Edited version of private advice

Authorisation Number: 1052060313808

Date of advice: 22 November 2022

Ruling

Subject: Small business restructure rollover of partnership assets

Question

Will the small business restructure roll-over under subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997) be available for the proposed transfer of the business assets from the partnership of Individual A, Individual B and the Family Trust (the Partnership) to a newly established company (referred to as XXX)?

Answer

Yes

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Partnership is owned by Individual A, Individual B and the Family Trust.

Revenue for the Partnership has more than doubled in the last three years.

It is proposed that the Partnership business assets (including goodwill, depreciating assets and trading stock) be transferred to XXX. The shareholding in XXX will be owned by Individual A, Individual B and the Family Trust in the same proportions as their partnership interests.

The Family Trust has made a Family Trust Election.

The Deed of Settlement of the Family Trust limits beneficiaries to family members.

The Partnership is a small business entity under section 328-110 of the ITAA 1997.

XXX will carry on the business after the transfer and will be a small business entity under section 328-110 of the ITAA 1997.

The business assets to be transferred are active assets of the Partnership business under section 152-40 of the ITAA 1997.

All parties to the transfer meet the residency requirements in section 328-445 of the ITAA 1997.

The Partnership, each of the Partners and XXX will apply a roll-over under Subdivision 328-G of the ITAA 1997 in relation to the relevant Partnership business assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 40-340

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 Subdivision 328-G

Income Tax Assessment Act 1997 section 328-110

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

Income Tax Assessment Act 1997 subsection 328-440

Income Tax Assessment Act 1997 section 328-445

Taxation Administration Act 1953 section 370-5 of Schedule 1

Income Tax Assessment Act 1936 Schedule 2F

Reasons for decision

Summary

All legislative references are to ITAA 1997 unless otherwise stated.

The proposed transfers of relevant business assets from the Partnership to XXX will meet the requirements for small business restructure rollover relief under Subdivision 328-G.

Detailed reasoning

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

Subsection 328-430(1) outlines the conditions to be met for the roll-over relief to be available:

1. The transfer of the asset is, or is part of, a genuine restructure of an ongoing business (paragraph 328-430(1)(a)); and
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)); and
3. There is no material change in the ultimate economic ownership of the transferred asset (paragraph 328-430(1)(c)); and
4. The asset being transferred is an active asset of the relevant small business entity at the time of the transfer (paragraph 328-430(1)(d)); and
5. Both the transferor and each transferee are residents of Australia (paragraph 328-430(1)(e)); and
6. Both the transferor and each transferee choose to apply the roll-over (paragraph 328-430(1)(f)).

All conditions in subsection 328-430(1) need to be met for the Subdivision 328-G rollover to be applied to the transfer of the rollover.

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.

Application to your circumstances

The private ruling application provides that the Partnership structure is not conducive to the growth of the business as it exposes the partners personally to litigation risk from the operation of the Partnership business and provides difficulties in obtaining finance. The private ruling application contends that the company structure will simplify dealings with suppliers and financial institutions and allow for the possibility of bringing employees into partial ownership of the business.

We accept the contention and agree that the restructure will provide opportunities for growth by allowing for improved financing options. The restructure is not unduly tax driven, nor is there evidence that it is an attempt to wind down or extract wealth from the business. We agree that the proposed transfer of each of the Partnership assets are part of a genuine restructure of an ongoing business and paragraph 328-430(1)(a) is satisfied.

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.

Application to your circumstances

The Family Trust, Individual A and Individual B are each a partner in the Partnership that is a small business entity, therefore subparagraph 328-430(1)(b)(iv) is satisfied for each of the transferors of the assets.

As XXX will be a small business entity in the income year, subparagraph 328-430(1)(b)(i) is satisfied for the transferee of the assets.

As each party to the transfer satisfies a relevant requirement, the small business entity test in paragraph 328-430(1)(b) will be satisfied for the transfer of the Partnership assets.

Condition 3: Ultimate economic ownership

Paragraph 328-430(1)(c) requires that 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

The term 'ultimate economic ownership' is not defined in the income tax provisions. Paragraph 1.29 and 1.30 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Act 2016 explains that the ultimate economic owners of an asset are individuals who, directly or indirectly, beneficially own an asset. As the ultimate economic owners can only be individuals, a look through approach applies where a company, partnership or trust owns the asset.

Under ordinary legal concepts, a beneficiary of a discretionary trust does not have any beneficial interest in any trust property prior to a distribution or appointment of income or capital. Instead, a beneficiary of a discretionary trust only has a right to require the trustee to consider whether or not to exercise their discretion (Gartside v. Inland Revenue Commissioner (1968) AC 553.

In relation to the application of the ultimate ownership test to discretionary trusts, the Commissioner's view provided in paragraph 107 of LCR 2016/3 is that a transfer of assets from or to a discretionary trust will generally not meet the requirements for ultimate economic ownership on their facts.

Alternative economic ownership test

Section 328-440 provides that for the purpose 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)    just before the transaction took effect, the asset was included in the property of a non-fixed trust that was a family trust;

(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.

Application to your circumstances

After the transfer the assets to XXX, the Family Trust, Individual A, and Individual B will own shares in XXX in the same proportions as they held their interest in the Partnership assets.

We accept that the transfer of the Partnership assets held by Individual A and Individual B to XXX will meet the requirements of the ultimate economic ownership in paragraph 328-430(1)(c). The ultimate economic ownership can be traced to Individual A and Individual B, and the individuals retain the same respective economic benefit as held prior to the transfers

It is not possible however, to determine or fix each individuals proportionate interest in the Partnership assets held by the Family Trust. This is because it is a discretionary trust with multiple individual beneficiaries who stand to benefit subject to the trustee's discretion in their favour. Consequently, the alternative economic ownership test must be considered.

For the purpose of the ultimate economic ownership test in paragraph 328-430(1)(c), the alternative economic ownership test in section 328-440 is satisfied for the transfer of the Partnership assets held by the Family Trust as:

•         just before the transfer the Partnership assets were included in the property of the Family Trust a non-fixed trust that was a family trust

•         every individual who had ultimate economic ownership in the assets before the transfer and every individual who the ultimate economic ownership of the assets post the transfer is a member of the same family group.

The ultimate economic ownership test in 328-430(1)(c) is satisfied for the transfer of the Partnership assets held by each partner to XXX.

Condition 4: Active assets

Paragraph 328-430(1)(d) sets the requirement that the asset to be transferred 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

A CGT asset (whether a tangible or intangible asset) is an active asset at a time if, at that time, you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by you, an affiliate of yours, or by another entity that is connected with you (subsection 152-40(1)).

Application to your circumstances

Subparagraph 328-430(1)(d)(iii) is satisfied for the Partnership business assets being transferred as these are active assets and interests in the assets of the partnership.

Subparagraph 328-430(1)(d)(i) is satisfied as the business assets transferred will be active assets of XXX.

The active asset test will be satisfied for all parties to the transfers and the active asset test in 328-430(1)(d) is satisfied.

Condition 5: Residency requirements

All parties to the transfer meet the residency requirements in section 328-445 satisfying paragraph 328-430(1)(e).

Condition 6: All parties choose to apply the rollover

Each of the Partners and the Company will apply a roll-over under Subdivision 328-G in relation to the business assets satisfying 328-430(1)(f).