Under the current tax laws, CGT roll-over relief is available for individuals, trustees and partners who incorporate, should a small business wish to restructure. However, other restructures have the potential to trigger a CGT event.
The Tax Laws Amendment (Small Business Restructure Roll-over) Act 2016 (Cth) (the Act) was passed by the Senate on 29 February 2016 and given assent on 8 March 2016. The Act will apply to transfers of business assets occurring on or after 1 July 2016.
The Act intends to make it easier for small business owners to change their legal structure without affecting their income tax position, acknowledging that they might find that a different legal structure may be more appropriate as the business becomes more established or the nature of the business changes over time.
The Act will give small businesses the option to defer gains or losses that would otherwise arise from transferring business assets from one entity to another as part of a restructure until the eventual disposal of the assets. The effect is that the new entity will be taken to have acquired each asset for the previous entity's tax cost at the time of the transfer, and the restructure will not affect the small business' income tax position. The Act applies to small businesses with an aggregated annual turnover of less than $2 million.
The new laws will apply to the transfer of active assets that are CGT assets, depreciating assets, trading stock or revenue assets as part of a genuine restructure of an ongoing business. In some circumstances, the roll-over will also be available where the business assets to be transferred are held by an entity connected with the small business, an affiliate of the small business, or, if the small business is a partnership, a partner of that partnership.
The roll-over will only apply to transfers of business assets that do not result in a change in the ultimate economic owner of the assets, being the person who, directly or indirectly, beneficially owns the assets. If more than one person is the ultimate economic owner, there is an additional requirement that the shares of each of the owners in relation to the asset remain unchanged after the transaction. A family trust can meet this requirement if every person who had ultimate economic ownership of the asset before and after the transfer are members of the family group relating to the family trust.
Both entities must be considered to be residents of Australia. Further, both entities, not just the transferor, must qualify as a small business, being that the entity has an aggregated annual turnover of less than $2 million. Finally, both entities must choose to apply the roll-over provisions.
Matters to consider
The Australian Tax Office issued two Law Companion Guidelines on 24 March 2016 in respect of the Commissioner's interpretation of the Act. The Guidelines will be finalised as public rulings when the Act comes into effect.
The first Guideline is in relation to the consequences of a rollover (Law Companion Guideline LCG 2016/D2), and it highlights two important limitations associated with the Act, as follows:
- The roll-over provisions only apply in respect of active assets. This means that assets that are not active assets, such as Division 7A loans, are not exempt from any tax consequences that may arise as a result of their transfer (or in the case of loan accounts, their forgiveness); and
- The transfer of liabilities are also not included within the scope of the roll-over provisions, such that any tax consequences associated with novating loans, for example, will not be deferred in accordance with the Act.
A further limitation associated with the Act is that a small business is not exempt from any other tax consequences other than those associated with income tax which arise from the restructure. For example, a small business will not be exempt from any duty arising from the assignment of a lease.
Limitation of scope of provisions
The second Guideline determines the meaning of a "genuine restructure of an ongoing business" (Law Companion Guideline LCG 2016/D3), and it appears to significantly limit the scope of the Act.
While the Guideline provides that this is a question of fact that is determined having regard to all of the circumstances surrounding the restructure, it goes on to provide that the restructure must be such that it "could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business going forward."
It further provides that the roll-over "is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests."
Further specific examples of transfers of business assets that are not genuine restructures of an ongoing business are provided in the Guideline, as follows:
- where the restructure is a preliminary step to facilitate the economic realisation of assets – such as transferring business assets held by a company to an individual to claim a CGT discount when they are sold to a third party;
- where the restructure effects an extraction of wealth from the assets of the business (including accumulated profits) for personal investment or consumption or otherwise designed for use outside of the business – such as the transfer of active assets from a trust to a beneficiary in order to satisfy unpaid present entitlements;
- where artificial losses are created or there is a bringing forward of their recognition;
- the restructure effects a permanent non-recognition of gain or the creation of artificial timing advantages; and
- there are other tax outcomes that do not reflect economic reality.
However, if no significant assets, apart from trading stock, are disposed of or used for private purposes by the small business for a period of three years after the restructure, and the assets continue to be active assets of the business, then the restructure will be automatically considered to be a genuine restructure of an ongoing business in accordance with the safe harbour rule contained in the Act.
Despite the apparently broad language of the Act, the Guideline significantly narrows the scope of the Act. In view of the stringent test in relation to whether a transfer of business assets is due to a genuine restructure of an ongoing business, we recommend that advice be sought by small businesses who wish to claim the benefit of the roll-over provisions prior to the transfer to ensure that the restructure does not affect the small business' income tax position.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.