Edited version of private advice

Authorisation Number: 1052174385367

Date of advice: 10 October 2023

Ruling

Subject: CGT - small business rollover

Question

Will the proposed transfer of farming land from the applicant to Person A, 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 period.

Year ended 30 June 2024

The scheme commences on:

1 July 2023

Relevant facts and circumstances

1.    The applicant, is a discretionary trust. The Trustee of the Trust is a company that is incorporated in Australia.

2.    The directors of Trustee company are:

•                     Person A;

•                     Person B; and

•                     Person C.

3.    The shareholders of XXX are:

•                     Person A;

•                     Person B;

•                     Person C; and

•                     Person D.

4.    The applicant's class of beneficiaries is limited to the children of Person E and any spouse or issue of Person E, as well as any spouse or issue of any of Person E's children. The Principal beneficiaries are listed as Person D, wife of Person E, Person A, Person B, and Person C, children of Person E.

5.    The trustee of the applicant holds:

•                     Cash and deposits;

•                     Listed shares;

•                     Farm plant and equipment; and

•                     Farm land and buildings.

6.    The applicant leases the farm land and buildings to Person A who uses them to operate their farming business as a sole trader. Person A does not pay any lease payments to the Trust for the use of the farm land and buildings.

7.    The applicant's aggregated turnover for the year ended 30 June 2023 was less than $10 million.

8.    Person A's aggregated turnover for the year ended 30 June 2023 was less than $10 million.

9.    The applicant has made a family trust election, in accordance with Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) nominating Person E as the test individual.

The Proposed Transactions

10.  The applicant considers their asset ownership to be sub-optimal in that the cash and share portfolio are exposed to the inherent risks of holding the farm land.

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

12.  In order to achieve enhanced asset protection, it is proposed that the applicant will transfer the farm land and buildings to Person A, and Person A will transfer the farm land and buildings to a new discretionary trust (New Trust).

13.  In this regard, the proposed restructure will involve two separate steps

(a)          the transfer of farm land and buildings from the applicant to Person A (step 1); and

(b)          the transfer of farm land and buildings from Person A to New Trust (step 2).

14.  The transfer from the applicant to New Trust is required to be undertaken as two separate transactions in order to meet the requirements for obtaining an exemption from XXX duty under section 56 of the Duties Act 2000.

15.  The Proposed Transactions are intended to provide a structure that better isolates passive investments from the risks inherent in farm land ownership.

16.  Person A will also be a director and shareholder of the trustee company of New Trust.

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

18.  New Trust proposes to make a family trust election in accordance with Schedule 2F of the ITAA 1936, nominating Person A as the test individual.

19.  The beneficiaries of New Trust will be limited to individuals who are members of the family group of the New Trust.

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

Assumptions

21.  The applicant and New Trust will be connected with Person A, or failing that, would be affiliated with Person A.

22.  The applicant and New Trust will be resident trusts for CGT purposes.

23.  Following step 2, for a period of at least 3 years:

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

•                     the farm land and buildings held by New Trust will be active assets as they will continue to be farmed by Person A who will also be connected with New Trust; and

•                     there will be no significant or material use of those assets for private 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 328-435(a)

Income Tax Assessment Act 1997 section 328-440

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

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question

Will the proposed transfer of farming land from the applicant to Person A qualify for small business restructure relief under subdivision 328-G of the ITAA 1997[1]?

Summary

No, the proposed transfer of farm land from the applicant to Person A will not qualify for small business restructure relief under subdivision 328-G of the ITAA 1997.

Detailed reasoning

1.    The applicant proposes to transfer farming land to Person A, who will then transfer the farming land to New Trust.

2.    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.

3.    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 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.

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).

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 Transactions 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 of an ongoing business

Restructure of an ongoing business

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 (LCR 2016/3) 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.

Application to your circumstances

12.  The applicant states that its asset ownership is suboptimal in that its share portfolio and cash is exposed to inherent risks in holding the farm land. It submits that it wishes to maximise the protection of the assets by separating them by implementing the proposed arrangement.

13.  The transaction relevant to the applicant under the proposed arrangement in relation to its eligibility for rollover in Subdivision 328-G is the transfer of the farming land from the applicant to Person A (step 1).

14.  It is not accepted that the transaction will offer any additional asset protection to the applicant or Person A. Person A conducts their farming business as a sole trader and is the entity that is open to business risk. There is no risk to the passive assets held by the applicant in connection with the farm land by the operation of Person A's business activities. In contrast, the transfer of the farm land to Person A in their personal capacity will introduce additional business risk compared to the current structure.

15.  The transaction is entirely for the purposes of gaining an exemption from XXX stamp duty. Consequently, the transaction is not one that is a genuine restructure of an ongoing business.

16.  Additionally, the transaction does not form part of a genuine restructure. The transaction cannot be explained as delivering any benefits to the efficient conduct of the farming business or structure it in a manner that it would have been structured had professional advice been sought at the time the business activity commenced. The holding of the farm land by New Trust will not facilitate growth, innovation, allow the activities to adapt to changed conditions or some similar benefit. Nor does it reduce administrative burdens or compliance costs. As Person A will continue to lease, for no cost, the farm land from a trust structure, the holding of the farm land by New Trust will not in any way benefit their farming activities.

17.  Further, the proposed arrangement, will not achieve any additional asset protection to the current structure. As such, there is no inherent risk to the remaining assets of the applicant and no additional asset protection that would be achieved through the holding of the farm land by New Trust.

18.  Consequently, in accordance with the views outlined in LCR 2016/3, the transaction is not part of a genuine restructure of an ongoing business as it is not one that could be reasonably expected to deliver benefits to Person A in respect of their efficient conduct of business. There will be no change to Person A's business operations other than them leasing, for no lease payments, the farm land from an existing trust to a newly formed trust. The proposed transaction does not aid Person A to expand, grow or otherwise benefit their business operations.

Conclusion - genuine restructure of an ongoing business

19.  As the transaction is not, or is not part of, a genuine restructure of an ongoing business, paragraph 328-430(1)(a) will not be satisfied.

Section 328-435 - genuine restructure - safe harbour rule:

20.  Section 328-435 provides a safe harbour rule which is an alternative way to satisfy the 'genuine restructure of an ongoing business' condition. A transaction will be taken to be a genuine restructure of an ongoing business for the purposes of paragraph 328-430(1)(a) where the conditions in section 328-435 have been satisfied.

21.  Paragraph 78 of LCR 2016/3 states that:

Where the safe harbour rule is satisfied, it is not necessary to consider whether the arrangement would otherwise be a 'genuine restructure of an ongoing business' under paragraph 328-430(1)(a).

22.  Section 328-435 provides that, for the purposes of paragraph 328-430(1)(a), a transaction is, or is part of, a genuine restructure of an ongoing business if, for a period of three years after the transaction occurs:

(a)          there is no change in the ultimate economic ownership of any of the significant assets of the business (other than trading stock) that were transferred under the transaction; and

(b)          those significant assets continue to be active assets; and

(c)           there is no significant or material use of those significant assets for private purposes.

No change in ultimate economic ownership - subsection 328-435(a):

23.  Ultimate economic ownership is not defined in the ITAA 1997.

24.  Higgins J in Amalgamated Society of Engineers v. Adelaide Steamship Co Ltd (1920) 28 CLR 129 at 161 to 162 states that:

...a statute is to be expounded according to the intent of the Parliament that made it; and that intention has to be found by an examination of the language used in the statute...when we find what the language means, in its ordinary and natural sense, it is our duty to obey that meaning, even if we think the result to be inconvenient, impolitic or improbable.

25.  The Macquarie Dictionary defines:

•         'ultimate' as 'forming the final aim or object' or being the 'last, as in a series',

•         economic' as 'relating to the production, distribution, and use of income and wealth', and

•         'ownership' as 'the state or fact of being an owner' or the 'legal right of possession; proprietorship'.

26.  Further, extrinsic material can be consulted to resolve ambiguity or confirm the ordinary meaning conveyed by the text of the provision: pursuant to section 15AB of the Acts Interpretation Act 1901 (AIA).

27.  The Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 (the EM) states at paragraph 1.29 that:

[t]he ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset.

28.  At paragraph 1.30, the EM also provides that the

[u]ltimate 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.

29.  The Commissioner is satisfied that the definition provided in the EM reflects the ordinary meaning of the phrase.

30.  Section 328-440 provides an alternative ultimate economic ownership test for discretionary trusts. However, the test in section 328-440 applies only for the purposes of paragraph 328-430(1)(c).

31.  Therefore, it must be determined which natural persons directly or indirectly (through any interposed entities) beneficially own the significant assets after the transaction.

32.  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.

33.  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 (Gartside). Further, a property interest will only arise if the discretion is exercised in that beneficiary's favour or the trust vests.

34.  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.

35.  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 subsection 328-435(a).

36.  There is no analogous administrative concession for section 328-435 and discretionary trusts as is the case with Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (IT 2340) for the interpretation of 'majority underlying ownership' with respect to discretionary trusts and former section 160ZZS of the ITAA 1936.

Conclusion - genuine restructure - safe harbour rule

37.  The transaction relevant to the applicant in relation to its eligibility to rollover is the transfer of the farm land to Person A (step 1).

38.  In the 3 year period after step 1 occurs, Person A will transfer the farm land to New Trust (step 2).

39.  Consistent with the discussion above, no beneficiary of New Trust will have ultimate economic ownership of the farm land for the purposes of subsection 328-435(a). Therefore, as Person A will not have ultimate economic ownership of the farm land following the transfer of the farm land to New Trust, there will be a change in the ultimate economic ownership of the significant assets of the business that were transferred under step 1.

40.  Therefore, as there will be a change in the ultimate economic ownership of the transferred assets within a three year period, the safe harbour conditions cannot be satisfied.

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

41.  As the safe harbour conditions cannot be satisfied for step 1 and as per above, there has not been a genuine restructure of an ongoing business, paragraph 328-430(1)(a) cannot be satisfied.

42.  Consequently, consideration of the remaining requirements of Subdivision 328-G is not necessary and rollover will not be available to the applicant under the proposed arrangement.

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