Edited version of private advice

Authorisation Number: 1052204792701

Date of advice: 20 December 2023

Ruling

Subject: Small business restructure

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 ended 30 June 20YY.

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

Company A is a private company incorporated in Australia.

Company A operates a contracting business specialising in a specified industry.

Company A has 10 ordinary shares on issue and these are held by Company B as trustee for Trust A.

Company B is a private company incorporated in Australia.

Individual A is the sole shareholder, director and secretary of Company B.

Individual B is the Appointor of Trust A and Individual A and Individual B are primary beneficiaries of Trust A.

Trust A is a discretionary trust.

A family trust election was made on a specified date with Individual B as the specified individual.

The secondary beneficiaries of the Trust A are the spouse or partner living in a domestic relationship with a Primary Beneficiary.

Tertiary beneficiaries of Trust A are:

•         Parents, brothers and sisters of a Primary Beneficiary

•         Parents, brothers and sisters of a Primary Beneficiary's spouse or widow or widower

•         Children, grandchildren and great grandchildren of a Primary or Secondary Beneficiary.

Tertiary beneficiaries are the default beneficiaries for income and capital.

The financial accounts of Company A have experienced year on year growth and as of 30 June 20YY the value of Property, Plant and Equipment (PP&E) less accumulated depreciation was a specified amount.

Company A will enter into an Agreement under which Company A will transfer the PP&E of its business to Company C as trustee for Trust B.

Company C is a private company incorporated in Australia.

Trust B is a discretionary trust.

The primary beneficiaries of Trust B are Individual B and Individual A.

Children of the Primary Beneficiaries are the default beneficiaries for income and capital.

Prior to entering into the Agreement, a family trust election will be made specifying Individual B as the specified individual.

Individual A is the sole director and secretary of Company C and will enter into a share sale agreement with Company A to purchase all shares on issue in Company C prior to the Agreement being entered into.

Under the terms of the Agreement:

•         Company A will sell all of the PP&E used in the course of its business to Trust B;

•         the purchase price is equal to the written down asset value of the PP&E less any assumed liabilities, where the assumed liabilities means all of the liabilities of Company A created to fund the purchase of the PP&E by Company A of any of the PP&E or any liability that represents the refinancing of any of these amounts;

•         the intention is to continue to depreciate the PP&E in the accounts of Trust B at the same rate and value as what would have occurred in Company A;

•         Company A will continue to

o   derive all income of the business

o   pay all outgoings of the business, which will include a hire fee charged by Trust B for the provisions of the PP&E to Company A on an arm's length basis

•         Company A and Trust B will elect to apply for rollover relief under Subdivision 328-G of the ITAA 1997 and rely on the automatic rollover relief available under subsection 40-340(1) of the ITAA 1997 in relation to the PP&E that is a depreciating asset, transferred under the Agreement.

Reason for restructure

The restructure is being undertaken to diversify the risk profile of the business to protect the growing value of PP&E due to the business' growth over the past several years.

Risk exposure to the business includes:

•         work in hazardous worksites.

•         exposure to liquidated and general damages claims:

o   a failure to meet timeframes in contracts;

o   the specified material Company A has agreed to supply is not supplied;

o   there are often counter suits if Company A is forced to take legal action against a client;

o   Company A partners with others and they are concerned about their partner's risks of insolvency given their other projects;

o   they need to have PPSA protection on their equipment.

•         use of machinery on client sites and exposure to operator errors and resulting damage to persons and property.

•         at risk of being supplied with contaminated material, which if then supplied to a client site is an issue that they are liable for.

The restructure is not being entered into to divest Company A of its asset to facilitate the realisation of the assets.

The PP&E will continue to be used in the business and the parties propose to enter into a licence agreement for the continued use of the PP&E by Company A in the business.

Company A will continue to operate the business.

The arrangement proposed by Company A would likely have been adopted had they sought professional advice when setting up the business.

The restructure is not being entered into during the course of winding down or realising ownership interests of Company A.

In specified income years Company A had an aggregated turnover of less than $10 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 1953 section 370-5 of Schedule 1

Income Tax Assessment Act 1936 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

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 Company A no longer considers it optimum for the entity operating the business to be the same entity that also holds the assets critical to the business operations. The restructure is being undertaken to diversify the risk profile of the business to protect the growing value of PP&E due to the business' growth over the past several years and in consideration of the risks involved with its business operations.

We accept that the proposed restructure will reduce the risk exposure to the PP&E and is not unduly tax driven. 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 Company A is a small business entity and therefore subparagraph 328-430(1)(b)(i) is satisfied.

Trust B would be connected to Company A. Company A would also be an affiliate of Trust B.

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 after the proposed transaction the assets will be included in the property of Trust B, a non-fixed trust that is a discretionary family trust. Trust B will have a family trust election in place with Individual B named as the specified individual before the transfer takes effect.

Before the proposed transfer the assets will be held by Company A, and all of the shares will be owned by Trust A. Trust A has a family trust election in place with Individual B being named as the specified individual.

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 Company A and Trust B 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 Company A and Trust B 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.