Private ruling: Small business restructure rollover
Date of advice: 26 February 2018
Published: June 2018
Ruling period: 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the transfer of assets from Entity A to Entity C be eligible for the small business restructure rollover under subdivision 328-G of the Income Tax Assessment Act (ITAA 1997)? | A1: No

Relevant facts and circumstances: Entity B was incorporated October 20XX. The director and sole shareholder of the company is Individual B. The main business of Entity B is in relation to the provision of natural therapy treatments. Entity A was established during the year ended 30 June 20XX. The partners of Entity A are Individual A and their partner Individual B. Entity A conducts a primary production business involving production activities. Both Entity B and Entity A meet the definition of small business entity in section 328-110 of the ITAA 1997. Since 20XX, Entity A has expanded its operations though the purchase of properties in 20XX, 20XX, and 20XX. Other land used in the operations is owned by a related entity. The short term goal of Entity A is to operate a specific primary production business with a view to being EU accredited. In the longer term, Entity A aims to establish a small back grounding business where specific animals are sourced from its own breeding operation. The business operated by Entity A is currently operating at a loss though future profits are expected to be generated. Given the current size of Entity A and the intention to further expand the business, it is considered that restructuring is warranted. To that end it is intended that a company will be registered and the assets of Entity A transferred to that entity to carry the business activity forward. The prime contention in favour of restructuring is to increase asset protection as well as to shelter the taxpayers from the risk of legal action which may otherwise arise in the course of the expanding primary production business. Entity A has not been subject to litigation or currently subject to litigation. In addition, it has been contended transitioning Entity A to an incorporated structure will provide a structure through which the enterprise is able to seek funding from banks and eliminate the personal risks that would otherwise apply if a partnership structure continued. Furthermore, Entity B is stated to be strongly considering its potential to dispense medicinal horticulture activities. These would be grown on the farm land currently owned by Entity A, externally processed and ultimately sold through Entity B. In order to operate their health business and primary production business in a more appropriate legal structure with improved business efficiencies, Individual A and Individual B are considering a broader restructure into a tax consolidated group. There are no transactions currently occurring directly between Entity A and Entity B. Entity A prepared a business plan in respect to a Herb Growing Operation in March 20XX. The majority of the harvested produce will be used by Entity B and any excess sold to healthcare brands. Entity B will also provide some of the funding required to plant, cultivate and harvest the crop. Individual A has started assessing which plots on the property are appropriate to plant the medicinal herbs as outlined in the business plan. The proposed restructure 1. A new private company (Entity C) will be incorporated in which Individual A and Individual B hold 50% of the shares each. Individual A and Individual B will also be the directors. 2. The assets of Entity A will be transferred to Entity C pursuant to a Small Business Restructure Rollover under Subdivision 328-G of the ITAA 1997. 3. The shares in Entity C will then be acquired by Entity B pursuant to a scrip for scrip rollover under Subdivision 124-M of the ITAA 97. As a result, Individual A and Individual B will be issued shares in Entity B in exchange for the shares which they own in Entity C. 4. Entity B will then make a choice to consolidate with Entity C and form a consolidated group, with Entity B as the head company (Group A). 5. Group A will then interpose a new head company pursuant to the rollover under Division 615 ITAA 97.

Relevant legislative provisions: Subdivision 328-G of the Income Tax Assessment Act 1997

Reasons for decision: Detailed Reasoning - Small Business Restructure Rollover (SBRR): Subdivision 328-G of the ITAA 1997 is intended to provide relief to small business entities restructuring their businesses. It does this via a rollover mechanism which acts to disregard tax gains and losses that would otherwise arise from transactions associated with the restructure. Broadly, for this subdivision to apply, the following key elements are required: ● Each party to the transaction is a small business entity ● The transaction is part of a genuine restructure of an ongoing business ● The ultimate economic ownership of the assets remains unchanged The relevant assets for which rollover relief under SBRR is available include CGT ‘active’ assets. In addition rollover relief will extend to depreciating assets and trading stock used in the business carried on by a small business entity. The relevant entities in the proposed restructure at first instance are Entity A and Entity C. Entity A carries on a business as a small business entity and has assets which it uses in the carrying on of that business that will be transferred to Entity C pursuant to the SBRR. Entity C will be a small business entity. CGT ‘active’ assets, trading stock and depreciating assets of Entity A would be eligible for roll-over relief under the SBRR. The Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters explains the meaning of the term ‘genuine restructure of an ongoing business’. Paragraph 6 states 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. However, it is a composite phrase emphasising that the SBRR is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests. Paragraph 7 states the following features indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business': 1. It is a bona fide commercial arrangement undertaken in a real and honest sense to: i. facilitate growth, innovation and diversification ii. adapt to changed conditions, or iii. reduce administrative burdens, compliance costs and/or cash flow impediments. 2. 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. 3. The economic ownership of the business and its restructured assets is maintained. 4. The small business owners continue to operate the business through a different legal structure. For example, there is: i. continued use of the transferred assets as active assets of the business ii. continuity of employment of key personnel, and iii. continuity of production, supplies, sales or services. 5. It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business. The SBRR contains a safe harbour rule at section 384-435 which provides an alternative way to meet the ‘genuine restructure of an ongoing business’ condition. A transaction is, or is a part of, a genuine restructure of an ongoing business if, in a 3 year period after the transaction takes effect: ● There is no change in the ultimate economic ownership of the assets transferred ● The assets remain ‘active’ assets ● There is no significant or material private use of the assets. Where the safe harbour is used, it is not necessary to consider whether the arrangement would otherwise be a ‘genuine restructure’ under paragraph 328-430(1)(a). The LCR provides examples of restructures that are simple and effective for meeting the genuine restructure requirement. Where the restructure of Entity A into an incorporated entity was the only proposed action, and where the other conditions of Subdivision 328-G were met, it is considered likely that the arrangement would satisfy the intention of a ‘genuine restructure of an ongoing business’ such that rollover relief would be available. However, that is not the case in this instance. In this matter, the proposed restructure extends beyond the mere incorporation of Entity A. Subsequent steps are planned to immediately follow post incorporation which are complex, involving several transactions and changes in ultimate economic ownership. It is the ATO’s view that conduct after the transfer of assets may be taken into account when determining whether a restructure was a ‘genuine restructure of an ongoing business’. Those subsequent steps raise the question of when a restructure begins and ends. We consider the steps following the transfer of assets from Entity A to Entity C require consideration and should be taken into account when determining whether the restructure is a ‘genuine restructure of an ongoing business’. We cannot consider the transactions in isolation. It is considered the restructure in this instance ends with the final step – the creation of the new consolidated group. Importantly, we consider the capital contribution from Entity B under the proposed scrip-for-scrip rollover facilitates a merger of businesses. One business is profitable (Entity B) and the other business loss making (Entity A). In this instance it is not accepted that this transaction amounts to capital raising after a restructure to facilitate growth or major expansion as described in Example 3 of the LCR. The change in ultimate economic ownership occurs as a result of the restructure transactions which include a partial divestment of Individual B’s ownership interest in Entity B. Therefore the proposed restructure, being an initial step in a broader reorganisation of your affairs, is not considered a ‘genuine restructure of an ongoing business’. For this reason you would not be eligible for rollover relief