In the context of small businesses, a restructure can afford significant advantages ranging from decreased operational costs, increased efficiency and communication as well as simplifying management. Often these restructures involve the disposal of major assets which may incur CGT consequences for the business resulting in an inefficient restructure. In this regard, there are mechanisms available to businesses to reduce your tax liability for restructures. This article will discuss three groups of the most common exemptions our Taxation team uses to maximise the efficiency of business restructures including:
- CGT relief under Subdivision 152 which affords a suite of relief which can potentially extend outside restructures;
- Roll-Overs under Subdivision 328-G for genuine business restructures; and
- Roll-overs under 122A & B for individuals, trustees and partnerships incorporating.
- Relief under Subdivision 152
152-A: Conditions for Relief
Subdivision 152 applies on the condition that a CGT event happens in relation to a CGT asset, the event results in a gain and commonly either:
- You are a CGT Small Business Entity (Turnover of $2 mil per 152.10(1AA));
- Satisfy the maximum net asset value test (Total assets of company and any entities connected is less than $6 mil); or
- You are a partner in a partnership that is a CGT Small Business Entity;
Further to this, the CGT asset disposed of must be an active asset. This means that the asset must be used or held ready to use in the course of carrying on a business by you, an affiliate or an entity that is connected with you.
Once the above conditions are satisfied, you are afforded the suite of relief covered under subdivision 152 assuming you meet the requirements in each individual section.
The exemption subdivisions can be used in any order that you choose . For example you can choose the 15 year exemption under 152 – B by itself. You may choose to rollover the gain under 152 – E because you do not wish to retire yet and the asset will have a cost base set back at the time of the original asset purchase together with its time of acquisition. Many combinations are possible.
The application of the provisions to assets used in the business by other controlled entities is important to also consider.
We now set out summary thoughts on the subdivisions :
152-B: 15 Year Exemption
This section enables an entity that meets the specified requirements to disregard all capital gains made on an active asset in relation to an individual's retirement. This is a particularly appealing exemption due to the following:
- It applies to the "raw" capital gain made without the need to take into account capital losses;
- There is no cap on the amount exempted; and
- The capital proceeds can be paid tax free to shareholders or beneficiaries if distributed within 2 years, distributions after 5 years may qualify an entity for a look through earn out.
As a result, this exemption is the most generous in subdivision 152 and is afforded priority over the other types of relief under the subdivision. The exemption applies to individuals on the following conditions:
- The basic conditions above are satisfied;
- You continuously owned the CGT asset for a period of 15 years;
- If the CGT asset is a share in a company or an interest in a trust, the company or trust had a significant individual during which you owned the CGT asset; and
- You are over 55 and the disposal happens in regard to your retirement; or
- You are permanently incapacitated at the time of the event.
Assuming that there is a company or trust, additional conditions apply in respect of the active assets being 80 per cent of the assets of the entity. As well as proving the basic conditions in 152-A and owning an active asset for 15 years, companies and trusts must also show that there is a significant individual present in the company or trust and either that significant individual was permanently incapacitated or the individual was over 55 and the disposal occurred in relation to their retirement.
152-C: 50% Reduction
Once the basic requirements in 152-A are satisfied, this exemption will apply. In contrast to 152-B, there is no requirement that there be a significant individual present.
Given that this reduction halves any capital gains made on an active asset, it also applies following the CGT discount in section 115. This effectively means that if you do not qualify for the exemption under 152-B, the capital gains you are liable for may be reduced to 25%. Unlike the discount afforded under 115, you do not need to hold the asset for 12 months.
152-D: Small Business Retirement Exemption
This section allows the taxpayer to disregard all or part of the capital gain made from a CGT asset. Although the wording of this provision acknowledges it is related to retirement purposes, there is no actual need for the taxpayer to retire. An individual who is say 30 may claim the exemption, assuming that they put it to their super. However there is a lifetime limit of $500,000. This exemption applies on the following:
- You meet the conditions in 152-A;
- If you are under the age of 55, you can contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund; and
- CGT event J2, J5 or J6 occurs; or
- The contribution is made otherwise at the later date of when you made the choice and when you received the proceeds.
Companies or trusts can choose to disregard the amount if:
- 152-A applies;
- The company or trust has a significant individual; and
- The company or trust makes a payment to at least one of its CGT concession stakeholders
Taxpayers over the age of 55 may claim the exemption without the need to put the claimed amounts into their super.
Subdivision 152-E enables business owners to postpone the taxation of a capital gain, it does not exempt your capital gains unlike the other exemptions offered in section 152. Aside from meeting the requirement of a small business entity or net asset test seen above, although not explicitly stated, the application of this provision pivots on whether a replacement asset has been acquired by the business owner. The replacement asset must be acquired within the two year period after the capital gain is made. As a result, taxpayers may elect to apply this roll over even when they haven't acquired a replacement asset yet.
It should be noted that if no mention of the capital gain is made on the tax return for that financial year, then implicitly the tax payer has chosen to apply the roll over relief. It is recommended that since taxpayers bear the onus in appealing the excessiveness of an amended assessment by the ATO, taxpayers should supply a supplementary document indicating that they have elected to receive the roll over relief under subdivision 152-E.
There are two circumstances that necessarily follow from a business electing the roll over relief:
- CGT Event J5: This happens when you disregard a capital gain but do not acquire a replacement asset. Hence, you make a capital gain equal to the capital gain disregarded following the two year period.
- CGT Event J6: Occurs when you have acquired replacement asset/s however the roll over amount is greater than the amounts paid to acquire the replacement asset/s as well as any incidental costs or capital improvements made to the replacement asset or assets already owned. As a result, your capital gain ending on the two year period following the disposal of the asset is equal to the difference between capital gain disregarded under the roll over and the amount incurred on the replacement asset or capital improvement.
In addition to the roll over relief, assuming the 15 year ownership exemption does not apply to your asset, business owners can also apply the other exemptions under section 152 and 115 to reduce the capital gain made after the roll-over is applied.
James is the owner of a chain of bakeries whose aggregate turnover is always less than $10 million. He decides to dispose of some of his industrial ovens he bought 10 months ago and makes a capital gain of $4,500,000 on October 2023. As a result of this, James decides to open a new bakery location which costs him $500,000.
Since James is an individual and is an Australian citizen, he can elect to receive a 50% discount on his capital gains made under section 115. Further, James can also choose to receive an additional 50% discount on his capital gains made under subdivision 152-C. This brings the capital gains he made to $1,125,000. James then elects to roll-over this.
As CGT event J6 occurs as James has acquired a replacement asset, James' capital gains on October 2025 for the sale of the industrial ovens in $625,000. If he is under the age of 55, he can claim $500,000 and puts that into his super. The capital gains he has to declare on that financial year is $125,000.
- Roll-Over under Subdivision 328-G
These provisions offer a much larger turnover of $10 mil to satisfy the small business entity test compared to the relief offered under the small business provisions of s 152.
Prior to the introduction of 328-G, roll-over relief was available in limited circumstances for business restructures from a trust to another identical trust or to a partnerships of trusts.
Separation of parts of the business is possible.
The splitting of assets to different trusts within the same family but controlled by different family members can be considered.
No rollover was available for a restructure that transfers business assets from a company or trust to a partnership of its existing shareholders or unitholders or the sole shareholder or unitholder.
Hence, this roll-over is particularly attractive if a company or trust wanting to transition to a sole trader or partnership of its existing shareholders or unitholders. Normally business risks need to be considered of course and the shareholders are preferably other companies or are trusts.
Interestingly where the provisions of safe harbour (discussed below) are not required to be met but all other criteria are met, the provisions can be considered for restructures prior to a capital raising as is set out in the example given in LCR 2016/3.
What is needed to satisfy the rollover?
The restructure must involve a small business or entities that are connected or affiliated with the small business.
It is necessary to note that since 1 July 2016, the threshold of a small business has been increased for a business with a turnover of $2 million for a financial year to $10 million. The restructure must also not change the ultimate economic ownership of the transferred assets.
This means that the individual/s who directly, indirectly or beneficially own the asset must not change. The assets transferred must be active assets, which will include CGT assets, trading stock, revenue assets or depreciating assets.
Note that real property may be an active asset when used in a business but it is not always so. An asset that is leased to a connected entity or affiliate for use in its business may still be an active asset. It is the use of the asset in that entity's business that will determine the active asset status of the asset.
Further in respect of shares as active assets, they may be active assets where they meet the 80% test (market value of the company active assets and financial instruments and cash make up at least 80% of the market value of the company assets. Note the definition of active assets is defined in section 152-40 for the purposes of this section and the extended definition is in section 152.40 (3). Further, the transferor and transferee must meet residency requirements under 328-445 and each of those parties must elect to apply the roll-over.
Notably, the restructure must be a genuine restructure of an ongoing business. This is the most contentious part of proving that 328G applies given each restructure will be assessed on a case by case basis. The ITAA 1997 does not provide any guidance on what this means, however the explanatory memorandum and guidance provided by the Tax Office offers insight on what constitutes a genuine restructure and we discuss this below.
Further there must be no change in the ultimate economic ownership which is a concept relating to ultimate economic ownership and control rather than actual legal ownership and we discuss this below. Ownership is interest includes legal or equitable interest under section 118.130 in respect of property and also a share, option, right or similar interest issued by the company in respect of a share.
Ultimate Economic Ownership
The ultimate economic owners of the asset must remain unchanged following the transfer. The ultimate economic owners of an asset according to the exposure draft are the individuals who, directly or indirectly, beneficially own an asset. If there is more than one individual who is are the ultimate economic owners (E.g. A fixed trust), there is an additional requirement that each of those individual's shares must be unchanged maintaining a proportionate ownership in the asset.
The situation is a bit more complicated for discretionary trusts given that the beneficiaries do not have an interest in the asset until the trustee exercises their discretion. The ITAA 1997 in s328- G provides for this in the context of family trusts where a transaction will not be taken to change the ultimate economic ownership of assets where immediately before or after the transaction took effect, the assets were included in the property of a discretionary trust that was a family trust and every individual who just before or just after the transfer took effect, had the ultimate economic ownership of the asset was a member of the family group of that trust. An operating family trust election is preferable for both trusts in our view.
What is a Genuine Restructure of an Ongoing Business?
Subdivision 328-G operates on the condition that the transaction, which involves the transfer of the asset, is part of a genuine restructure of an ongoing business and also meets the other criteria of section 328 – 430.
Whether a transaction is a genuine restructure of an ongoing business is a question of fact.
The requirements for the small business restructure rollover do also include a further provision of safe harbour under section 328 G Section 328 – 435 if:
- There is no change in the ultimate economic ownership of any of the significant assets of the business that were transferred under the transaction for three years after the transfer ;
- Those significant assets continue to remain as active assets; and
- There is no significant or material use of those significant assets for private purposes.
In the event that the taxpayer does not satisfy the requirements
in the safe harbour, the tax office has provided guidance on which
transactions may constitute a genuine restructure of an ongoing
business with ATO's guidance provided under LCR 2016/3 that
should be read in conjunction with LCR 2016/2 .
The primary consideration is whether the transaction is expected to deliver benefits to small business owners in respect of their efficient conduct of the business. The following are features which indicate that a transaction is part of a genuine restructure of an ongoing business:
- Is a bona fide commercial arrangement undertaken in a real and
honest sense to:
- Facilitate growth, innovation or diversification;
- Adapt to changed conditions; or
- Reduce administrative burdens, compliance costs and/or cash flow impediments; or
- Is authentically restructuring the way in which the business is conducted as opposed to a divestment or preliminary step to facilitate the economic realisation of assets;
- The economic ownership of the business and its restructured assets is maintained;
- The small business owner/s continue to operate the business
through a different legal structure;
- g. Continue used of transferred assets, continuity of employment of key personnel, continuity of production, supplies, sales or services.
- It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business.
Tax considerations are relevant considerations to an extent. LCR 2016/3 indicates that a business subject to significant tax rates may restructure their business such that a lower tax rate applies to them. However, where the restructure is significantly or wholly motivated by tax implications, then this would not be a genuine restructure of an ongoing business. For example a restructure intended to eliminate an impending or existing tax liability.
There are other factors which would indicate to the ATO that the restructure is not part of a genuine restructure. These include:
- Where the restructure is a preliminary step to facilitate the economic realisation of assets, or takes place in the course of winding down to transfer wealth between generations;
- 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;
- 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/or
- There are other tax outcomes that do not reflect economic reality.
Craig is the sole shareholder of Company X that wholly owns two businesses. Craig incorporates a new company, Company Y, and transfers all the active assets of the restaurants from Company X to Company Y.
Two years later Craig wants to retire soon and wants to leave his business to his two children. He effects a transfer of the two businesses to his two children.
Per the factors above, this is not a genuine restructure of an ongoing business. The restructure occurs during the course of Craig winding down his business and to transfer his wealth and assets between generations to his children. The safe harbour rule also does not apply as the transaction occurred within the three year period under s 328.435.
- Rollover under s 122A and B
These are the original rollovers and are used either alone or together to achieve the desired restructure. Subdivision 122A and B is applicable to restructures which involve the disposal or creation of assets by an individual, trustee or partner/s in a partnership to a wholly-owned company. Where the relevant party effects a transfer, that party must own all the shares in the company. These roll overs are useful for SMEs who want to incorporate and to minimise the tax liabilities arising from incorporation.
To apply for a rollover under this subdivision, the following conditions must be followed:
Applicable CGT event
Section 122-15 provides for the circumstances in which the rollover is available. As such, a company or partner may apply if either of the following occur:
- CGT Event A1 – disposal of a CGT asset to a company
- CGT Event D1 – creation of rights, contractual or otherwise in the company
- CGT Event D2 – granting of an option to a company
- CGT Event D3 – granting a company the right to income from mining
- CGT Event F1 – the granting of a lease to a company (including renewals or extensions).
Section 122.25 denotes what assets are precluded from the roll over. These include but are not limited to collectable or personal use assets, decorations awarded for valour or brave conduct, an asset that becomes a trading stock of the company just after the disposal or creation and assets that becomes a registered emission units and precluded assets. Precluded assets are depreciating assets, trading stock, an interest in the copyright in a film or a registered emissions unit.
Substantially Similar Consideration
The market value of the shares received by the taxpayer must be substantially the same as the market value of the transferred asset/s.
The shares received by the transferor must be non-redeemable. This means that the transferee company must not be able to buy back the shares from the transferor.
Subject to Tax
During the year of the disposal or creation of the asset, the company cannot be exempt from tax.
Both parties must be residents. If this is not the case, then the transfer must effect "taxable Australian property".
Immediately following the transfer, the transferor must own all the shares in the company.
Restructures often provide a better method to progress the business of yourself or your client. We have conducted many hundreds of restructures for our clients and are very happy to discuss your particular needs.
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.