In November we reported on the draft legislation to introduce a roll-over to allow a small business to change its legal structure, without incurring a capital gains tax (CGT) liability. This was first announced in the 2015-2016 budget.
What is new?
Importantly, there have been a few improvements made to the draft legislation we first reported on.
The new features include:
The first draft of the legislation required that no consideration could be provided for the transfer. We said that this doesn’t make commercial sense. If the roll-over relief is to provide for the original tax cost of assets to be carried over to the new structure, the transfer should at least be allowed to occur for that amount. The logic was that, because there is (to be) no change in the underlying economic ownership, there is no need for any consideration.
Thankfully, this has been amended in the draft bill.
The new legislation considers that new membership interests are issued as consideration for the transfer of a roll-over asset or assets. It says that the cost base and reduced cost base of those new membership interests is worked out based on the sum of the roll-over costs and adjustable values of the roll-over assets, less any liabilities that the transferee undertakes to discharge in respect of those assets, divided by the number of new membership interests.
An example is provided, where a company transfers three assets it owns to a trust. Two are CGT assets with a combined cost base of $1.1 million, and the third is a depreciating asset with an adjustable value of $400,000. The trust issues 10 units to the company, in exchange for the transfer. In this case, the cost base and reduced cost base of each unit is $150,000, calculated by adding all three values and dividing this by 10 units ($100,000 plus $1 million plus $400,000).
Where the roll-over involves transfer of assets to a discretionary trust, there will be no membership interests issued as consideration.
One of the roll-over requirements is that it be a “genuine restructure” of an ongoing business.
A safe harbour rule has been introduced, which says that a restructure will be a ‘genuine restructure of an ongoing business’ where, for three years following the roll-over:
- there is no change in the underlying economic ownership of any of the significant assets (other than trading stock);
- the significant assets transferred continue to be active assets; and
- there is no material or significant private use of the significant assets transferred.
If a small business does not meet the requirements of the safe harbour, it can still access the roll-over by satisfying the general principle that the transaction is, or is a part of, a genuine restructure of an ongoing business.
The roll-over extends beyond ensuring no CGT or balancing adjustment arises on a transfer of assets. It also provides that Division 7A will not operate to deem a dividend if assets are transferred from a company.
How the rollover will apply
In summary, the rollover will apply to transfers of assets from one entity to another, including from or to a company to a sole trader, partnership, trust, or company occurring on or after 1 July 2016. It provides small businesses with the flexibility to change their legal structure without realising an income tax liability on the transfer of those assets.
It will apply to:
- an entity that is as a ‘small business entity’ in the income year in which the transfer takes place; and
- an entity that is an affiliate, or that is connected with, a small business entity for the income year and which holds assets that are used by the small business entity in its business.
A small business entity is a business entity with an annual turnover, which when combined with that of its affiliated and connected entities, is less than $2 million.
Requirements for the rollover
As we reported previously, there are a number of conditions for the roll-over to be available. These include:
- the transferor transferring a CGT asset or all business CGT assets;
- the transaction being a restructure;
- the transferor transfers a CGT asset that is an active asset;
- the transferor chooses to apply the roll-over;
- each party to the transfer is a small business entity, or is an affiliate or is connected to a small business entity;
- the transferor, transferee and the ultimate owners of the assets transferred are Australian residents; and
- the transfer does not have the effect of changing the ultimate economic ownership of the asset or assets transferred.
In the case of discretionary trusts, there will be no change in ultimate economic ownership If immediately before or after the transaction, the asset was included in the property of a discretionary trust that was a family trust (i.e. there is a family trust election in place), and every individual who, just before or after the transfer took effect, had ultimate economic ownership of the asset, was a member of a family group of that family trust.
The legislation is proposed to apply to roll-overs from 1 July 2016.