Edited version of private advice

Authorisation Number: 1052187945833

Date of advice: 22 November 2023

Ruling

Subject: CGT - small business restructure rollover

Question

Does the Restructure qualify for roll-over relief under Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

Individual A and Trust A operate a XXXXXX business (Business) in a partnership (ABN XXXX) (Partnership).

The partners hold interests in the Partnership in the following proportions:

•                     Individual - YY%

•                     Trust - ZZ%

The trading name of the business is "XXX".

The Partnership is a small business entity, with an aggregated turnover of less than $10 million (section 328-110 of the ITAA 1997).

The Trust is a 'discretionary trust' established for the benefit of Individual A and their family.

The partners have decided that a partnership is no longer the most appropriate structure to operate the Business. The partners are seeking to restructure the Business into a newly incorporated company (NewCo).

The purpose of the restructure is to provide a more straightforward structure that is easily understood by both customers and suppliers, and to allow for the working capital of the business to be funded at the corporate tax rate.

There is no proposal to sell the business or change any of the underlying owners of the business in the foreseeable future.

Details regarding the proposed restructure (Restructure) are:

NewCo

NewCo will be initially incorporated with the following share capital:

•                     Individual A - YY Ordinary Shares (YY%)

•                     Trust A - ZZ Ordinary Shares (ZZ%)

There is no intention to change the shareholders or shareholding percentages of NewCo in the foreseeable future.

NewCo will commence operating the Business upon the completion of the Restructure.

The business assets

The following assets are essential to the conduct of the Business:

•                     XXX (Trading Stock);

•                     Assets which decline in value and which are subject to Division 40 of the ITAA1997 (Depreciating Assets);

•                     The lease which provides the Partnership with the land to conduct the activity (Lease). The Lease also facilitates the right to utilise the improvements that have been made to the land during the term of the lease (Leasehold Improvements); and

•                     The goodwill of the business (Goodwill).

Transfer of the business assets

The Partnership and NewCo will enter into a business sale agreement (Agreement) under which the Partnership will transfer the Business Assets to NewCo.

Under the Agreement, NewCo will agree to provide the following consideration for the acquisition of the Business Assets.

Table 1: Consideration for the acquisition of the business assets

The decision has been made to provide nominal consideration (that is, $1) for the Lease and the Goodwill because they do not have a cost/cost base for tax purposes.

NewCo will also agree to assume the obligation to pay liabilities that relate to the Business Assets. The total consideration payable under the Agreement will be reduced by the amount of the liabilities to be assumed by NewCo.

The Partnership and NewCo will jointly choose to apply the roll-over relief under Subdivision 328-G of the ITAA 1997 to the Restructure.

The Trust has not made a family trust election (FTE) to date. However, the Trust will make an FTE for the income year ended 30 June 20XX, nominating Individual A as the specified individual.

Relevant legislative provisions

Taxation Administration Act 1953 Schedule 1 section 370-5

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 subsection 40-340(1)

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

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

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 subsection 328-110(1)

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 subparagraph 328-430(1)(b)(i)

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 subparagraph 328-430(1)(d)(i)

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 1997 subsection 995-1(1)

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.

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.

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).

The Partnership (the transferor) proposes to transfer the assets of the Business to the NewCo (the transferee).

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

Each requirement in subsection 328-430(1) will be considered in detail.

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 if:

•                     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.

The Business will continue to be carried on by NewCo after the Restructure has been implemented and there are business benefits gained. 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 Restructure 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.

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.

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.

In this case, the Partnership, the transferor, is 'a small business entity' as it carries on a business with an aggregate turnover for the previous year that was less than $10 million. NewCo, the transferee, is a small business entity as it will commence operating the primary production business upon the completion of the Restructure.

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.

The members of the Partnership are Individual A with an YY% economic ownership in the Partnership assets. The Trust has the remaining ZZ% interest in the partnership.

Individual A will retain the same economic ownership of the assets having acquired YY% of the shares in NewCo.

While the Trust A acquires ZZ% of the shares in NewCo, the same interest it held in the Partnership, under ordinary legal concepts, a beneficiary of a non-fixed or 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 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. Therefore, due to the discretionary nature of such a trust, determining whether the transaction has not had the effect of materially changing which individual have the ultimate economic ownership of the assets may be unachievable due to uncertainty.

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.

The Trust is a non-fixed trust for the purposes of section 272-70 of Schedule 2F of the ITAA 1936 and is to make a family trust election for the income year ending 30 June 20XX, the 'family trust' requirement is satisfied.

At general law a partnership is not a separate legal entity to its members. Consequently, just before the transaction took effect the Trust's proportionate interest of ZZ% in the business assets were included in the property of the Trust.

Every individual who, just before the transfer took effect, had the ultimate economic ownership of the assets was a member of Individual's family group.

After the transfer takes effect the individuals that have the economic ownership of the assets are members of Individual's family group.

Hence this alternative test is satisfied.

Paragraph 328-430(1)(d) - active assets

Paragraph 328-430(1)(d) requires the CGT asset 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.

In this case, subparagraph 328-430(1)(b)(i) applies, therefore the condition in subparagraph 328-430(1)(d)(i) must be satisfied. To satisfy this condition, the Business assets must be an 'active asset'.

Active asset

Subparagraph 328-430(1)(d)(i) of the ITAA 1997 provides that where a party to the transfer is a small business entity under subparagraph 328-430(1)(b)(i), the asset being transferred must be a CGT asset that is an active asset, other than a depreciating asset, at the time of the transfer.

Relevantly, 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.

Additionally, if the CGT asset is an intangible asset, paragraph 152-40(1)(b) provides that the asset will be an active asset if you own the asset and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate or another entity that is connected with you.

However, certain types of CGT assets are excluded from being active assets under subsection 152-40(4). These types of excluded assets are not presently relevant.

The assets being transferred by the Partnership to NewCo are the assets that are used in carrying on the primary production business. These assets include depreciating assets, livestock/trading stock used in operating the Business, the lease and the goodwill.

Therefore, the requirement in subparagraph 328-430(1)(d)(i) will be satisfied.

Depreciating assets

Section 40-30 of the ITAA 1997 provides that a depreciating asset is an asset that has limited effective life and can reasonably be expected to decline in value over the time it is used. The exceptions to this definition are land, trading stock, and intangible assets.

The note to subsection 328-430(1) of the ITAA 1997 states that 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). Section 40-340 outlines the circumstances in which roll-over relief is available where specified balancing adjustment events have occurred for a depreciating asset.

Roll-over relief is available under section 40-340 if there is a balancing adjustment event because an entity disposes of a depreciating asset to another entity, and the disposal involves a CGT event. Additionally, one of the conditions listed in the table in subsection 40-340(1) must be satisfied.

Item 8 of the table in subsection 40-340(1) outlines the consequences where there is a transfer of a depreciating asset under a small business restructure roll-over. In this situation, roll-over relief is available under section 40-340 if a roll-over under Subdivision 328-G would be available in relation to the asset if the asset were not a depreciating asset.

Note that the Commissioner has exercised his remedial power in section 370-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA) to modify the operation of section 40-340. The effect of this modification is to ensure that where the restructure otherwise satisfies the conditions for roll-over under Subdivision 328-G, the transfer of depreciating assets will have no direct income tax consequences.

Consequently, the transfer of any depreciating assets under the restructure will also not have any direct consequences under the income tax law.

Paragraph 328-430(1)(e) - 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, Individual A is an Australian resident and both the Trust and NewCo are Australian residents for the purposes of paragraph 328-430(1)(e) of the ITAA 1997.

Paragraph 328-430(1)(f) - roll-over choice

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

The Partnership and NewCo will choose to apply the roll-over in relation to the transfer of the Business assets Therefore, the requirement in paragraph 328-430(1)(f) will be satisfied.

Conclusion

As each of the requirements in subsection 328-430(1) have been met, the Trust is eligible to choose roll-over relief under Subdivision 328-G in relation to the Proposed Transaction.