There has been some excitement and chatter generated by the recently enacted Small Business Restructure Roll-over. No doubt, taxpayers and their advisers are identifying opportunities to move to better structures from 1 July 2016, without the usual tax impediments. But care is required.

2016 Budget announcement

The Government’s 2016 Budget announcement increasing the turnover threshold for businesses to qualify as a small business from $2 million to $10 million (and ultimately to $1 billion) will attract even more attention to the roll-over.

However, it is not yet clear whether the Government intends that the increased turnover threshold will apply to the roll-over or the $2 million threshold; which is being retained for the Division 152 small business CGT concessions.

Our guess is the increased threshold will apply, at least to a point. However, it is hard to envisage it applying to a business with a turnover approaching $1 billion.

Proceed with caution

Caution is needed before embarking on a restructure. Unlike most other roll-overs, the Small Business Restructure Roll-over comes with a specific requirement that the transaction be or be part of a ‘genuine restructure of an ongoing business’.

A similar requirement was introduced when demerger tax relief was enacted back in 2002. The demerger roll-over was accompanied by amendments to the integrity rules in section 45B of the Income Tax Assessment Act 1936, designed to limit the availability of the tax relief to ‘genuine demergers’. This left SME taxpayers and their advisers scratching their heads as to what did and did not constitute a genuine demerger and caught some taxpayers out; with significant consequences.

Conscious of the difficulties facing taxpayers in applying a ‘genuine’ test, the Government inserted a safe harbour rule into the Small Business Restructure Roll-over. The rule deems the transaction to be or be part of a genuine restructure of an ongoing business if:

  • there is no change in the ultimate economic ownership of the significant business assets (excepting trading stock) for a period of 3 years after the transaction;
  • the significant assets continue to be active assets; and
  • there is no material use of the significant assets for private purposes.

While, in practice, taxpayers may plan to rely on the safe harbour rule, whether it is, in fact, available can only be measured at the expiry of the 3 year period. For instance, a taxpayer might perform a restructure intending that the business will continue to be held for at least three years, only to enter into an unforseen sale within the 3 years. In such a case, the safe harbour will not be available and the taxpayer will, instead, need to assess if the restructure met the requirements of a genuine restructure of an ongoing business.

For taxpayers who do not meet the safe harbour, the ATO has been commendably quick to market in releasing draft guidelines on what it believes constitutes a genuine restructure of an ongoing business. The ATO’s approach to determining what constitutes a genuine restructure of an ongoing business is similar to its approach to what constitutes a genuine demerger. Essentially, the restructure needs to be commercially driven rather than, say, a step in a process designed to achieve a more tax effective sale or a succession/estate planning tool.

Draft Law Companion Guideline LCG 2016/D3 states that a genuine restructure of an ongoing business:

‘is one that could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business going forward…the SBBR is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests.’

Features of a genuine restructure of an ongoing business include:

  • a bona fide commercial arrangement designed to facilitate growth, innovation and diversification, adapt to changed conditions or reduce administration and compliance or cash flow impediments
  • it is not a divestment or preliminary step to facilitate economic realisation of assets
  • the economic ownership is maintained
  • the owners continue to operate the business through a different legal structure, with, for example, continued use of active assets, continuity of key personnel and continuity of production, supplies, sales or services
  • it results in the owners adopting a structure that would likely have been used if advice had been obtained at the outset.

Factors suggestive of a restructure not being a genuine restructure of an ongoing business include:

  • where the restructure is directed at eliminating an impending or existing tax liability
  • where the restructure is a preliminary step in the economic realisation of assets
  • where the restructure extracts wealth from the assets of the business for personal investment or consumption or for use outside the business
  • the creation or earlier recognition of tax losses
  • the permanent non-recognition of gains
  • other tax outcomes that are not reflective of economic reality

The draft guidelines contain a series of examples indicating when a restructure will and will not be viewed by the ATO as a genuine restructure of an ongoing business. The favourable examples deal with restructures designed to provide asset protection, retain essential employees, raise new capital and simplify affairs. The negative examples involve pre-sale restructures and restructures designed to facilitate succession planning outcomes and wealth extraction.

Is ‘trust cloning’ back?

Claims that the roll-over has re-enlivened ‘trust cloning’ should be viewed with great caution.

It might be okay if asset protection is the goal and risky business assets are being separated from passive assets, permitting the business owners to engage in more risk. But it won’t be OK if splitting assets is done as a precursor to or as part of an estate or succession planning process. Proving why the Roll-over has been adopted may not be easy, as the same facts could lead to differing conclusions as to the reasons for the restructure. Remember, the taxpayer has the onus of proof.

Even if a trust cloning falls within the three year safe harbour, the ATO might seek to apply the general anti-avoidance rules in Part IVA if it views the transaction being undertaken as part of an estate or succession planning process.

Other tax consequences

As always when contemplating a roll-over, it is critical to remember that while it may provide CGT and income tax relief, there can be other liabilities triggered such as for duties and GST.