Edited version of private advice

Authorisation Number: 1052163582698

Date of advice: 4 September 2023

Ruling

Subject: CGT - small business restructure rollover

Question 1

Will the Applicant 'the transferor' for the purposes of section 328-430 of the Income Tax Assessment Act 1997 (ITAA 1997)[1] under the proposed arrangement?

Answer

Yes.

Question 2

Is the Applicant eligible to apply a roll-over under section 328-430 in respect of the transfer of the business goodwill under the proposed restructure?

Answer

No.

Question 3

Is the Applicant eligible to apply a roll-over under section 328-430 in respect of the transfer of the software and associated intellectual property under the proposed restructure?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

The Applicant is the head company of a consolidated group that includes its subsidiaries Company A and Company B.

The assets of Company B are comprised of tangible and intangible assets (Business Assets).

The Applicant was incorporated in Australia and is a tax resident of Australia.

The combined turnover of the consolidated group was below $10 million in year income year before the current year.

The shares in the Applicant are all held by various discretionary trusts.

All dividends payable in respect of the profits of the Applicant have been paid to the holders of the ordinary shares.

The directors of the Applicant essentially control the trusts.

Proposed Restructure

It is proposed that each of the trusts will makes a family trust election.

The trust deeds for each of the trusts will be amended to provide that the trustee will be prohibited from distributing the income and capital of the trust to anyone outside the family group, as defined under Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936).

A new company, New Co, will be incorporated, with the directors and shareholders of being identical to the directors and shareholders of the Applicant. New Co will not join the consolidated group.

Company A will transfer all their Business Assets to New Co.

In the three-year period subsequent to the transfer:

•                There will be no change in the shareholding of New Co

•                There will be no disposal of any of the significant assets

•                There will be no alterations to the trust deeds that provide for any entity to benefit under the deeds other than members of the 'family group'

•                Any and all dividends will be paid to the holder of the ordinary shares other than in the event of the death or disability of director (in which case the associated trust of the director will receive the agreed sum)

•                New Co shall continue to carry on the Company A's business, and

•                There shall not be any significant or material use of the Business Assets for private purpose.

Relevant legislative provisions

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 subparagraph 328-440(a)(ii)

Reasons for decision

Question1:

Will the Applicant be the transferor for the purposes of section 328-430 under the proposed arrangement?

Summary

As the head company of the consolidated group, the Applicant will be the relevant transferor for the purposes of section 328-430 under the proposed arrangement.

Detailed reasoning

EXPLANATION OF THE LEGISLATION

Restructures of small businesses:

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 explains the conditions that must be satisfied when, under a transaction, an entity (the 'transferor'), transfers an asset to one or more other entities (the 'transferees'), for a rollover to be available (the relevant conditions are explained in detail below). Therefore, the provision requires consideration of the entity that would be considered the transferor.

Single Entity Rule:

Broadly, section 701-1 provides that the members of a consolidated group are treated as a single entity (being the head company) for calculating the head company's liability to income tax.

Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997 ('TR 2004/11') sets out the Commissioner's view on the application of the single entity rule (SAR).

Paragraph 31 of TR 2004/11 states:

A consequence flowing from the SER is that while an entity is a subsidiary member of a consolidated group, actions and transactions of that member are treated as having been undertaken by the head company. In addition, the assets owned by subsidiary members of the group are taken to be owned by the head company (other than assets where the rights and obligations are between members of the group) [see the EM - paragraphs 2.12, 2.20 and 2.26].

Application to your circumstances:

The proposed arrangement involves a number of steps, including the transfer of Company A's Business Assets to New Co.

The Applicant is the head company of the tax consolidated group with Company A being its subsidiary. In accordance with section 701-1 and TR 2004/11, as the head entity of the consolidated group, the Applicant will be deemed to be the relevant transferor under the proposed transaction.

Question 2:

Is the Applicant eligible to apply a roll-over under section 328-430 in respect of the transfer of the business goodwill under the proposed restructure?

Summary

The Applicant is not eligible to apply a roll-over under section 328-430 as the applicant cannot satisfy the requirement of paragraph 328-430(1)(c).

Detailed reasoning

REQUIREMENTS FOR ROLLOVER

Subsection 328-430(1) provides that:

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 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.

Paragraph 328-430(1)(a) - genuine restructure of an ongoing business

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 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 transaction occurs:

(i)        a small business entity

(ii)       an affiliate of a small business entity

(iii)      connected with a small business entity, and

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

Paragraph 328-430(1)(c) - Ultimate economic ownership

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.

The phrase 'ultimate economic ownership' is not defined in the ITAA 1997. Guidance on the meaning of the term can be found in the Explanatory Memorandum (the EM) to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016, which introduced the provisions. 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.

The EM further provides that for the purposes of subparagraph 328-430(1)(c)(ii), an individual's share of the ultimate economic ownership being 'materially unchanged' means that they have the same proportion of ultimate economic ownership before and after the transaction. In other words, that an individual's share of ultimate economic ownership is ascertainable. Paragraph 1.31 states:

1.31 If there is more than one individual who is an ultimate economic owner of an asset, there is an additional requirement that each of those individuals' shares of that ultimate economic ownership be materially unchanged, maintaining the same proportionate ownership in the asset. [Schedule 1, item 1, subparagraph 328-430(1)(c)(ii)]

Ultimate economic ownership - discretionary trusts

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.[2] 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[3]. Given this, the portion of the share of the ultimate economic ownership of an asset held by a beneficiary of a discretionary trust is impossible to specify.

The requirement under paragraph 328-430(1)(c) would generally not be able to be satisfied by discretionary trusts, 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 provides that:

328-440 Ultimate economic ownership - discretionary trusts

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) 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 of facts to the law

In order for the Applicant to be eligible to choose roll-over in relation to the transfer of the Business Assets to New Co, all the conditions in section 328-430 must be satisfied. Consequently, if the arrangement fails one of the conditions, the Applicant will not be able to satisfy section 328-430.

Ultimate economic ownership

Under the proposed arrangement, the Business Assets of the Applicant will be transferred to New Co. The directors and shareholders of New Co will be identical to the directors and shareholders of the Applicant. That is, the shareholders of New Co will be the same discretionary trusts as those owning the shares in the Applicant.

As explained in above, under ordinary legal concepts, the proportion of share to a beneficiary of a discretionary trust is impossible to specify. Therefore, it is not possible to attribute specific proportions to each individual within those discretionary trusts.

For the reason outlined above, the Applicant cannot satisfy the requirement of subparagraph 328-430(c)(ii), as a result the Applicant is not eligible for a roll-over under section 328-430.

Although paragraph 328-430(1)(c) has not been satisfied, it is necessary to consider whether the Applicant meets the alternative test for non-fixed trusts in section 328-440.

Under the proposed transaction, the Business Assets to be transferred are not included in the property of those discretionary trusts either just before or just after the proposed transaction and paragraph 328-440(a) cannot be satisfied. As such, section 328-440 has no application in the proposed transaction. The proposed arrangement will not satisfy all the conditions in section 328-430 and the Applicant will not be eligible to choose roll-over.

Question 3:

Is the Applicant eligible to apply a roll-over under section 328-430 in respect of the transfer of the software and associated intellectual property under the proposed restructure?

Summary

The Applicant is not eligible to apply a roll-over under section 328-430 as they cannot satisfy the requirement of paragraph 328-430(1)(c).

Detailed reasoning

Refer to the reasoning outlined in Question 2.

[1] All future legislative references are to the Income Tax Assessment Act 1997, unless otherwise specified.

[2] Commissioner of Stamp Duties (NSW) v. Buckle (1998) 192 CLR 226.

[3] Gartside v. Inland Revenue Commissioner [1968] AC 553.