Private ruling: Subdivision 328-G small business restructure roll-over
Date of advice: 24 July 2018
Published: September 2018
Ruling period: Income year 1 July 2018 to 30 June 2019
Date scheme commenced: The date of incorporation of W Pty Ltd

Ruling: Q1: Will W Pty Ltd be entitled to a deferral from a CGT liability under the small business restructure roll-over relief in Subdivision 328-G of the Income Tax Assessment Act 1997 in respect of the proposed transaction? | A1: Yes | Q2: Will the transfer of the units from W Pty Ltd to X Trust trigger any Division 7A Income Tax Assessment Act 1936 consequences for the shareholders of that company (or their associates) if there is no consideration given for the transfer of the units? | A2: No

Relevant facts and circumstances: 1. W Pty Ltd (or “the Company”) is a private company owned equally by five individual Australian resident shareholders and is carrying on a business of manufacturing a product in a particular industry. 2. W Pty Ltd is a small business entity for the purposes of the small business restructure rollover relief under Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997). 3. Z Trust is a discretionary trust which supplies personnel/labour hire to W Pty Ltd. 4. W Pty Ltd acts as trustee for Z Trust. 5. Z Trust is also a small business entity for the purposes of Subdivision 328-G ITAA 1997. 6. Y Trust is a unit trust which owns the land and industrial building located in Australia (“the Property”); 7. The Property is occupied solely W Pty Ltd and is used exclusively to conduct the business activity of product manufacture by the Company. The premises will continue to be used exclusively for this purpose post the proposed restructure. 8. Other than cash reserves of $XXX,000, the Property is the only other asset owned by Y Trust, valued currently at $X million, which would represent 93.8% of the market value of its assets, totalling $X,XXX,000. 9. The Property has been owned by Y Trust since 2003 and has never been used for any other purpose other than to conduct the business activity of product manufacture by the Company. 10. The same five Australian resident individuals who equally own the shares in W Pty Ltd, own (between them in equal proportions) one third of the units in Y Trust (i.e. each individual owns 1/15 th or 6.79% of the units in Y Trust). The balance of the units (two thirds or 66.67%) is currently owned by W Pty Ltd. 11. Therefore, the ultimate economic ownership of the Company, and Y Trust is by the same five individuals (in equal proportions of 20% each). 12. Each unit holder in Y Trust owns partly paid units. 13. The cost base of the Company’s units in Y Trust is currently $1,XXX,XXX. 14. The Company acquired its unit holding in Y Trust as partly paid units upon the unit trust’s formation in June 2003. 15. The shareholders of the Company have recently expressed concern over the asset protection of the structure, given the current economic climate of the particular industry in a relevant State of Territory and the recent spate of insolvencies in the industry in Australia. In addition, they are also concerned about the risk of the Company being sued by a customer of the business in the event that they sustain a serious injury whilst using the product – i.e. due to the high risk of injury and dangerous nature of the industry. 16. Furthermore, the shareholders of the Company want to grow the business further by increasing marketing of their products within the industry, which will in turn lead to dealing with new customers. However they are concerned that the equity in the property (owned indirectly by the Company, via its unit holding in Y Trust) will be at risk if they begin to deal with new builders and customers that they have not dealt with in the past. This is therefore holding the Company back from potential future growth and enhanced profits. 17. The shareholders and ultimate unit holders are therefore contemplating the transfer of the Company’s unit holding in Y Trust to a new entity, called the “X Trust”, which will then greatly assist in protecting the equity in the property should the Company fall victim to customers becoming insolvent or in the event of litigation. 18. X Trust will take over the activities currently conducted by Z Trust. That is, X Trust will supply personnel/labour hire to W Pty Ltd. 19. X Trust will be a small business entity for the purposes of Subdivision 328-G ITAA 1997. 20. The units of X Trust will be equally owned by the same five individual Australian residents who own all of the shares in W Pty Ltd. 21. The Company’s Units in Y Trust have a cost base of $1,XXX,XXX. It is proposed to transfer these units to X Trust for nil consideration.

Relevant legislative provisions: 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 Section 328-430 | Income Tax Assessment Act 1997 Section 328-435 | Income Tax Assessment Act 1997 Section 328-445 | Income Tax Assessment Act 1997 Section 328-450

Reasons for decision: Summary: 1. Small business restructure roll-over relief is available for W Pty Ltd and the X Trust as all required conditions within Subdivision 328-G Income Tax Assessment Act 1997 (ITAA 1997) are satisfied – i.e.: ● The proposed transaction is the result of a genuine restructure of an on-going business; ● Each party to the transfer is a small business entity or it has an affiliate that is a small business entity or it is connected with an entity that is a small business entity or it is a partner in a partnership that that is a small business entity for that income year; ● The transaction does not change the individual’s share of its ultimate economic ownership in the relevant assets; ● The asset is a CGT asset that is an active asset; ● The transferor and transferees meet the residency requirement; and ● The transferor and transferees will all choose to apply a roll-over in relation to the assets transferred under the transaction. The proposed transfer of units owned in Y Trust from W Pty Ltd to the X Trust will be eligible for small business restructure roll-over relief per Subdivision 328G ITAA 1997 . 2. As section 328-450 ITAA 1997 ‘switches off’ the direct income tax law consequences of the transfer, W Pty Ltd will be able to transfer the units to the X Trust for nil consideration, without triggering Division 7A Income Tax Assessment Act 1936 (ITAA 1936). | Detailed Reasoning - 1. Will W Pty Ltd be entitled to a deferral in a CGT liability under the small business restructure roll-over relief in Subdivision 328-G ITAA 1997?: Subdivision 328-G ITAA 1997 was introduced from 30 June 2016 to facilitate flexibility for owners of small business entities to restructure the way their business assets are held while disregarding tax gains or losses that would otherwise arise. The assets in this instance which require roll-over relief are the units in Y Trust which are currently held by W Pty Ltd. The proposed transaction currently being contemplated is to transfer the units from W Pty Ltd to X Trust - thereby maintaining the same ultimate economic ownership levels in the Property. However it will greatly assist in protecting the equity in the Property should the Company fall victim to customers becoming insolvent or in the event of litigation and will facilitate growth. Section 328-430 ITAA 1997 outlines the six conditions which must be satisfied to allow small business roll-over relief to be available to an entity: | Detailed Reasoning - First condition: Paragraph 328-430(1)(a) ITAA 1997 refers to the transaction being part of a genuine restructure of an ongoing business. Further, Law Companion Guide LCG 2016/3 explains the meaning of the term ‘genuine restructure of an ongoing business’ and also provides various examples of circumstances that would qualify as a genuine restructure. The first example given in LCG 2016/3 (outlined in paragraphs 17 – 23) refers to asset protection as being a suitable ‘genuine reason of restructure.’ | Detailed Reasoning - Example 1: Asset protection: Facts 17. Mark has been operating a small bookkeeping business and has branched out into financial planning after receiving his financial planning licence. Mark's business has grown significantly and his financial advice arm now generates much larger profits. 18. 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. 19. Mark transfers his active assets used to carry on his financial planning business into a discretionary family trust. He and his wife are the beneficiaries and Mark is the primary individual specified in the family trust election in force in respect of the trust. For asset protection purposes, a corporate trustee is appointed and the trust contracts with clients. Mark does not personally provide guarantees or indemnities. Mark has also caused the trustee to employ other staff to service the larger client base. The trustee pays Mark and the other employees a salary commensurate to the services they provide to the business. 20. Mark and the trustee of the discretionary family trust choose to apply the SBRR. Relevant considerations 21. 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. 22. The evidence available supports Mark's claim of asset protection. Mark's asset protection strategy and commitment to expand his business is comprehensive and effective. Conclusion 23. Mark has achieved benefits to the ongoing efficient conduct of his small business. 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. As explained in the facts, the Company operates in a very high risk industry. The current economic climate of the particular industry in Australia is firstly of concern (heightened by the recent spate of insolvencies) and there is also concern about the risk of the Company being sued by a customer of the business in the event that a customer sustains a serious injury whilst using its product – i.e. the high risk of injury and dangerous nature of the industry. The Company (which operates in this high risk environment) also owns 66.67% of the units in Y Trust – which, in turn, owns the land and industrial building in Australia. Furthermore, the shareholders want to grow the business further by increasing marketing of their products within the industry, which will in turn lead to dealing with new customers. However they are concerned that the equity in the property (owned indirectly by the Company (via its unit holding in the Y Trust) will be at risk if they begin to deal with new builders and customers that they have not dealt with in the past. This is therefore holding the Company back from potential future growth and enhanced profits. LCG 2016/3 paragraph 23 states, in the example, that: “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.” The reason for the proposed restructure is for asset protection and will facilitate further growth of the W Pty Ltd business. This first condition in paragraph 328-430(1)(a) ITAA 1997 would therefore be satisfied. | Detailed Reasoning - Second condition: Paragraph 328-430(1)(b) of ITAA 1997 relevantly requires that each party to the transfer is a small business entity for the income year during which the transfer occurred. Section 328-110(1) ITAA 1997 then explains the meaning of a small business entity as: You are a small business entity for an income year (the current 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.” W Pty Ltd is a small business entity as defined in section 328-110 as it carries on a business of manufacturing/fabricating of metal products and has aggregated turnover of below $10 million in the previous financial year. X Trust (the proposed transferee) will also be a small business entity as defined in section 328-110 as it will carry on a business of labour hire/provision of personnel services and will have aggregated turnover of below $10 million. | Detailed Reasoning - Third condition: Paragraph 328-430(1)(c) ITAA 1997 requires the transaction does not materially change each individual’s share of ultimate economic ownership in the assets. W Pty Ltd is owned equally by five individual Australian resident shareholders. X Trust will also be owned equally by the same five individuals who also equally own the shares in the Company. The same five Australian resident individuals who own the shares in W Pty Ltd equally also own (between them in equal proportions) one third of the units in Y Trust (i.e. each individual owns 1/15 th or 6.79% of the units in Y Trust). The balance of the units (two thirds or 66.67%) is currently owned by W Pty Ltd. As the shares in the Company are equally owned by the same individuals who will also equally own all of the units in the X Trust, the transfer of the Company owned units in the Y Trust to the X Trust, will not create any change in the ultimate economic ownership of the Y Trust (i.e. the five individuals will continue to ultimately own all of the shares in the Company and all of the units in both X Trust and Y Trust). The ultimate economic ownership in the assets will therefore remain the same, thus satisfying paragraph 328-430(1)(c) ITAA 1997. | Detailed Reasoning - Fourth condition: Paragraph 328-430(1)(d) ITAA 1997 relevantly requires that the asset is a CGT asset (other than a depreciating asset) that is, at the time the transfer takes effect an active asset. Subsection 152-40(1) ITAA 1997 provides that a CGT asset is an active asset at a time if, at that time you own the asset (whether the asset is tangible or intangible) and it is used , or held ready for use, in the course of carrying on a business that is carried on by you, your affiliate or another entity that is connected with you. The business conducted by W Pty Ltd (i.e. the manufacture of products in the particular industry) is currently carried on at the business premises located in Australia, which is owned by the Y Trust. The property is occupied solely by W Pty Ltd and is used exclusively to conduct the business activity of product fabrication by the Company. As the business premises is and will continue to be used exclusively for this purpose post the proposed restructure, it is therefore regarded as an active asset as defined in section 152-40 of the ITAA 1997. Further, subsection 152-40(3) ITAA 1997 states that: A CGT asset is also an active asset at a given time if, at that time, you own it and: (a) it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs; and (b) the total of: (i) the market values of the active assets of the company or trust; and (ii) the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on; and (iii) any cash of the company or trust that is inherently connected with such a business ; is 80% or more of the market value of all of the assets of the company or trust. The assets to be transferred are the units in the Y Trust which are currently owned by W Pty Ltd. Paragraph 325-125(1)(a) ITAA 1997 relevantly provides that an entity is connected with an entity if either entity controls the other entity. Control exists if an entity owns interests in the other entity that carry with them the right to receive at least 40% of any distribution of income by the other entity or any distribution of capital by the other entity. W Pty Ltd currently owns two thirds (i.e. 66.67%) of the units in the Y Trust. W Pty Ltd therefore controls the Y Trust. Other than the cash reserves of $XXX,000, the business premises is the only other asset owned by Y Trust (currently valued at $X million), which would represent 93.8% of the market value of the Y Trust assets, totalling $X,XXX,000. As the business premises are an active asset, and the market value of the business premises exceeds 80% of all of the assets of the Y Trust, the units in the Y Trust would therefore in turn be regarded as an active asset. As the business premises is used exclusively to conduct the business, the premises represent greater than 80% of the market value of all of the assets of the Y Trust and the Y Trust is connected with the Company, the units in the Y Trust, currently owned by the Company, would therefore be regarded as an active asset. | Detailed Reasoning - Fifth condition: Paragraph 328-430(1)(e) ITAA 1997 requires the transferor and all transferees to meet the residency requirement in section 328-445 for an entity. Section 328-445 provides that, for the purposes of paragraph 328-430(1)(e), the residency requirement for an entity is that, relevantly, if the entity is a company, the entity is an Australian resident, or if the entity is a trust, it is a resident trust for CGT purposes. W Pty Ltd is an Australian resident company with central management and control being in Australia. X Trust will be an Australian resident trust which will always maintain its central management and control in Australia. In addition, all five of the individual shareholders are Australian residents for taxation purposes. Both the transferor and transferee will therefore meet the residency requirements. | Detailed Reasoning - Sixth condition: Paragraph 328-430(1)(f) ITAA 1997 requires the transferor and all transferees involved to choose to apply a roll-over in relation to the asset being transferred. It is envisaged, if the proposed transaction proceeds, that all parties will have elected to apply the small business restructure roll-over relief under subdivision 328-G. | Detailed Reasoning - Conclusion: After application of the facts directly to the legislation (Subdivision 328-G ITAA 1997) we have concluded the Company will be eligible to apply the small business restructure roll-over provisions upon the transfer of all units held by the Company to the X Trust whilst maintaining the same ultimate economic ownership in the assets which existed prior to the transfer. 2. Will the transfer of the units from the Company to X Trust trigger any Division 7A ITAA 1936 consequences for the shareholders of the Company (or their associates) if there is no consideration given for the transfer of the units? It is proposed that the Company transfers the units owned in the Y Trust to the X Trust (having a cost base of $1,XXX,XXX) for nil consideration under the small business restructure roll-over provisions in Subdivision 328-G ITAA 1997. Section 328-450 of the ITAA 1997, explains the consequences of a roll-over under this Subdivision, and explains that the small business transfers do not have any direct consequences under the income tax law: (1) Except as provided by this Subdivision, a transfer of an asset has no direct consequences under the * income tax law if: (a) the transfer occurs under a transaction in relation to which section 328-430 applies; and (b) a roll-over under this Subdivision is available under that section in relation to the asset. The legislation then gives the following example under Section 328-450 (b): Example: If the transfer were a transfer of the asset from a company to a shareholder, it would not be treated as a payment of a dividend under Division 7A of Part III of the Income Tax Assessment Act 1936 . Further, the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 explanatory memorandum states: | Detailed Reasoning - Transfers not to affect income tax position: 1.45 As with other roll-overs, the small business restructure roll-over is intended to be tax-neutral, in the sense that no income tax consequences arise from the transfer of the asset(s). This will provide small businesses with the flexibility to change their legal structure without the cash flow problems that may arise from realising an income tax liability on the transfer of assets to a different entity. [Schedule 1, item 1, section 328-450] 1.46 The roll-over can be used for transfers from and to a range of different entity types, and such transfers may trigger various provisions under the existing income tax law. For example, a transfer of an asset by a company to a shareholder may be an assessable dividend under section 44 of the ITAA 1936 or Division 7A. 1.47 Section 328-450 ensures that there are tax neutral consequences for a transfer that qualifies for the roll-over, by ‘switching off’ the application of the existing income tax law. [Schedule 1, item 1, section 328-450] The Company has proposed to transfer the units owned in the Y Trust to X Trust (having a cost base of $1,XXX,XXX) for nil consideration. Due to the operation of section 328-450, as small business restructure roll-over relief under Subdivision 328-G is satisfied, the direct consequences of the transfer of the units, under income tax law, would be ‘switched off’. The transfer of the units to a shareholder (or an associate of a shareholder) for nil consideration, would ordinarily trigger Division 7A ITAA 1936. However, as this is a direct income tax consequence of applying the transfer under the small business restructure roll-over, the Division 7A consequence that would normally apply will be ignored. Therefore, as section 328-450 ITAA 1997 ‘switches off’ the direct income tax law consequences of the transfer, the Company will be able to transfer the units to X Trust for nil consideration, without triggering Division 7A.