Edited version of private advice

Authorisation Number: 1052128140038

Date of advice: 19 June 2023

Ruling

Subject: Small business restructure roll-over

Question 1

Will the transfer of assets from the Trust to a new company with a different discretionary trust shareholder, satisfy the requirements of the small business restructure roll-over in Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

In the event the answer to question 1 is no, will the transfer of assets from the Trust to a new company with the same Trust as the shareholder, satisfy the requirements of the small business restructure roll-over in Subdivision 328-G of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20xx

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

The Trust operates a business,

Company A is the trustee of the Trust.

The Trust:

•         is a discretionary trust and is a non-fixed trust (for the purposes of section 272-70 of Schedule 2F to the ITAA 1936 (Non-fixed Trust); and

•         has a family trust election made under section 272-80 (FTE) nominating Person Z as the specified individual.

Person Z died a number of years ago.

The Proposed Restructure

The family operating the Trust's business wish to be able to retain profits in the business going forward to facilitate business reinvestment and growth.

Therefore, they wish to transfer the majority of the business assets to a newly incorporated company (New Co).

The intention is that the shareholder of New Co will be a new Non-Fixed trust (New Trust) rather than the Trust. The reason New Trust has been selected is due to the test individual for the purposes of the FTE for the Trust being deceased.

The transfer of the business assets will occur for accounting purposes at the cost reported in the accounts and for tax purposes.

The draft trust deed of New Trust will restrict the discretionary beneficiaries to any person who, under section 272-90 of Schedule 2F to ITAA 1936, is a member of the Family Group of Person Z if Person Z were the individual specified in an FTE.

The proposed trustee of New Trust will be Company A.

The Trust is an Australian resident as will be the New Co.

Both the Trust and New Co will elect for the Subdivision 328-G of the ITAA 1997 roll-over to apply.

The Alternative Restructure

As an alternative to the Proposed Restructure, it has been proposed that in the event the answer to Question 1 is no, the transfer the business assets will occur from the Trust to New Co with the Trust as the sole shareholder.

The sole difference in this Alternative Restructure to the Proposed Restructure will be that the sole shareholder of New Co will be the Trust, instead of New Trust.

Assumptions

•         The aggregated turnover of the Trust and New Co will be less than $10 million for the period of the private ruling.

•         At the time of the transfer of the asset, or assets, the Trust and the New Co will satisfy the residency requirement in section 328-445 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 122-A

Income Tax Assessment Act 1997 section 152-10

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

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 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 328-440

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

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

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

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

Income Tax Assessment Act 1997 paragraph 328-445

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

Income Tax Assessment Act 1936 Division 7A

Reasons for decision

Question 1

Summary

The Proposed Restructure will not qualify for small business restructure relief under Subdivision 328-G of the ITAA 1997.

[Note: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified. References to the Income Tax Assessment Act 1936 are referred to as the 'ITAA 1936'].

Detailed reasoning

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.

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.

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 restructure are not either of these types of entities, subsection 328-430(2) does not apply.

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

Paragraph 328-430(1)(a) 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 of 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 provides guidance of the Commissioner's view on whether a transaction will be part of a 'genuine restructure of an ongoing business'.

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.

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.

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. (Refer to paragraph 10 of LCR 2016/3).

The private ruling applicationstates that the reason for the proposed restructure is for the purpose of facilitating business growth through profit retention. The only intended transaction in the three years following the restructure is the ordinary sale of the trading stock.

As the restructure is intended to facilitate growth, and the owners will continue to operate the business in a different legal structure, the Commissioner accepts that the restructure is a 'genuine restructure' of an ongoing business.

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

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

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.

You have advised that the Trust carries on a farming business in the current year and had an aggregated turnover in the previous year of less than $10 million and that New Co will conduct the business once the assets have been transferred to it. As this is expected to occur part way through the financial year, and the expected aggregated turnover for the financial year is less than $10 million New Co satisfies this requirement.

Therefore, the requirements in subsection 328-110(1) to be considered a small business entity will be satisfied.

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

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.

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 (i) has a right to require the trustee to consider whether or not to exercise their discretion; (ii) has a 'mere expectancy' in the income or capital of a trust; and (iii) does not have an interest in possession: Gartside v. Inland Revenue Commissioner [1968] AC 553.

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.

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. [Emphasis added]

The Trust is a Non-fixed Trust for the purposes of section 272-70 of Schedule 2F to the ITAA 1936 and has made an FTE nominating a specified individual, Person Z, under section 272-80 of Schedule 2F to the ITAA 1936. As the assets proposed to be transferred are the property of the Trust immediately before the Proposed Transaction takes effect, this will fall within subparagraph 328-440(a)(i).

In relation to paragraph 328-440(b) it is satisfied as every individual who, just before the Proposed Restructure happens, will have the ultimate economic ownership of the asset and will be a member of the Family Group relating to the Trust (i.e., the trust referred to in subparagraph (a)(i)).

Paragraph 328-440(c) requires that, '...every individual who, just after the transfer takes effect, has the ultimate economic ownership of the asset is a member of that family group...' [Emphasis added]

The reference to '... that family group ...' is a reference to the family group referred to in paragraph 328-440(b) (which, in turn, refers to the FTE made in relation to the trust in paragraph 328-440(a)).

Section 272-90 of Schedule 2F to the ITAA 1936 defines the term Family Group by reference to the individual specified in the FTE.

It is considered that paragraph 328-440(c) imposes an actual requirement that the individuals that have the ultimate economic ownership of the asset after the transfer are a member of the Family Group of the specified individual in relation to the FTE referred to in paragraphs 328-440(a) and (b).

Paragraph 328-440(c) will not be satisfied where the relevant individuals are merely notionally, or hypothetically, a member of the Family Group of the specified individual in relation to the FTE referred to in paragraphs 328-440(a) and (b).

In this case, the FTE is the one made by the Trust and the individual specified in that FTE is Person Z. The legislative requirement in paragraph 328-440(c) will be satisfied if New Trust makes a valid FTE that is in force with Person Z as the specified individual.

In relation to the Proposed Restructure and New Trust it is noted that:

•         New Trust is proposed to be the sole shareholder of New Co;

•         New Trust cannot make an FTE specifying Person Z as the specified individual as he is now deceased;

•         It is not proposed that New Trust will make an FTE specifying a different specified individual; and

•         The draft trust deed for New Trust will restrict the discretionary beneficiaries to any person who, under section 272-90 of Schedule 2F to the ITAA 1936, is a member of the Family Group of Person Z if Person Z were the individual specified in an FTE.

As the ultimate economic ownership test in paragraph 328-430(1)(c) cannot be satisfied, the conditions in subsection 328-430(1) are not satisfied, and the Proposed Restructure will not qualify for small business restructure relief under subdivision 328-G of the ITAA 1997.

Question 2

Summary

The Alternative Restructure will qualify for small business restructure relief under subdivision 328-G of the ITAA 1997.

Detailed reasoning

As detailed above in Question 1, the ultimate economic ownership test under section 328-440 must be satisfied for relief under subdivision 328-G.

In the case of the Alternative Restructure, the sole shareholder of New Co will be the Trust, instead of being New Trust.

The Trust is a Non-fixed Trust for the purposes of section 272-70 of Schedule 2F of the ITAA 1936 and has made an FTE nominating a specified individual, Person Z, under section 272-80 of Schedule 2F to the ITAA 1936. As the assets proposed to be transferred are the property of the Trust immediately before the Proposed Transaction takes effect, this will fall within subparagraph 328-440(a)(i).

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.

In relation to paragraph 328-440(b) it is satisfied as every individual who, just before the Proposed Restructure happens, will have the ultimate economic ownership of the asset and will be a member of the Family Group relating to the Trust (i.e., the trust referred to in subparagraph (a)(i)).

Similarly, paragraph 328-440(c) requires that, every individual who, just after the transfer takes effect, has the ultimate economic ownership of the asset is a member of the Family Group (i.e., of the individual specified in the FTE referred to in paragraphs 328-440(a) and (b)). As the sole shareholder of New Co will be the Trust, paragraph 328-440(c) will be satisfied.

As the requirements of section 328-440 are satisfied the requirements of 328-430(1)(c) are also satisfied.

Active assets

Section 328-430(1)(d) requires that the transferred asset is a CGT asset (other than a depreciating asset) that is an active asset, at the time the transfer takes effect.

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.

The assets being transferred to the New Co are used in the course of a carrying on the business. Therefore, the assets will be active assets and the requirement in subparagraph 328-430(1)(d)(i) will be satisfied.

Residency

Both the Trust and New Co are Australian residents and meet the residency requirements of subsection 328-430(1)(e).

Roll-over choice

Both the Trust and the New Company will choose for the roll-over to apply in relation to the assets and paragraph 328-430(1)(f) will, therefore, be satisfied.

Conclusion

As each of the requirements in paragraphs 328-430(1)(a) to (f) will be satisfied if the Alternative Restructure is implemented, it will qualify for small business restructure relief under subdivision 328-G.