Edited version of private advice

Authorisation Number: 1052199760762

Date of advice: 19 December 2023

Ruling

Subject: Small business restructure rollover

Question

Will 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 period:

Year ending 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

The ABC Trust (the Taxpayer) is an Australian resident discretionary trust. XYZ Pty Ltd is the trustee for the Taxpayer.

XYZ Pty Ltd sole director is Individual A, and its principal beneficiaries are Individual A along with his spouse, Individual B.

The Taxpayer operates under a trading name PQR.

The Taxpayer's business operations were established by Individual A & Individual B in the 20XX year.

PQR is a family owned and operated business employing experienced and fully qualified staff to provide a range of services from residential to commercial and industrial.

The Taxpayer has made a family trust election (FTE) with 2023 as its specified income year and Individual A as the specified individual.

The Taxpayer owns business operational assets which include:

•         Motor vehicles (being depreciating assets that are not being considered in respect of the provisions within Subdivision 328-G)

•         Office equipment (being depreciating assets that are not being considered in respect of the provisions within Subdivision 328-G)

•         Plant and equipment (being depreciating assets that are not being considered in respect of the provisions within Subdivision 328-G)

•         Goodwill.

The Taxpayer has an aggregated turnover of less than $XX million.

The Taxpayer is an Australian resident for the purposes of section 328-445.

Individual A is a resident of Australia.

Reasons for the restructure

It is now apparent, given the growth of the business over the years, having the business operated by a discretionary trust is not the optimum structure and that the business operations are best suited being housed within a corporate operating entity.

Such a restructure results in a new legal structure that does not replicate the original structure and it changes the way in which assets used in the Taxpayer's ongoing business are being held.

The reduction in compliance costs derived by simplifying the business structure relieves the administrative burden of tracking and dealing with unpaid beneficiary entitlements on foot and into the future.

The key driver here is cashflow management. Operating via a discretionary trust structure requires that the annual net income of the trust be distributed or else it is taxed at the top marginal tax rate. Use of a company as the operating structure allows after-tax profits to be retained thereby eliminating the creation of beneficiary entitlements that are required to be managed via the Division 7A rules.

The restructure will also allow for the potential introduction of employee equity holders in the future.

The Company

A company will be incorporated in Australia in the 20XX financial year (the Company).

Once incorporated, the director of the new Company will be the same director of the trustee company.

The Taxpayer will hold all of the shares in the new Company.

The Taxpayer will be the sole shareholder of the Company.

The Company will be an Australian resident for the purposes of section 328-445 of the ITAA 1997.

The Company will have aggregated turnover of less than $XX million.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 40-340

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 328-430(1)

Income Tax Assessment Act 1997 subsection 328-440

Income Tax Assessment Act 1997 section 328-445

Taxation Administration Act 1953section 370-5 of Schedule 1

Income Tax Assessment Act 1936Schedule 2F

Does Part 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

Subsection 328-430(1) of the ITAA 1997 outlines the conditions to be met for the roll-over relief to be available:

a)    The transfer of the asset is, or is part of, a genuine restructure of an ongoing business; and

b)    Each party to the transfer is either a small business entity, or affiliate of or connected with a small business entity, or a partner in a partnership that is a small business entity; and

c)    There is no material change in the ultimate economic ownership of the transferred asset; and

d)    The asset being transferred is an active asset of the relevant small business entity at the time of the transfer; and

e)    Both the transferor and each transferee are residents of Australia; and

f)     Both the transferor and each transferee choose to apply the roll-over.

All conditions need to be met for the roll-over to be applied.

Genuine restructure of an ongoing business

Law Companion Ruling LCR 2016/3 - Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3) explains the meaning of the term 'genuine restructure of an ongoing business. Whether a transaction is or is part of a genuine restructure of an ongoing is a question of fact that is determined having regard to all of the circumstances surrounding the restructure.

Paragraph 7 of LCR 2016/3 states:

The following features indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business':

•         It is a bona fide commercial arrangement undertaken in a real and honest sense to

o   facilitate growth, innovation and diversification

o   adapt to changed conditions, or

o   reduce administrative burdens, compliance costs and/or cash flow impediments.

•         It is authentically restructuring the way in which the business is conducted as opposed to a 'divestment' or 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. For example, there is:

o   continued use of the transferred assets as active assets of the business

o   continuity of employment of key personnel, and

o   continuity of production, supplies, sales or services.

•         It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business.

Application to your circumstances

In this case Individual A, the sole director of the trustee, no longer considers it optimum for the business, PQR, be operated by a discretionary trust, and more suitable to be operated by a corporate operating entity, given its growth over the past few years.

By operating via a discretionary trust structure requires the annual net income of the trust be distributed or else it is taxed at the top marginal rate. Use of a company as the operating structure allows after-tax profits to be retained thereby eliminating the creation of beneficiary entitlements that are required to be managed via Division 7A rules. It also allows for the potential introduction of employee equity holders in the future.

We accept that the proposed restructure will reduce cash flow impediments, provide opportunities for further growth and is not unduly tax drive. Further we do not consider there is any evidence that it is an attempt to wind down or extract wealth from the business. Therefore, we accept the proposed transaction is a genuine restructure of an ongoing business.

Small business entity

Paragraph 328-430(1)(b) requires that each party to the transfer is an entity to which 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.

Application to your circumstances

In this case the Taxpayer, being a discretionary trust is a small business entity and therefore subparagraph 328-430(1)(b)(i) is satisfied.

As the new Company will be a small business entity in the income year, subparagraph 328-430(1)(b)(i) is satisfied for the transferee of the assets.

Therefore, the small business entity test in paragraph 328-430(1)(b) will be satisfied for the transfer of the assets.

Ultimate economic ownership

Paragraph 328-430(1)(c) requires that 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

The term 'ultimate economic ownership' is not defined in the income tax provisions. Paragraph 1.29 and 1.30 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business Restructure Roll-over) Act 2016 explains that the ultimate economic owners of an asset are individuals who, directly or indirectly, beneficially own an asset. As the ultimate economic owners can only be individuals, a look through approach applies where a company, partnership or trust owns the asset.

Under ordinary legal concepts, a beneficiary of a discretionary trust does not have any beneficial interest in any trust property prior to a distribution or appointment of income or capital. Instead, 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.

In relation to the application of the ultimate ownership test to discretionary trusts, the Commissioner's view provided in paragraph 107 of LCR 2016/3 is that a transfer of assets from or to a discretionary trust will generally not meet the requirements for ultimate economic ownership on their facts.

Alternative economic ownership test

Section 328-440 provides that for the purpose 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 to your circumstances

In this case, just before the proposed transaction the assets were included in the property of the trust, a non-fixed trust that was a trading discretionary family trust. The trust has a family trust election in place with Individual A named as the specified individual.

After the proposed transfer the assets will be held in a Company and all of the shares will be owned by the Taxpayer. Therefore, every individual who, just after the transaction takes effect, has the ultimate economic ownership of the asset is a member of that family group.

The ultimate economic test in paragraph 328-430(1)(c) of the ITAA 1997 is satisfied because of the alternative test in section 328-440 of the ITAA 1997.

Active assets

Paragraph 328-430(1)(d) sets the requirement that the asset to be transferred 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

A CGT asset (whether a tangible or intangible asset) is an active asset at a time if, at that time, you own the asset 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 you, an affiliate of yours, or by another entity that is connected with you (subsection 152-40(1)).

Depreciating Assets

The Subdivision 328-G rollover does not directly apply to the transfer of depreciating assets.

The note to subsection 328-430(1) 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 that 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 Taxation Administration Act 1953 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.

Application to your circumstances

In this case, as a rollover would apply to the transfer of the depreciating assets if they were not in fact depreciating assets, the rollover relief in section 40-340 will be available.

Residency requirements

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 discretionary 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, both the Taxpayer (discretionary trust) and the new Company will meet the residency requirements in in section 328-445 of the ITAA 1997 satisfying paragraph 328-430(1)(e) of the ITAA 1997.

All parties choose to apply the rollover

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.

In this case, both the Taxpayer and the new Company will make the choice to apply the roll-over under Subdivision 328-G of the ITAA 1997 in relation to the assets transferred under the transaction, satisfying 328-430(1)(f) of the ITAA 1997.

Conclusion

As each of the requirements of section 328-430 of the ITAA 1997 will be met, the restructure will qualify for roll-over relief under Subdivision 328-G of the ITAA 1997.