ownership passes to or from a discretionary trust, this requirement would generally not be able to be met. 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: Commissioner of Stamp Duties (NSW) v. Buckle (1998) 192 CLR 226. A beneficiary of a discretionary trust only has a right to require the trustee to consider whether or not to exercise their discretion. Instead, a beneficiary of a discretionary trust generally has a 'mere expectancy' in the income or capital of a trust and does not have an interest in possession: Gartside v. Inland Revenue Commissioner [1968] AC 553.

30.       However, section 328-440 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.

31.       Section 328-440 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 takes / took effect[1]. 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 (within the meaning of Schedule 2F to the ITAA 1936) relating to the family trust.[2]

32.       The phrase 'ultimate economic ownership' is not defined in the ITAA 1997. However, the Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 (the EM) states:

1.29 The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset.

1.30 Ultimate economic ownership of an asset can only be held by natural persons. Therefore, where a company, partnership or trust owns an asset it will be the natural person owners of the interests in these interposed entities that will ultimately benefit economically from that asset.

33.       The New Family Trust 1 and New Family Trust 2 are non-fixed trusts for the purposes of section 272-70 of Schedule 2F of the ITAA 1936 and will each make a family trust election nominating a specified individual, the sole shareholder of the Company, under section 272-80 of Schedule 2F to the ITAA 1936. As the assets will be the property of the New Family Trust 1 and New Family Trust 2 immediately after the Proposed Transaction takes effect, this will satisfy the requirement in subparagraph 328-440(a)(ii).

34.       Just before the transaction takes effect, the individual who has the ultimate economic ownership of the land is the sole shareholder of the Company. Since he is also a member of the family group relating to the New Family Trust 1 and New Family Trust 2 at this time, the requirement in paragraphs 328-440(b) is satisfied.

35.       Just after the Proposed Transaction takes effect ultimate economic ownership of the land will be the family group members of the New Family Trust 1 and New Family Trust 2, with the sole shareholder of the Company as the test individual, thereby satisfying the requirements in paragraph 328-440(c).

36.       Consequently, as the alternative ultimate economic ownership test under section 328-440 will be satisfied, this will satisfy the requirement of paragraph 328-430(1)(c).

Paragraph 328-430(1)(d) - active assets

37.       Paragraph 328-430(1)(d) requires the CGT asset 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 would be satisfied in that income year if paragraph 152-10(1AA)(b) were disregarded; or

(iii)          if subparagraph (b)(iv) applies - an active asset and an interest in an asset of the partnership referred to in that subparagraph

38.       In this case, subparagraph 328-430(1)(b)(i) applies. Therefore the asset being transferred, (being the land), must be an active asset.

Active asset

39.       Paragraph 152-40(1)(a) provides that a tangible or intangible CGT asset is an active asset if you own the asset and it is used, or held ready for use, in a business carried on (whether alone or in partnership) by you, your affiliate or another entity that is connected with you.

40.       The asset being transferred by the Company is land that is used in the course of a carrying on the businesses. The land is therefore an active asset. The requirement in subparagraph 328-430(1)(d)(i) will be satisfied.

Paragraph 328-430(1)(e) - residency

41.       Paragraph 328-430(1)(e) requires both the transferor and the transferee to meet the residency requirements outlined in section 328-445. As the Company and New Family Trust 1 and New Family Trust 2 are Australian residents for tax purposes, the requirement in paragraph 328-430(1)(e) will be satisfied.

Paragraph 328-430(1)(f) - roll-over choice

42.       Paragraph 328-430(1)(f) requires both the transferor and the transferee to choose to apply the roll-over under Subdivision 328-G in relation to the assets transferred under the transaction.

43.       The Company, New Family Trust 1 and New Family Trust 2will choose to apply the roll-over in relation to the transfer of the land. Therefore, the requirement in paragraph 328-430(1)(f) will be satisfied.

Conclusion

44.       As each of the requirements in subsection 328-430(1) have been met, the Company is eligible to choose roll-over relief under Subdivision 328-G in relation to the Proposed Transaction.

Question 2

Summary

Since section 328-430 applies to this transaction, section 328-450 will operate to stop the application of section 109C of the ITAA 1936.

Detailed reasoning

45.       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.

46.       The legislation provides the following example under paragraph 328-450(1)(b):

If the transfer were a transfer of the asset from a company to a shareholder, it would not be treated as a payment of a dividend under Division 7A of Part III of the Income Tax Assessment Act 1936.

47.       Further, the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 explanatory memorandum states:

Transfers not to affect income tax position

1.45 As with other roll-overs, the small business restructure roll-over is intended to be tax-neutral, in the sense that no income tax consequences arise from the transfer of the asset(s). This will provide small businesses with the flexibility to change their legal structure without the cash flow problems that may arise from realising an income tax liability on the transfer of assets to a different entity. [Schedule 1, item 1, section 328-450]

1.46 The roll-over can be used for transfers from and to a range of different entity types, and such transfers may trigger various provisions under the existing income tax law. For example, a transfer of an asset by a company to a shareholder may be an assessable dividend under section 44 of the ITAA 1936 or Division 7A.

1.47 Section 328-450 ensures that there are tax neutral consequences for a transfer that qualifies for the roll-over, by 'switching off' the application of the existing income tax law. [Schedule 1, item 1, section 328-450]

48.       The Company has proposed to transfer the land to New Family Trust 1 and New Family Trust 2. Since it has been established that section 328-430 applies to this transaction, section 328-450 will operate to 'switch off' any direct income tax law consequences of the transfer.

49.       Therefore, as section 328-450 ITAA 1997 'switches off' the direct income tax law consequences of the transfer, the transfers are not considered payments under section 109C of the ITAA 1936.

[1] Paragraph 328-440(a)

[2] Paragraph 328-440(b) and (c)