New laws have recently been passed which will allow small businesses to restructure into a different legal form without triggering income tax. This concession has been long awaited and will enable many small businesses to unlock structures which are no longer ideal from a commercial, legal or tax perspective.
For a variety of reasons, many small businesses operate through less than ideal legal structures. We have seen examples where a structure was designed to deal with a particular rule or regulation applying at a point in time that is no longer relevant, was setup in anticipation of a rule change that never arrived or simply where facts or circumstances have changed and the entity no longer provides appropriate commercial and tax outcomes or protection of assets.
Unfortunately once a business has been operating through a structure for a period of time, it often becomes valuable and cannot easily be restructured without incurring significant tax liabilities.
These new rules will allow certain businesses to freely move into different structures without income tax consequences. Whilst there are a number of rollovers currently available under tax law, most are limited to allowing businesses operated through certain structures, e.g. trusts and partnerships, to roll into a company. The new rules are far wider in their potential application and will allow entities running a qualifying business, and certain related entities, to transfer any ‘active asset’ to another qualifying entity without tax.
Who is it for?
These measures are targeted at small businesses. An entity will qualify if they are a ‘Small Business Entity’ (‘SBE’) (including partners in an SBE partnership) or an ‘affiliate’ or ‘connected with’ an SBE. An SBE is an entity that conducts a business with estimated turnover for the current year of less than $2 million, or turnover for the previous year of less than $2 million. Both the transferor and transferee must meet these requirements.
When is it available?
The rollover is optional and available where an active asset is transferred from one eligible entity to another as part of a ‘genuine restructure’ where the ‘ultimate economic ownership’ of the asset does not change as a result of the transfer.
The term ‘genuine restructure’ is not defined however a safe habour rule has been included which says there will be a genuine restructure where, for the three years following the roll-over:
There is no change in the underlying economic ownership of any of the significant assets other than trading stock;
The significant assets transferred continue to be active assets; and
There is no material or significant private use of the significant assets transferred.
Where these requirements are not met, there may be other ways in which a genuine restructure might be demonstrated.
Proving that ultimate economic ownership has not changed would usually be reasonably straight forward, however it can be complicated when a discretionary trust is one of the parties to the transaction. As these trusts are generally not ‘owned’ in the legal sense, an alternative test is available which says there will be no change in ultimate economic ownership if, immediately before and/or after the transaction (as relevant), the discretionary trust had made a Family Trust Election and all individuals who had ultimate economic ownership of the asset just before or after the transfer took effect (as relevant) are members of the family group of the trust.
The rollover is only available where all parties to the transaction, and the ultimate economic owners of the asset/s transferred, are Australian residents for tax purposes.
What assets are covered?
The rollover is only available in respect of capital gains realised on active assets. An active asset covers most assets used in a business, including goodwill.
How does the rollover work?
Where the rollover is available and the transferor elects for it to apply, any capital gain arising on transfer of the asset/s is disregarded. The transferor is taken to have received an amount equal to the roll-over cost of the asset (typically the CGT cost base) to them and the transferee is taken to have acquired the asset for the same amount.
If membership interests are issued by the transferee in exchange for the asset/s, then the CGT cost base of these interests will be the combined value of all roll-over costs of the assets transferred, less any liabilities the transferee assumes.
When will it apply from?
The new rules apply to assets transferred from 1 July 2016, however now is an ideal time to begin the planning process if your small business is eligible and you wished to consider restructuring from 1 July.
What other matters should be considered?
For any assets transferred and for which the rollover is applied, the transfer date is taken to be purchase date for the purposes of the 50% CGT discount. This means you cannot transfer an asset from a company (which would not have access to the 50% discount) to a trust and then immediately dispose of the asset and claim the benefit of the discount.
However, the original purchase date of the transferring entity is taken to be the purchase date for the transferee for the purpose of applying the 15 year exemption under the Small Business CGT Concessions. This means ownership continuity for this exemption is not broken when the small business restructure rollover is applied.
It is important to note that this rollover will only apply to income tax that might otherwise apply on transfer of an eligible asset. It will not apply to transfer (stamp) duty or GST, and any restructure being contemplated will need to consider those rules separately.
These rules are complicated and professional advice should be sought by anyone contemplating a restructure of their small business.
If you would like to discuss your circumstances further please do not hesitate to contact Aaron Fitchett on 03 9851 9000.
Aaron is the tax partner at Baumgartners. He is a Chartered Tax Adviser with 18 years’ experience advising private and corporate clients on a wide range of tax and commercial matters. Aaron also represents clients in disputes with the Australian Tax Office and state revenue authorities. Aaron holds a Master of Taxation from UNSW and is an active member of the Taxation Institute of Australia.