Private ruling: Income tax - capital gains tax - restructure roll-over - subdivision 328-g
Date of advice: 22 December 2017
Published: May 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the Small Business Restructure Roll-over contained in Subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 1997) be available in relation to the proposed restructure? | A1: No.

Relevant facts and circumstances: A unit trust was established (the Unit Trust). The units held in the Unit Trust are held by a number of individuals in equal proportions. The Unit Trust owns an Asset which it uses in carrying on a business. The Unit Trust and its affiliated entities have an annual turnover of less than $2 million. The Unit Trust is seeking additional capital for its business. In establishing the Unit Trust, the unit holders did not obtain advice and were not aware of the most appropriate business structure to operate its business activity. The unit holders have now sought advice from a business planning organisation and had discussions with potential investors and now realise that their business activity should be operated through a company structure. The unit holders of the Unit Trust are proposing to transfer the Asset and operate the business activity though a company. The shares in the new company (the Company) which will acquire the Asset will be issued in equal portions to each individual’s discretionary family trusts where each family trust will make a Family Trust Election in accordance with section 272-80 of Schedule F to the Income Tax Assessment Act 1936 (ITAA 1936). Each individual co-founder will be the specified individual of their family trust. The trustee of the each family trust will be a company, each having a sole shareholder being the specified individual under the Family Trust Election. This individual will also be the appointer of the family trust. The Unit Trust and the Company will meet the residency conditions of Subdivision 328-G of the ITAA 1997 and will choose to apply a roll-over under Subdivision 328-G if the roll-over is available.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 328-430 | Income Tax Assessment Act 1997 Paragraph 328-430(1)(a) | Income Tax Assessment Act 1997 Section 328-440 | Income Tax Assessment Act 1997 Paragraph 328-440(1)(c)

Reasons for decision: Summary: All the legislative references that follow are to the Income Tax Assessment Act 1997 . Subsection 328-430(1) states that a restructure roll-over under Subdivision 328-G is available in relation to an asset that, under a transaction, an entity (the transferor) transfers to one or more other entities (transferees) if: (a) the transaction is, or is a part of, a genuine restructure of an ongoing business, and (b) each party to the transfer is an entity to which any 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; and (c) 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 ownership; and (d) the asset 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 (e) the transferor and the transferee meet the residency requirements in section 328-445 for an entity; and (f) the transferor and the transferee choose to apply a roll-over under this subdivision in relation to the assets transferred under the transaction. For the restructure roll-over provided for by Subdivision 328-G to be available, there is a requirement that the restructure does not have the effect of materially changing which individual has, or which individuals have, the ultimate economic ownership of the business assets (paragraph 328-430(1)(c)). In this case, it is proposed that the Unit Trust transfer the Asset to a new company. The units in the Unit Trust are owned by X individuals in equal proportions. The shares in the new company will be issued in equal proportions to each of the individual’s discretionary family trusts. Each of the discretionary trusts will make a Family Trust Election and each individual will be the specified individual of their family trust. It is the Commissioner’s view that a purely discretionary trust could not satisfy the ultimate economic ownership test without relying on the special rule in section 320-440. This is because the economic interests that the objects of such a trust have in an asset are not fixed in proportion, and would depend on the trustee exercising their discretion. In the current situation, the ultimate economic ownership of the Asset rests with the X individuals. Under the proposed transfer, it cannot be concluded that the ultimate economic ownership of the Asset still rests with only those X individuals, as any of the beneficiaries of the discretionary family trusts could benefit economically from the Asset depending on how the trustees exercise their discretion. Therefore the proposed restructure would have to meet the alternative ultimate economic ownership test provided by section 328-440 in order for the restructure roll-over to be available. For section 328-440 to apply the assets must be included in the property of a family trust either just before the transaction or just after it and that is not the case here. Before the transaction the Asset was included in the property of the Unit Trust and just after the transaction the Asset will be included in the property of the new company. It is noted that the family trusts will own the company, and therefore it could be argued that in effect the Asset will form part of the property of the family trusts. However, the wording in subparagraph 328-440(a)(ii) is very specific and we do not consider that it can be interpreted that broadly. After the restructure the Asset will be included in the property of the company rather than the family trusts. It is the shares in the company that will be included in the property of the family trusts. As subparagraph 328-440(a)(ii) will not be met, the restructure roll-over will not be available with respect to the proposed restructure. As the proposed restructure is not available due to neither the ultimate economic ownership test in paragraph 328-430(1)(c) or the alternative test in section 328-440 being met, it is not necessary to consider whether the proposed transfer is a genuine restructure of an ongoing business. It is noted that you referred to IT 2340 in your private ruling application. IT 2340 considers section 160ZZS of the ITAA 1936 (rewritten as section 149-30). This provision applies where an entity such as a company or trust acquired assets prior to 20 September 1985 and on or after that date there is a change of 50 per cent or more in the underlying ownership of the assets (in the case of a company, a change of 50 per cent or more in the beneficial ownership of the company's shares). Where such a change occurs the provision operates to deem the assets to have been acquired after 19 September 1985 so that any subsequent real capital gain on the assets will fall within the tax base. In relation to discretionary trusts, IT 2340, contemplates the situation where the same discretionary trust owns the asset pre and post 19 September 1985 and states that ‘in considering the question of whether majority underlying interests have been maintained it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised’. We do not think the principles in IT 2340 are applicable in the present situation as we are not dealing with a situation where an asset continues to be owned by the same entity. Rather in the present case, ownership will pass from individuals to discretionary trusts. Even if the principles in IT 2340 were to be applied to the present case, as the underlying ownership only lay with the individual previously it would have to be shown that the trustee will only distribute to that individual and this is not possible as any distributions will happen in the future and as the trust is discretionary, it cannot be guaranteed which beneficiaries will receive distributions. Therefore, it is clear that IT 2340 is not applicable when considering the ultimate economic ownership test for Subdivision 328-G.