Edited version of private advice

Authorisation Number: 1052090178113

Date of advice: 27 February 2023

Ruling

Subject: CGT - small business relief

Question

Does the proposed transfer of farming land qualify for small business restructure relief under subdivision 328-G of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer

No.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.    The applicant, the Trust, is a discretionary trust that owns:

•         Cash and deposits;

•         Listed shares;

•         Farm plant and equipment; and

•         Farmland and buildings.

2.      The applicant leases the farmland and buildings to Z who uses them to operate their farming business as a sole trader.

3.      Company Pty Ltd is a company incorporated in Australia and is the trustee company of the applicant.

4.      The directors of Company Pty Ltd are:

•         X;

•         Y; and

•         Z.

5.      The shareholders of Company Pty Ltd are:

•         X;

•         Y;

•         Z; and

•         B.

6.      The applicant's aggregated annual turnover for the year ended 30 June 20XX was less than $XX million.

7.      Z's aggregated annual turnover for the year ended 30 June 20XX was less than $XX million.

8.      The applicant's asset ownership is considered sub-optimal in that the cash and share portfolio are exposed to the inherent risks of holding the farmland.

9.      The applicant wishes to maximise the asset protection of its assets by separating them.

10.   The applicant's class of beneficiaries is limited to the children of A and any spouse or issue of A, as well as any spouse or issue of any of A's children. The principal beneficiaries are listed as B, wife of A, X, Y, and Z, children of A.

11.   The Trust made a family trust election for the 20xx income year, in accordance with Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) nominating A as the test individual.

12.   A is now deceased.

The Proposed Transaction

13.   The Proposed Transaction is intended to provide a structure that better isolates passive investments from the risks inherent in farmland ownership.

14.   In order to achieve enhanced asset protection, it is proposed that the applicant will transfer the farmland and buildings to another discretionary trust (New Trust).

15.   Z will also be a director and shareholder of the trustee company of New Trust.

16.   The trustee company of New Trust will be a company incorporated in Australia.

17.   The beneficiaries of New Trust will be limited to individuals who are members of the family group of both the applicant and New Trust. The beneficiaries of applicant and New Trust will be the exact same individuals.

18.   New Trust proposes to make a family trust election in accordance with Schedule 2F of the ITAA 1936. As New Trust cannot nominate a deceased individual as the test individual in the family trust election, it will instead nominate Z.

19.   Following the transaction, for a period of at least 3 years:

•         there will be no change to the ownership of the significant assets of New Trust;

•         the farmland and buildings held by New Trust will be active assets as they will continue to be farmed by Z who will also be connected with New Trust; and

•         there will be no significant or material use of those assets for private purposes.

20.   The applicant and the New Trust will choose to apply the roll-over under Subdivision 328-G of the ITAA 1997.

Assumptions

21.  The applicant and New Trust will be connected with Z, or failing that, would be associated with Z.

22.  The applicant and New Trust at the time of the transfer will be resident trusts for CGT purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-40

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 paragraph 328-430(1)(c)

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

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 328-435

Income Tax Assessment Act 1997 section 328-440

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

Reasons for decision

All future legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified.

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 six basic conditions in subsection 328-430(1) that must be satisfied 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 trustee for the Trust (the transferor) proposes to transfer farming land to the New Trust (the transferee).

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 apply.

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 of the Commissioner's view on whether a transaction will be part of a 'genuine restructure of an ongoing business'.

9.      The Commissioner's view in LCR 2016/3 is 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 the Commissioner accepts will indicate that 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 Commissioner's view is that 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. In the Commissioner's view, 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 farming enterprise will continue to be carried on by Z, who will lease the farmland and buildings from the New Trust.

13.   The applicant has stated that the reason for the Proposed Transaction is for asset protection, to ensure the trust's passive assets are not exposed to the risks of ownership of farmland.

14.   The Commissioner accepts that the restructure is a 'genuine restructure' of an ongoing business.

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.

18.          The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators to determine the matter, these indicators are summarised in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production. These indicators are applicable to business activity generally.

19.          The Commissioner views the following indicators as relevant:

•           whether the activity has a significant commercial purpose or character;

•           whether the taxpayer has more than just an intention to engage in business

•           whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

•           whether there is repetition and regularity of the activity

•           whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

•           whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit and

•           the size, scale and permanency of the activity.

20.          You have advised that Z carries on a farming business in the current year and had an aggregated turnover in the previous year of less than $10 million. He would therefore satisfy the requirements in subsection 328-110(1) to be considered a small business entity.

Connected with a small business entity

21.          Subsection 328-125(1) states 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.

22.          If the Trust and New Trust can establish that they are controlled by a small business entity, in this case Z, they can satisfy paragraph 328-430(1)(b).

23.          In determining whether a discretionary trust is controlled by another entity, the relevant control tests are set out in subsection 328-125(3) and (4) as follows:

Direct control of a discretionary trust

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

(4)          An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a)   the trustee of the trust paid to, or applied for the benefit of:

(i)            the first entity; or

(ii)           any of the first entity's *affiliates; or

(iii)          the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b)           the percentage (the 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.

(5)          An entity does not control a discretionary trust because of subsection (4) if the entity is:

(a)           an *exempt entity; or

(b)           a *deductible gift recipient.

24.          Z is a director and shareholder in the trustee company, Company Pty Ltd.

25.          The other directors and shareholders are relatives of Z.

26.          The applicant has advised that Z and their affiliates control the Trust as Company Pty Ltd acts, or could reasonably be expected to act, in accordance with Z.

27.          Z will also be a director and shareholder in the trustee company for the New Trust. The applicant has advised that Z will control the New Trust as the trustee company will act, or could reasonably be expected to act, in accordance with Z.

Conclusion

28.          The applicant has advised that Z controls the Trust and will control the New Trust. In accordance with subsection 328-125(3), both the trusts as transferor and transferee will be connected with a small business entity, being Z. The applicant has advised that, paragraph 328-430(1)(b)(iii) is satisfied.

29.          The applicant has advised that Z would also be an associate of the Trust and New Trust so that paragraph 328-430(1)(b)(ii) would also be satisfied.

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

30.          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.

31.          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.

32.          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.

33.          Section 328-440 is satisfied 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.

34.          The applicant is a non-fixed trust for the purposes of section 272-70 of Schedule 2F of the ITAA 1936 and has made a family trust election nominating a specified individual, A, under section 272-80 of Schedule 2F to the ITAA 1936. As the assets proposed to be transferred are the property of the applicant immediately before the Proposed Transaction takes effect, this will fall within subparagraph 328-440(a)(i).

35.          It is proposed to transfer the assets to New Trust which will make a family trust election under section 272-80 of Schedule 2F to the ITAA 1936 to nominate Z, as the specified individual.

36.          After undertaking the planned restructure, there will be two trusts identified by paragraph 328-440(a), the applicant and New Trust. However, each election will have a different specified person and therefore a different family group. As a family group is defined by reference to an individual[1], this necessarily requires both family trusts to have family trust elections in place that specify the same individual. Where there is a family trust election in place for only one of the trusts, and the second proposes to make an election, it must specify the same individual.

37.          Paragraph 328-440(b) requires that the trust or trusts are those that are identified in paragraph 328-440(a), and that we consider whether all the ultimate economic owners of the transferring trust are members of the family group. However, the two trusts identified in paragraph 328-440(a) have different family groups. Similarly, paragraph 328-440(c) requires that all ultimate economic owners of the assets in New Trust are members of 'that family group'. Again, a single family group cannot be identified because the two trusts identified for paragraph 328-440(a) do not have the same family group.

38.          Consequently, the alternative ultimate economic ownership test under section 328-440 cannot be satisfied due to the applicant trust and New Trust not having the same family group. Therefore, the condition in paragraph 328-430(1)(c) will not be satisfied.

Conclusion

39.          As the ultimate economic ownership test in paragraph 328-430(1)(c) cannot be satisfied, the proposed transfer of farming land will not qualify for small business restructure relief under subdivision 328-G of the ITAA 1997.

[1] Subsection 272-90(1) of Schedule 2F to the Income Tax Assessment Act 1936.