Edited version of private advice

Authorisation Number: 1052257339929

Date of advice: 4 June 2024

Ruling

Subject: Small business restructure roll-over

Question 1

Will the proposed transaction be part of a genuine restructure of an ongoing business for the purposes of paragraph 328-430(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the proposed transaction result in the ultimate economic ownership of the assets being maintained for the purposes of paragraph 328-430(1)(c) of ITAA 1997?

Answer

Not applicable

This ruling applies for the following period:

Year ending 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

Background and Current Structure

1.    Mr and Mrs X (the Taxpayers) own various parcels of land (the land).

2.    The land is utilised by another entity for the business operations.

3.    Between 19XX and 20XX, the business was carried on through the Family Trust.

4.    The Trustee Company also owns land, and plant and equipment which the business uses. The class of beneficiaries are limited to the Taxpayers and their three children.

5.    The business operations carried out on the land was then conducted by Trading Entity. The Trading Entity commenced operating the business operations on X Month in 20XX.

6.    The business is currently being operated by Trading Entity.

Proposed Transaction and New Structure

7.    The Taxpayers propose to transfer the land to two New Landholding Trusts rather than the Family Trust due to the age and limited perpetuity period of the Family Trust, as well as the substantial value of the assets currently owned by the Family Trust.

8.    To separate the ownership of business operations and the lands the Taxpayers propose to separate the land into the two New Landholding Trusts.

9.    The New Landholding Trusts will make a family trust election in accordance with Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936).

10.  The Taxpayers are the primary beneficiaries of both New Landholding Trusts, as well as the appointors (controllers), directors and shareholders of these Trusts.

11.  The division of land between the two New Landholding Trusts has been determined on a monetary value basis, being that each New Landholding Trust is to hold land up to a maximum value of $X million dollars, which has been calculated at $X per acre which is its approximate market value.

12.  The $X million cap represents to the Taxpayers an acceptable level of asset protection that will isolate the land between the 2 New Landholding Trusts to mitigate the risk that the Taxpayers face should any claims or liabilities arise from the business operations or be made against one of the two New Landholding Trusts.

13.  As the land cannot be separated equally, the Taxpayers will exhaust the $X million cap (to the extent that the land can be proportionately separated on the $X per acre basis) and therefore Landholding Trust 1 will hold land with an estimated value of $X, while Landholding Trust 2 will hold land with an estimated value of $X.

14.  The Family Trust owns and maintains all assets required to run the business.

15.  Once the land held by the Taxpayers is consolidated into the two New Landholding Trusts, the Family Trust will retain the current land as well as the plant and equipment held within it.

16.  The Trading Entity will continue to operate as the trading business vehicle. All plant and equipment required to operate the business will be owned by the Family Trust.

17.  Post the restructure, the intention for the ongoing business is that formal business leases will be established and entered into between the Trading Entity, as tenant, and the Landholding Trust 1, Landholding Trust 2 and the Family Trust as Landlords (as the case may be). The leases will set out the commercial terms and fees that are reflective of standard practise within the local region. The Trading Trust will then continue to operate the business operations on the land.

18.  The intention of the leases is to create a legal relationship between the Trading Entity and Landholding Trusts which provides a layer of protection to the Taxpayer by separating the land from the trading operations and in turn limit the exposure the Taxpayers may be subjected to for any claims or liabilities that may arise from the business operations via the Trading Trust.

19.  There are no plans to wind down the business or transfer the land/assets used in the business in the future.

Reasons for Proposed Restructure

20.  The main reason for the proposed restructure is the potential risks and liabilities that may arise from their business activities including workplace accidents, environmental damage, and legal liability.

Workplace Accidents

21.  There is a high rate of worker related injuries within their business sector. As the Taxpayer's are currently structured, if a workplace injury or fatality occurred within the business, the Family Trust and the Taxpayers claim they would be liable for any claims or prosecution that arose because of an injury or fatality. Therefore, the assets owned by these entities, including the land, could potentially be at risk to meet the payment obligations of any judgment or compensation in the event of a successful claim or prosecution. This is even more likely as the land increases in value and available for litigants to recover against.

22.  State level agency for health and safety regularly prosecutes businesses in their sector for breaches of workplace safety legislation. A paper from the state level agency for health and safety summarised recent prosecutions relating to their business section which highlight the risks associated with carrying on a business in their sector.

23.  The proposed restructure will address this risk by separating the trading operations, plant and equipment and land into the separate entities. Specifically, the Trading Entity will be the entity which engages employees and will not own any land, and therefore, if a claim or prosecution is brought against the Trading Entity or the Taxpayers for a workplace injury or fatality, the land and plant and equipment should not be at risk as it will be sitting in the New Landholding Trusts and Family Trust. Further to this, should it be determined that one of the other entities be liable alongside the Trading Entity, the liability is limited only to the assets held within that entity, protecting the balance of assets owned by the Taxpayer.

Environmental Damage

24.  As the Trading Entity undertakes a significant amount of activity on the land, and there is a substantial amount of chemical fertiliser used. Conversely, the use of the fertiliser includes pesticides that carries a significant risk of environmental damage to the local ecosystem if the fertiliser were to be incorrectly sprayed which could result in the contamination of the water sources, non-targeted neighbouring properties, animals, and native vegetation.

Legal Liability

25.  Similar to the above, by implementing the proposed restructure, the risk of the Taxpayers assets being subjugated to local government or third-party claims will be significantly reduced by isolating their liability to the Trading Entity only in first instance, while the balance of the Taxpayers assets is separated into their personal assets, the Family Trust and 2 new Landholding Trusts.

Innovation and Diversification

26.  Their business is about the whole and understanding the impact of any single change on that whole business enterprise. Appreciating the technical complexity and interactions within their business system reduces the risk of unintended and unpleasant consequences.

27.  The interplay between the choice of business activity on the land can be a complicated consideration, adding further to that complication is the need to adjust mindset about climate and weather conditions and how that has progressively varied even over the lifetime of this business enterprise.

28.  Having regard to these challenges and the need to continue to innovate and trial new things to ensure that profitability and sustainable growth can continue for the whole business, the Taxpayers have identified a need to consider the diversification of business practices and that to achieve this goal a restructure and segregation of the land is necessary.

29.  The business enterprise can achieve this by continuing to adopt more traditional business methods on the larger portion of land identified to be allocated to Landholding Trust 1, ensuring that the business has sufficient working capital available by allowing the banks to maintain security over the land contained in this trust, satisfying the need for more predictable cash flow to service debt, cover expenses and living costs and to ensure that the bank's lending risk profile is not compromised.

30.  However, given the growth of the business and the stability that will come from activities and traditional business methods being applied to the land contained in Landholding Trust 1 it creates opportunity for innovation and diversification to occur with the land identified for Landholding Trust 2.

31.  The land that has been identified to transition to Landholding Trust 2 has been earmarked for the trialling of different business methods, for example it is intended by the Taxpayers that different methods of business will be conducted looking at things such as the timing, type and duration. The aim is to fundamentally achieve higher yielding of business production by the trialling of different methods.

32.  Conducting this method of hybrid business activities carries some risk however having regard to the size of the total business enterprise, if the more traditional methods of business can continue in Landholding Trust 1 then the opportunity to innovate through a segregated the business structure as proposed allows diversification to occur with a risk mitigation strategy in place. Had the Taxpayers known at the time the structures were established the changes, challenges and need for innovation in business practices that exist today, together with the growth of the business size they would have established a different structure and one more in line with what is currently proposed through the intended restructure.

33.  In addition, and subject to the initial signs of success of the alternative business methods as trialled, the separation of the landholdings will allow opportunity for separate funding through Landholding Trust 2 creating further opportunities for the future.

Summary

34.  The Taxpayers' proposed restructure allows them to hold the land owned by them in two separate landholding trusts (New Landholding Trusts) due to the substantial value of the land owned by the Taxpayers. The Taxpayers consider it appropriate for the business operations to be in a separate entity to the entities that own the land and plant and equipment to provide greater asset protection from the business operations.

35.  By segregating the land ownership, plant and equipment and the trading operations between the Family Trust, the New Landholding Trusts and the Trading Entity, it creates a layer of protection for both the land and any plant and equipment the Taxpayers own against any claims or liabilities that may arise from the business operations.

36.  The restructure will allow the Taxpayers to isolate these risks and liabilities.

Relevant legislative provisions

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)(c)

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

Subdivision 328-G allows for tax-neutral consequences for a small business that restructures the ownership of the assets of the business without changing their ultimate economic ownership.

Subsection 328-430(1) 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

Paragraph 328-430(1)(a) requires that the transaction is, or 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 (LCR 2016/3) explains the meaning on the term 'genuine restructure of an ongoing business'.

At paragraph 7 of LCR 2016/3 features indicative of a genuine restructure are provided as follows:

•         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.

At paragraph 10 factors which tend to indicate that a restructure is not a 'genuine restructure of an ongoing business' include:

•         where the restructure is a preliminary step to facilitate the economic realisation of assets, or takes place in the course of a winding down to transfer wealth between generations

•         where the restructure effects an extraction of wealth from the assets of the business (including accumulated profits) for personal investment or consumption or otherwise designed for use outside of the business

•         where artificial losses are created or there is a bringing forward of their recognition

•         the restructure effects a permanent non-recognition of gain or the creation of artificial timing advantages, and/or

•         there are other tax outcomes that do not reflect economic reality.

Example 1 of LCR 2016/3 provides an example of a genuine restructure for asset protection purposes.

Example 1 in LCR 2016/3 (paragraph 17 to 23), involves an individual (Mark) who is expanding his sole trader bookkeeping business into the riskier operations of financial advice. After being sued by a client for negligent financial advice, Mark has decided he is not prepared to conduct his business on his own account.

Mark is transferring assets from the original entity (himself) to quarantine his business from his personal assets. This is a benefit to Mark in terms of his ability to grow the riskier operations and enhance its profits. The restructure is a response to his business needs, facilitates further growth and is not unduly tax driven. The economic ownership of the business is maintained. Accordingly, the 'genuine restructure of an ongoing business' condition is satisfied.

Application to your circumstances

Having regard to all of the facts and circumstances surrounding the proposed restructure and the factors that would indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business', it is considered that the proposed restructure is not a 'genuine restructure of an ongoing business' as contemplated by the legislation and does not satisfy the requirement in paragraph 328-430(1)(a).

In this case, the land you own are used in the business carried on by Trading Entity. You intend to transfer ownership of the land to two newly formed discretionary trusts (Landholding Trust 1 and Landholding Trust 2).

The Taxpayers are the primary beneficiaries of both Landholding Trust 1 and Landholding Trust 2, as well as the appointors (controllers), directors and shareholders of the Landholding Trustee 1 and Landholding Trustee 2.

In the private ruling application, it was advised that the reasons for proposed transfer relate to various risks of the Taxpayers, including workplace accidents, environmental damage and legal liability. According to the application, the proposed restructure will allow the Taxpayers to isolate these risks and liabilities.

The business activities have been operating, via a separate entity, for a significant period of time and the circumstances can be distinguished from example 1 of LCR 2016/3 which considers asset protection. In the example, the business operator's restructure was in response to an emerging business need that occurred as a result of the expansion of their activities and enhance his profits. The catalyst for restructuring in the example is the business commencing riskier financial advice operations and the transaction allows the business operations to be separated from the individual's personal assets.

In the Taxpayers' case the business activities on the land have been operating for over XX years. There is already an operating company that conducts business on the land and is a separate legally liable entity to the entity who holds the land. The operating company is legally liable for any damages in relation to its business activities. As such, the Taxpayers' liability is already limited. The operating company was incorporated in 20XX, started operating from July 20XX and replaced the previous structure operating from 19XX, being the Trust with the Taxpayers as trustees. Therefore, the Taxpayers had to be aware of any asset protection issues at least since the income year ended 30 June 20XX. As such, the reasoning provided in relation to workplace accidents and environmental damage is also not relevant for satisfying the conditions indicating that the restructure is "genuine". Consequently, the asset protection purpose seems to be not relevant to the on-going business going forward as the transfer of the land to the proposed structure is in response to the Taxpayer's individual preference how they hold this land rather than in response to any changes in the ongoing business (operating entity) going forward.

Additionally, there have been a number of structural changes during your involvement that could have facilitated the move into a different structure for "asset protection" purposes however this was not done.

Similarly, the business activities have been operated for a significant period of time and no evidence of any expansion or change in the operations has been provided.

The additional information provided in relation to innovation and diversification of the business activities after the proposed restructure is not sufficient to confirm that the proposed restructure is necessary to facilitate growth, innovation and diversification, mainly because these goals can be achieved in the current structure. In other words, the current business structure does not prevent or limit the Taxpayers from implementing innovative business methods and diversifying their business activities. The proposed structure in this matter is not necessary for that purpose.

Moreover, the additional information provided in relation to innovation and diversification of business activities does not clearly express what innovative methods of business will be implemented after the proposed restructure. The additional information explains that the traditional methods of business may not be entirely the most effective way of doing business in the future and may require changes in the future to be more effective. Similar statements could be made throughout the lifespan of every business. However, it is the actual change in current business activities that should be considered as a factor explaining the necessity of having a new structure. The new structure should effectively reflect that actual change and be more suitable for the future business needs as explained in the example 1 of LCR 2016/3 regarding asset protection. Therefore, the restructure should be the result of the change in current business operations, not the opportunity to make such a change in the future that may or may not happen. Moreover, as explained above, the current structure allows the Taxpayers as the landowners to make such a change. Consequently, the reasoning provided in relation to innovation and diversification as features indicating that the transaction is, or is part of, a" genuine restructure of an ongoing business" in accordance with paragraph 7 of LCR 2016/3 is not sufficient to confirm that view. As a result, this reasoning does not demonstrate the commercial rational to confirm that the proposed restructure is "genuine" for the purposes of paragraph 328-430(1)(a) of the ITAA 1997, as there are no changes contemplated in the restructure for the trading entity.

There has been no evidence provided that the restructure of the ongoing business is being undertaken to reduce administrative burdens, compliance costs and/or cash flow impediments. As a matter of fact, the proposed structure will consist of four additional entities, being 2 Landholding Trusts and 2 Corporate Trustees, increasing compliance and administration costs.

Moreover, there is no commercial rational behind establishing the cap monetary value of the New Landholding Trusts to hold land only up to $X million cap. Therefore, this is another factor confirming that the proposed restructure is not "genuine" and necessary for the future business operations, rather part of reorganisation of the Taxpayers' affairs as opposed to a current business need.

The proposed restructure will not change the type of entity in which the ongoing business is conducted and will not involve any changes to the way the ongoing business is conducted. As such, it is considered that the proposed restructure is not being undertaken to enhance the efficiency of the ongoing business.

The Commissioner does not accept your contention that the proposed restructure is a genuine restructure of an ongoing business that is expected to deliver benefits to the business owners in respect to their efficient conduct of the business by providing greater asset protection. The facts and circumstances provided do not provide support that the restructure is in response to a bona fide commercial arrangement undertaken to facilitate innovation and diversification, as there are no proposed restructure changes to the operational entity, but rather being an initial step in a broader reorganisation of the Taxpayers' affairs.

Question 2

Will the proposed transaction result in the ultimate economic ownership of the assets being maintained for the purposes of paragraph 328-430(1)(c) of ITAA 1997?

Summary

As the Commissioner is of the opinion the "genuine" restructure condition as not been met, the remaining conditions have not been considered and the rollover under section 328-430 will not be available. Therefore, the condition regarding the ultimate economic ownership of the assets contained in paragraph 328-430(1)(c) of ITAA 1997 was not considered.