As announced on budget night 12 May 2015, the new Small Business Restructure Rollover (Rollover) commenced on 1 July 2016 and is designed to provide more flexibility for small businesses to change their legal structure (i.e. company, trust, partnership, sole trader, etc.) without attracting a tax liability at that time. Whilst this opportunity is generating interest amongst taxpayers, caution needs to be exercised before undertaking a restructure to ensure that you are making the best decisions for your small business.
If you are operating your business in an entity structure (i.e. company, trust, sole trader) and feel that it no longer suitable for your needs, the new Rollover provides an opportunity to transfer the business to a new entity structure without incurring the tax costs that would normally arise when a business is transferred. The Rollover is available for a broad range of assets considered “active assets” and requires “ultimate economic ownership” of the business to be maintained.
To determine if you can access the Rollover a number of threshold questions need to be resolved:
Question 1: Are the transferor and transferee small businesses?
The Rollover applies to small businesses only, that is, businesses with an aggregated turnover of less than $2million. To determine the aggregated turnover of a business the taxpayer not only has to consider its own business turnover but also the business turnover of other entities that may be affiliated or connected entities. This can sometimes be a complex matter to determine – particularly where other businesses are conducted by the taxpayer or by other members of the family group.
Question 2: Will ultimate economic ownership of the business be maintained?
The Rollover requires that there is no change in the “ultimate economic ownership” of the business. This requires the proportionate ownership (direct and indirect) in the transferor and transferee to be the same, or, in the case of discretionary trusts, for ownership by members of the same family group to be maintained.
Question 3: Is the restructure a “genuine restructure”?
The legislation and the Legislative Companion Guidelines LCG 2016/3 provide details of the attributes of a “genuine restructure” of an ongoing business and how the Australian Taxation Office (ATO) interpret the term. For example, a genuine restructure will be able to demonstrate the following attributes:
– bona fide commercial arrangement undertaken to enhance business efficiency;
– the business continues to operate following the transfer, through a different entity structure;
– the transferred assets continue to be used in the business;
– the new structure is likely to have been adopted had appropriate professional advice been obtained when setting up the business;
– the restructure is not artificial or unduly tax driven; and
– not a divestment or preliminary step to facilitate the disposal of assets outside the business.
A safe harbour provision, where a restructure will be accepted as a “genuine restructure” if for three years following the Rollover:
– there is no change in the ultimate economic ownership (including proportionally) of any of the significant assets of the business (other than trading stock) that were transferred under the Rollover;
– those significant assets continue to be active assets; and
– there is no significant private use of those significant assets.
Importantly, the requirement of no significant private use of transferred assets may be restrictive where assets that are transferred are used privately and subject to FBT provisions (e.g. motor vehicles), as would likely be the case in many small businesses.
Question 4: What assets are to be transferred as part of the Rollover?
The Rollover applies to gains and losses arising from the transfer of “active assets” including CGT assets, trading stock, revenue assets, depreciating assets and membership interests (e.g. shares or units in a company or trust). It is intended that no income tax consequences arise from the transfer of the respective assets. The application of the Rollover only to “active assets” and related liabilities may present difficulty for some other common assets that may exist in small businesses. If, for example, a small business entity has Division 7A asset loans to associated individuals or entities, these assets will not be eligible for Rollover relief and ordinary income tax treatment will continue to apply to such loans.
Once a business has satisfied these threshold questions and chooses to access the Rollover, the tax effect is as follows:
Asset Classes – Specific Application
Specific application to the different classes of assets are as follows:
An integrity rule (the loss denial rule) ensures that a capital loss on any direct or indirect membership interest (e.g. shares or units in a company or trust) in the transferor or transferee that is made subsequent to the Rollover will be disallowed, except to the extent that the taxpayer can demonstrate that the loss is reasonably attributable to something other than the Rollover.
This rule will require adequate documentation is kept at the time of the Rollover and subsequently in order to be able to present any argument against the application of the loss denial rule.
As indicated by the inclusion of the requirement for a “genuine restructure” and the safe harbour provisions, this Rollover is expected to apply in circumstances where a small business is being operated from the “wrong” structure and seeks to roll into the “correct” one.
While the future ability to sell a business is a commercial factor commonly considered in restructuring a business, where a sale occurs in the short term this may be seen unfavourably in the context of this Rollover.
While on the face of it this Rollover may be attractive to many small businesses, it requires further investigation into the purpose of a restructure, the assets involved, the associated entities and various other considerations before hitting the “start” button.
An Important Message
While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents. Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.