Edited version of private advice

Authorisation Number: 1052116087153

Date of advice: 8 May 2023

Ruling

Subject: CGT - small business concessions

Question 1

Is the Commissioner satisfied under Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997) to allow small business restructure roll-over relief to apply to the transfer of primary production business real property from Person A to a new discretionary trust without incurring an income tax liability?

Answer

Yes.

Question 2

Is the land satisfy an active asset?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Person A is an Australian resident for income tax purposes. Person A is a partner in a farming partnership. All partners are Australian residents for income tax purposes. Pursuant to the partnership agreement, the partners' entitlement to share of profits and losses are as follows:

The partnership has an aggregated turnover of less than $10 million in the year ended 30 June 20XX. Person A Family Trust and Person A Trust have not made distributions of income or capital in the last 4 years, due to incurring losses.

Person A owns farming land (the land) which was acquired in the 1990s. The partnership carries on a primary production business on the land. These activities have continued since acquisition of the land. Person A works full-time in the farming business and contributes a significant amount of personal labour and management, including day-to-day activities of manual labour, machinery operation and decision making.

Proposed new transferee trust

Person A will be appointor of a new discretionary trust (Land Trust) which will have a corporate trustee. Person A and spouse will be directors and shareholders of the corporate trustee. The new trust will be an Australian resident for tax purposes. Its primary beneficiaries will be Person A and spouse; the secondary beneficiaries will be Person A's two children. The trustee will make a family trust election (FTE) nominating Person A as the test individual, pursuant to section 272-95 of Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936). Therefore, the Land Trust will be a family trust pursuant to Subdivision 272-D of Schedule 2F of the ITAA 1936. Person A will not be paid any consideration for the land by the new trust.

Reasons for restructure

The transfer of the land will allow for the consolidation of a major business asset into a single separate entity from its current owner, being Person A. Asset protection is a major driver of the restructure. There are a number of risks attached to the enterprise and nature of the business activity.

Because Person A is a partner in the primary production business partnership, if any legal action is brought against the business, then the partners are each jointly and severally liable, and assets that are held in their own names can be subject to any such action. Transferring the land from Person A to a new trustee will reduce the risk of significant land assets being exposed to legal action, and will reduce the overall risk of the business, and Person A's personal exposure to such risk.

The partnership equity percentages after the land transfer will remain the same as the equity percentages before the land transfer. There will be no notable change in the business operations after the restructure; the roles of Person A, spouse and two children will remain unchanged. The land will continue to be a business asset used in the primary production business partnership.

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F Subdivision 272-D

Income Tax Assessment Act 1936 Schedule 2F section 272-95

Income Tax Assessment Act 1997 section 152-35

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 328-110(1)

Income Tax Assessment Act 1997 section 328-125

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

Income Tax Assessment Act 1997 paragraph 328-125(1)(b)

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 subparagraph 328-125(2)(a)(ii)

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

Income Tax Assessment Act 1997 subsection 328-125(4)

Income Tax Assessment Act 1997 section 328-130

Income Tax Assessment Act 1997 subsection 328-130(1)

Income Tax Assessment Act 1997 subsection 328-130(2)

Income Tax Assessment Act 1997 section 328-430

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

Income Tax Assessment Act 1997 section 328-440

Reasons for decision

Subsection 328-430(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a roll-over under Subdivision 328-G 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 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; 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.

Section 328-440 of the ITAA 1997 discusses ultimate economic ownership in relation to non-fixed trusts and provides 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:

(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 (ITAA 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.

Genuine restructure of an ongoing business

Paragraph 328-430(1)(a) of the ITAA 1997 requires that the transaction is, or is part of, a genuine restructure of an ongoing business.

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 the circumstances surrounding the restructure.

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

Paragraph 6 of LCR 2016/3, in part, explains 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.

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.

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.

Small business entity

To satisfy paragraph 328-430(1)(b), both the transferor and the transferee must be one or more of the following:

(i)    a small business entity for the income year during which the transfer occurred

(ii)   an entity which has an affiliate that is a small business entity for the year in which the transfer occurred

(iii)  an entity which is connected with an entity that is a small business entity for the year in which the transfer occurred, or

(iv)  be a partner in a partnership that is a small business entity for the year in which the transfer occurred.

Subsection 328-110(1) of the ITAA 1997 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.

Connected with

Subsection 328-125(1) of the ITAA 1997 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.

Subsection 328-125(2) provides that an entity controls another entity (other than a discretionary trust) if it, or its affiliate, or both:

(a)  owns, or has the right to acquire, interests in that other entity that give the right to receive at least 40% of any distribution of income or capital by the other entity; or

(b)  if the other entity is a company, owns or has the right to acquire equity interests in the company that give at least 40% of the voting power of the company

Subsections 328-125(3) and (4) provide two tests for when an entity controls a discretionary trust.

Firstly, an 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 that entity, its affiliates, or both.

Secondly, an entity controls a discretionary trust for an income year if for any of the four income years before that year:

(a)  the trustee paid to, or applied for the benefit of, the beneficiary or their affiliates, or both the beneficiary and any of its affiliates, any of the income or capital of the trust, and

(b)  the amounts paid or applied were at least 40% (the control percentage) of the total amount of income or capital paid or applied for that income year (subject to the Commissioner's discretion where the control percentage is between 40% and 50%)

No change in economic ownership

Paragraph 328-430(1)(c) of the ITAA 1997 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.

Beneficiaries of a discretionary trust cannot have ultimate economic ownership of the assets of the trust. 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 a beneficiary of a discretionary trust does not hold an interest in any asset of the trust, it cannot be said that any beneficiary of a discretionary trust will have ultimate economic ownership for the purpose of paragraph 328-430(1)(c) of the ITAA 1997.

Alternative ultimate economic ownership test

Section 328-440 of the ITAA 1997 contains an alternative ultimate economic ownership test for discretionary trusts. Section 328-440 provides 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:

(a)  either or both of the following applies:

(i)    just before the transaction takes effect, the asset is included in the property of a non-fixed trust that is 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 (ITAA 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.

"Family group" is defined in section 272-90 of Schedule 2F to the ITAA 1936 with reference to the individual specified in a family trust election. The new Land Trust make a family trust election (FTE) and will specify Person A as the test individual.

Just before the proposed transaction, the land is property of Person A solely. Just after the proposed transaction, the land will be property of the Land Trust, which will be a non-fixed trust with an FTE in place.

Every individual (Person A) who, just before the transfer will take effect, had the ultimate economic ownership of the asset, was a member of the family group relating to the new Land Trust, and every individual (Person A) who, just after the transfer will take effect, has the ultimate economic ownership of the asset, is a member of that same family group. The ultimate economic ownership of the asset remains with individuals within the same family group after the transfer takes effect, and therefore the alternative ultimate economic ownership test in section 328-440 of the ITAA 1997 is satisfied.

Australian residents

Paragraph 328-430(1)(e) of the ITAA 1997 requires both the transferor and the transferee to meet the residency requirements outlined in section 328-445 of the ITAA 1997.

Where the entity is a trust, it must be a resident trust for CGT purposes. A family trust is a resident trust for CGT purposes for an income year if at any time during that income year, the trustee is an Australian resident, or the central management and control of the trust is in Australia.

Where the entity is a company, the entity must be an Australian resident. A company is a resident of Australia if it is incorporated in Australia, or it carries on business in Australia and has either its central management in Australia, or its voting power is controlled by shareholders who are residents of Australia.

In this case, Person A is an Australian resident, and the new corporate trustee will be incorporated in Australia and therefore be an Australian resident, satisfying paragraph 328-430(1)(e) of the ITAA 1997.

Choice

Paragraph 328-430(1)(f) of the ITAA 1997 requires that both the transferor and the transferee choose to apply the roll-over under Subdivision 328-G of the ITAA 1997 in relation to the assets transferred under the transaction.

Person A and the Land Trust will make the choice to apply the roll-over under Subdivision 328-G of the ITAA 1997 in relation to the land being transferred under the transaction.

Person A is connected with the primary production business partnership pursuant to paragraph 328-125(1)(a) of the ITAA 1997 due to satisfaction of the control test in subparagraph 328-125(2)(a)(ii).

Transferor - Person A

Person A is a partner in the primary production business partnership, which is a small business entity in the income year of transfer.

Transferee - Land Trust

The proposed new Land Trust will be controlled by Person A pursuant to section 328-125(3) of the ITAA 1997, because Person A will be a director and 50% shareholder of the corporate trustee, which could reasonably be expected to act in accordance with Person A's directions or wishes.

As noted above, pursuant to paragraph 328-125(1)(b) of the ITAA 1997, an entity is connected with another entity if both entities are controlled ... by the same third entity. Given that Person A has direct control of the partnership for the purposes of subsection 328-125(2) of the ITAA 1997 and will have direct control of the new trust pursuant to section 328-125(3), the new trust will be considered to be connected to the partnership by virtue of paragraph 328-125(1)(b).

Reasons for restructure

The transfer of the land will allow for the consolidation of a major business asset into a single separate entity from its current owner, being Person A. Asset protection is a major driver of the restructure.

Because Person A is a partner in the primary production business partnership, if any legal action is brought against the business, then the partners are each jointly and severally liable, and assets that are held in their own names can be subject to any such action. Transferring the land from Person A to a new trustee will reduce the risk of significant land assets being exposed to legal action, and will reduce the overall risk of the business, and Person A's personal exposure to such risk.

The partnership equity percentages after the land transfer will remain the same as the equity percentages before the land transfer. There will be no notable change in the business operations after the restructure; the roles of Person A, their spouse and two children will remain unchanged. The land will continue to be a business asset used in the primary production business partnership.

Consistent with the commentary and examples provided in LCR 2016/3, this is considered to be a genuine restructure. The economic ownership of the business and the assets will be maintained. The conditions in section 328-430 of the ITAA 1997 have been satisfied and the small business restructure rollover relief is available under Subdivision 328-G in respect of the land transfer transaction.

Active asset

Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a time if, at that time:

(a)  you own the asset (whether the asset is tangible or intangible) 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:

(i)    you; or

(ii)   your affiliate; or

(iii)  another entity that is connected with you.

Person A's land has been used in the connected partnership's primary production business since Person A's acquisition of it. Accordingly, the land is an active asset.