Small business restructure relief under Subdivision 328-G was enacted in 2016, and applies to certain transfers of trading stock, depreciating, revenue and CGT assets on or after 1 July 2016.
Subdivision 328-G is beneficial for a few reasons:
- The small business CGT (SBCGT) concessions, which can also be used as a restructuring tool, only apply to entities with a turnover of less than $2 million (or a maximum net asset value of up to $6 million), whereas Subdivision 328-G applies to a turnover of less than $10 million, and so it is accessible to larger businesses;
- The SBCGT concessions are very difficult to apply (see our previous articles highlighting some of the issues here); and
- Other CGT rollovers are restrictive in nature, generally requiring assets be transferred to a company, or the need to introduce a company within an existing structure. Subdivision 328-G may, for example, allow assets to be transferred from an existing business structure to a different business structure without the constraint that the transferee is a company. For example, the restructure can be from a sole trader to a trust or a partnership, or possibly from a company to a trust or partnership, options which are not available under other CGT rollovers.
It could be assumed that it would be easy for taxpayers to qualify for Subdivision 328-G relief. After all, it is dealt with in only 11 sections of legislation. The original Explanatory Memorandum (EM) is only 17 pages. This isn’t a lot of detail given the potential for its use. So, it should be easy to access. Unfortunately, it isn’t!
Example 1 – transfer of shares
Take an example of a common restructure. Mr and Mrs Rich each own 50% of shares in Rich Co, a manufacturer of luxury goods, which has a turnover of $8 million per annum and a market value of $3 million. For asset protection reasons, they would like to transfer their shares to their trust, the Rich Family Trust.
Is the transfer of Rich Co shares eligible for relief under Subdivision 328-G?
The EM states:
The amendments make it easier for small business owners to restructure by allowing them to defer gains or losses that would otherwise be made from transferring business assets from one entity to another as part of a genuine restructure.
The new small business roll-over is in addition to roll-overs currently available where an individual, trustee or partner transfers assets to, or creates assets in, a company in the course of incorporating their business.
On an initial reading of the EM, Subdivision 328-G relief could arguably apply to the transfer of shares.
However, there are a number of hurdles that must be satisfied as follows:
- The transaction must be, or be part of, a genuine restructure of an ongoing business;
- Each party to the transfer must be one of a small business entity (SBE), with a turnover of less than $10 million being the threshold in this context, an affiliate of, or connected with an entity that is an SBE or be a partner in a partnership that is an SBE;
- The assets being transferred are active assets of the entities identified at Condition 2 above;
- The transaction does not have the effect of materially changing which individual/s have the ultimate economic ownership of the asset;
- The transferor and transferee meet Australian residency requirements; and
- Both the transferor and transferee choose to apply the roll-over.
For the purposes of this article, we have assumed that Conditions 1, 2, 5 and 6 will be met. However, as Mr and Mrs Rich are planning to transfer their shares in Rich Co to the Rich Family Trust, it is necessary to consider Conditions 3 and 4.
Are the shares an active asset for these purposes?
Unfortunately, no. Ordinarily shares could qualify as an active asset for the purposes of the SBCGT concessions in the situation where broadly more than 80% of the market value of the underlying assets of the company (in which the shares are held and are to be transferred) are active. However, as Rich Co is the SBE (rather than Mr and Mrs Rich on the basis that they do not carry on any business personally), the CGT asset being transferred needs to be an active asset in relation to which section 152-10(1A) is satisfied (or would be if the $2 million threshold for the SBCGT concessions were ignored).
In order for the requirements in section 152-10(1A) to be met:
- Rich Co (a SBE) must be an affiliate or connected with Mr and Mrs Rich – this would be satisfied;
- Mr and Mrs Rich must not carry on a business in the income year (other than in partnership) – we will assume this is satisfied;
- The SBE referred to above, i.e., Rich Co, is the entity that at a time in the income year, uses the subject asset in carrying on its business.
Given that the assets to be transferred are shares, this final requirement of Rich Co using the asset in carrying on its business cannot be met. The nature of shares means it is not possible to ‘use’ shares in the course of carrying on a business.
Ultimate economic ownership
Setting aside that the shares do not satisfy the active asset requirement at Item 3 above, let’s still consider the ultimate economic ownership requirement in the context of arrangements involving discretionary trust(s).
With restructures, particularly in the SME space, it is quite common to either have an existing discretionary trust in the structure, or to want to move an asset to a new discretionary trust. Ultimate economic ownership of an asset can only be held by natural persons. The nature of discretionary trusts therefore means that the requirement for no material change in ultimate economic ownership cannot be satisfied as there is no ultimate economic ownership of the asset.
To overcome this issue, section 328-440 applies special rules for discretionary trusts to meet this requirement. These are:
- Either or both of the following applies:
Just before the transaction took effect, the asset was included in the property of a family trust; and/or just after the transaction takes effect, the asset is included in the property of a family trust; and
- Every individual who, just before the transfer took effect, had ultimate economic ownership of the asset was a member of the family group within the meaning of the trust loss provisions relating to the trust; and
- Every individual who, just after the transfer takes effect, has the ultimate economic ownership of the asset, is a member of that family group.
Thus, to satisfy the modified ultimate economic ownership test for discretionary trusts, the asset being transferred must be an asset of a trust that has a family trust election (FTE) in force before or after the transfer takes effect.
In our above example the shares fail to satisfy the active asset requirement such that if Mr and Mrs Rich were to transfer their shareholdings in Rich Co to the Rich Family Trust, there will be a tax cost. An alternate option would be for Rich Co to transfer its active assets to the Rich Family Trust, and the trust carry on the business in the future. In the context of the modified ultimate economic ownership test, it is necessary for the Rich Family Trust to have an FTE in force in the year of transfer and for Mr and Mrs Rich be part of that trust’s family group.
Example 2 – Transfer of business assets (not shares)
What if Mr and Mrs Rich owned the business directly and want to transfer the business to a new company (NewCo) with the shares being held by a new discretionary trust, the New Rich Trust, will Subdivision 328-G apply?
Unfortunately, it won’t apply as the modified ultimate economic test for discretionary tests will not be satisfied. As noted above the test requires that the transferred asset be either the property of a family trust just before or just after the transfer takes effect. The subject assets are currently owned by Mr and Mrs Rich and, therefore, are not property of New Rich Trust just before the transfer. Just after the transfer, the subject assets are the property of NewCo (rather than being the assets of New Rich Trust). Whilst it could be argued that through New Rich Trust’s shareholding in NewCo, it is the owner of the assets transferred, the ATO does not adopt such a broad interpretation of section 328-440.
Whilst the policy intent of Subdivision 328-G is for small businesses restructures to be easier, the above examples show that this is definitely not the case. As noted, there are many hurdles that can prevent small businesses from qualifying for Subdivision 328-G rollover relief including satisfying the requirement of “genuine restructure” (or alternatively the application of the safe harbour rules).