16/11/2016 THE NEW SMALL BUSINESS RESTRUCTURE ROLLOVER. by Susan Young B.Com LLB Grad Dip Law

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1 THE NEW SMALL BUSINESS RESTRUCTURE ROLLOVER by Susan Young B.Com LLB Grad Dip Law 1

2 What we are covering How the new provisions work Interaction with existing small business CGT concessions Necessary elements for the rollover to be available Who qualifies for the rollover Residency requirement What is an active asset The ultimate economic ownership (UEO) rules What is a genuine business restructure Introduction With effect 1 July 2016, there is a new optional roll-over for gains and losses arising from the transfer of CGT assets, trading stock, revenue assets and depreciating assets as part of a restructure of an Australian resident small business The rollover enables small business entities (SBEs) to disregard any tax gain or loss made on the transfer of their business or assets into the new structures 2

3 Introduction The roll-over provides for tax neutral consequences for a transfer by "switching off" the application of the existing income tax law - but only for the purpose of the transfer and not for the purposes of GST, FBT or stamp duty. Obligations under other regulatory regimes, such as the corporations law, must still be complied with. Introduction The roll-over does not require that market value consideration, or any consideration, be given in exchange for the transferred assets. A transfer using the rollover provisions of an asset from a company to a shareholder will not be treated as a payment of a dividend under Division 7A. 3

4 Introduction Part IVA of the ITAA 1936, containing the general antiavoidance provisions of the taxation law, is not prevented from applying to a scheme involving the application of the roll-over Roll-over cost The rollover provisions provide the acquirer of the asset (the transferee) is effectively taken to acquire the asset for its roll-over cost (irrespective of the amount paid for the asset). The roll-over cost is the transferor's cost of the asset for income tax purposes, such that the transfer results in no gain or loss for the transferor. 4

5 Roll-over cost CGT assets The roll-over cost is the transferor's cost base for the asset just before the transfer takes effect. For example if the cost base of an asset is $100 and the market value of the asset is $200, the roll-over cost is equal to $100. Pre-CGT assets transferred under the roll-over retain their pre-cgt status in the hands of the transferee. Roll-over cost Trading stock The roll-over cost is the cost of the item for the transferor at the time of the transfer; or if the transferor held the item as trading stock at the start of the income year, the value of the item for the transferor at that time. Revenue assets The roll-over cost is the amount that would result in the transferor not making a profit or loss on the transfer. 5

6 Roll-over cost Depreciating assets The roll-over cost is the adjustable value of the asset. The transferee can deduct the decline in value of the depreciating asset using the same method and effective life (or remaining effective life if that method is the prime cost method) as the transferor used. Roll-over relief is also available for pooled assets. Roll-over cost Example from LCG 2016/2 Transfer of assets A company transfers its assets to a discretionary trust on 1 Jan The company and the trustee choose to apply the SBRR. As at 1 Jan 2017, the active assets of the company are: a small consulting room, which was acquired by Vitamin Pty Ltd for $200,000 in The market value is $230,000 goodwill, which is self-generated a pill press, with an adjustable value of $14,000, and trading stock - 50 bottles of homeopathic pills - cost $250 6

7 Roll-over cost Membership interests (shares and units) Where membership interests are issued in consideration for the transfer of assets, the cost base of those new membership interests will be: the roll-over cost of assets transferred that are not pre-cgt or depreciating assets; plus the adjustable values of the transferred depreciating assets; less any liabilities the new entity has undertaken to discharge associated with those assets divided by the number of membership interests Roll-over cost Example from EM Membership interests E Pty Ltd transfers three assets that it owns to the S Trust in circumstances that qualify for rollover: - a CGT asset having a cost base of $100,000; - a second CGT asset having a cost base of $1 million; and - a depreciating asset having an adjustable value of $400,000. The S Trust issues 10 units to E Pty Ltd in exchange for the transfer. The cost base of each unit is $100,000 + $1 million + $400,000)/10 = $150,000 7

8 Roll-over cost Membership interests A capital loss on membership interests cannot be realised as a direct result of the restructure. An example of this would be if assets are transferred out of a company and a loss is subsequently made on the shares in the company Effect on acquisition dates of assets With the exception of pre-cgt assets which retain their pre-cgt status following a restructure, assets transferred as a part of the restructure have a refreshed acquisition date being the date of the restructure. This means that the availability of the general 50% CGT discount is pushed back at least 12 months from the date of the restructure. 8

9 Interaction with existing small business concessions For small businesses that have already chosen to apply the small business CGT roll-over in relation to a CGT asset, those provisions apply to the transferee in a restructure roll-over as if they had made the choice, and not the transferor. Interaction with existing small business concessions Assets acquired by the transferee will carry the transferor's acquisition date for the purpose of the 15-year and significant individual rules when applying the small business CGT concessions. 9

10 Necessary elements for the roll-over to be available The restructure roll-over is available where the following is satisfied: an Australian resident small business entity transfers an active asset of the business to one or more other entities that are Australian resident small business entities the ultimate economic ownership ("UEO") of the asset (directly or indirectly) does not change; the assets are transferred as part of a genuine restructure of an ongoing business; and the transferor and each transferee choose to apply the roll-over in relation to the assets transferred. Necessary elements for the roll-over to be available Exempt entities and complying superannuation funds A roll-over under this Subdivision is not available if the transferor, or any transferee, is either an exempt entity or a complying superannuation entity. 10

11 Who qualifies for the roll-over To be eligible for the roll-over, each party to the transfer must be an Australian resident small business entity (SBE). An entity is a small business entity if it carries on a business and the combined annual turnover of the entity, and other entities that are affiliated or connected with it, is less than $10 million Who qualifies for the roll-over Some entities hold assets used by another entity in a small business. The roll-over extends eligibility to those passive entities where they: have an affiliate that is a small business entity for that income year; are connected with an entity that is a small business entity for that income year; or are a partner of a partnership that is a small business entity 11

12 Residency requirement There is a requirement: if the entity is an individual or a company - the entity is an Australian resident; or if the entity is a trust - it is a resident trust for CGT purposes; or if the entity is a partnership - at least one of the partners is an Australian resident Active asset requirement Section requires the asset to be an active asset at the time the transfer takes effect. An active asset is defined in section ITAA 97 12

13 Active asset requirement It is an asset, owned by the taxpayer (tangible or intangible): used or held ready for use in the course of carrying on a business; or used or held ready for use in the course of carrying on a business by the taxpayer s affiliate; or another entity connected with the taxpayer if the asset is an intangible asset it is owned by the taxpayer and it is inherently connected with a business that the taxpayer, its affiliate, or another entity connected with the taxpayer, carries on (for example, goodwill) Active asset requirement Unfortunately assets specifically excluded from being an active asset include assets whose main use is to derive rent, unless the main use for deriving rent is temporary. Assets used mainly to derive rent are excluded from being an active asset even if they are used in the course of carrying on a business (eg commercial premises rented to unconnected tenants) This exclusion means that rental properties will generally not qualify for the SBRR 13

14 Active asset requirement However where the premises are used in the course of carrying on a business by a connected entity or an affiliate they will be an active asset. Example from TD 2006/63 Joe owns 100 % of the shares in Smash Repair Co. Joe owns the business premises and leases them to the company for the conduct of its business. Although Joe is wholly using the premises to derive rent, Smash Repair Co (a connected entity) is using the premises in the course of carrying on a business. The premises are therefore an active asset of Joe's Active asset requirement Transfers by parties not small business entities Where a party to the transaction is not a small business entity, but is either: an entity that has an affiliate that is a small business entity; or an entity that is connected with a small business entity, then to qualify for the SBRR, the relevant small business entity must carry on business in relation to the asset 14

15 Active asset requirement Shares and units It will be difficult for the transfer of shares or interests in trusts to qualify for the SBRR. This is illustrated by an eg from LCG 2016/13. Active asset requirement Di provides accommodation services for travellers through a company, Fair Dinkum Backpackers Co which is a small business entity. She is the sole director and shareholder. Di transfers all of her shares in the company to a discretionary trust. The company is not a party to the transfer. The shares are not active assets of a small business entity as Di is not carrying on a business. They are not active assets of the connected company. Consequently, the SBRR is not available on the transfer of the shares 15

16 Active asset requirement Loans to shareholders of a company excluded Assets such as loans to shareholders of a company are not active assets of the business carried on by the creditor. A purported transfer of such assets to the debtor shareholder, or trust liable to pay the unpaid distribution could potentially defeat the operation of Division 7A. The EM states the rollover cannot be used for such transfers. Active asset requirement Liabilities excluded The roll-over provisions do not deal with transferring liabilities to the transferee (acquirer). Liabilities could be transferred under a separate transaction (not subject to the roll-over). However, one would need to consider the consequences that may occur (eg foreign exchange gains, debt forgiveness provisions, etc). 16

17 The ultimate economic ownership (UEO) rules To be eligible for the roll-over the transaction must not have the effect of changing the ultimate economic ownership of transferred assets in a material way. The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset. The ultimate economic ownership (UEO) rules Where an individual operates as a sole trader, they hold the UEO. Where the entity is a company, the provisions will look at the ultimate shareholders to determine the UEO 17

18 The ultimate economic ownership (UEO) rules Same proportionate ownership requirement If there is more than one individual who is an ultimate economic owner of an asset, there is an additional requirement that each of those individuals shares of that ultimate economic ownership be materially unchanged, maintaining the same proportionate ownership in the asset The ultimate economic ownership (UEO) rules Example from EM Penny runs a small furniture manufacturing business as a sole trader. She wishes to run the business through a unit trust. Penny sets up the Just Me Unit Trust for this purpose, with herself as sole unit holder, and transfers the active assets of the business to the trust. This would not result in a change in ultimate economic ownership of those assets. 18

19 The ultimate economic ownership (UEO) rules Example from EM Amy, Anna and Adrian run a business as equal partners and want to transfer their interests in the assets of the partnership to a company. Amy, Anna and Adrian establish a company, whereby 300 identical shares are issued. 100 shares are issued to Amy, 150 shares are issued to Anna, and 50 shares are issued to Adrian. While this doesn t change the individuals who have the ultimate economic ownership of the asset, there is a change in the proportionate share of that ultimate economic ownership. Accordingly, Amy, Anna and Adrian cannot use the small business restructure roll-over. The ultimate economic ownership (UEO) rules Special rule for discretionary trusts A special rule provides a transaction does not have the effect of changing the UEO if the transferor or transferee has made a family trust election and every individual who, just before or just after the transfer took effect had the UEO of the asset(s), was a member of the family group 19

20 The ultimate economic ownership (UEO) rules Example from LCG 2016/3 Steven operates a business through a company. Steven, his wife, Vicki, his son Daniel, and his daughter Courtney, are the shareholders. The company transfers the business' active assets to a trust where he and his family members are beneficiaries. A family trust election is made and Steven is the primary individual specified in the election. Steven, Vicki, Daniel and Courtney are all members of Steven's family group. The company can use the SBRR to transfer its assets to the trust. Genuine business restructure The SBRR is available where the following is satisfied: an Australian resident small business entity transfers an active asset of the business to one or more other entities that are Australian resident small business entities the ultimate economic ownership ("UEO") of the asset (directly or indirectly) does not change; the assets are transferred as part of a genuine restructure of an ongoing business; and the transferor and each transferee choose to apply the roll-over in relation to the assets transferred 20

21 Genuine business restructure Whether a restructure is 'genuine' is a question of fact that is determined having regard to all of the facts and circumstances surrounding the restructure Genuine business restructure The EM states the following factors would indicate a "genuine" restructure: a bona fide commercial arrangement undertaken to enhance business efficiency the business continues to operate after the transfer the transferred assets continue to be used in the business the restructure results in a structure likely to have been adopted had the business owners obtained appropriate professional advice when setting up the business the restructure is not artificially or unduly tax driven the restructure is not a divestment or a preliminary step to facilitate the economic realisation of assets 21

22 Genuine business restructure Safe harbour rule There is a "safe harbour" rule which provides a transaction will be taken to be part of a genuine restructure if, in the 3-year period after the transaction takes effect: there is no change in the UEO of the significant assets of the business (other than trading stock) that were transferred; those significant assets continue to be active assets; and there is no significant or material use of those assets for private purposes Genuine business restructure Law Companion Guideline LCG 2016/3 states the SBRR is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests 22

23 Genuine business restructure The LCG provides examples of what the ATO considers acceptable and not acceptable. Two of these are reproduced below. Example from LCG 2016/3 - Asset protection 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. Genuine business restructure 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. He transfers the active assets into a family trust and applies the SBRR. For asset protection purposes, a corporate trustee is appointed and the trust contracts with clients. Mark does not personally provide guarantees or indemnities. The evidence available supports Mark's claim of asset protection. The restructure is a response to his business needs, facilitates further growth and is not unduly tax-driven. The LCG states the 'genuine restructure of an ongoing business' condition is satisfied 23

24 Genuine business restructure Example from LCG 2016/3 - Succession planning Nick owns all the shares in Holding Co a company that operates two restaurants, Fish and Chips. Nick has two sons and is looking to retire. Nick causes the company to transfer the active assets relating to Fish restaurant to Gone Fish Inc., a newly incorporated company that he also owns. The SBRR is claimed. Genuine business restructure Sometime later, but within three years, Nick retires and disposes of the shares in the Holding Co (which now holds the active assets of Chips only) to his first son and the shares in the new company to his other son, so that each of them can run their own restaurants separately. Nick cedes control to his sons as a result of his plan to retire. Nick cannot use the safe harbour rule. Nick is breaking up the business to enable a tax-effective intergenerational transfer of wealth. He has no expectation of running his business going forward. 24

25 Genuine business restructure The LCG states Nick's conduct subsequent to the transfer of assets forms part of the evidence that is taken into account when considering the genuineness of the restructure. The LCG states the SBRR is not available to Holding Co and Gone Fish Inc., as the restructure is undertaken in the course of Nick winding down and facilitating an inter-generational transfer of wealth as opposed to a bona fide restructure of an ongoing business. What we have covered How the new provisions work Interaction with the existing small business CGT concessions The necessary elements for the rollover to be available Who qualifies for the rollover The residency requirement What is an active asset The ultimate economic ownership (UEO) rules What is a genuine business restructure 25

26 The End Thank You 26