Roll-over for small business restructures – Draft legislation released

In the 2015-2016 Budget, the Government announced that it would introduce a roll-over to allow small business to change its legal structure, without incurring a capital gains tax (CGT) liability.

Late last week, the draft legislation was release for comment. You can view the legislation here.

Sadly, this first draft seems very simplistic and hasn’t considered commercial reality; it looks at the tax aspect of a restructure in isolation. To require a restructure with no consideration makes no commercial common sense. The Explanatory Memorandum (EM) says that it is desirable to avoid complexity and the need for integrity rules. We don’t see any general complexity if the basic rule is to transfer assets at their actual costs. It’s not that hard to give integrity to historical cost.

Why the roll-over?

Currently, CGT roll-over relief is available for individual sole traders, partnerships and trusts that convert to a company structure (see Subdivisions 122-A and 122-B and Subdivision 124-N of the 1997 Act).

The proposed legislation extends the roll-over relief to transfers of assets from a company to a sole trader, partnership or trust, occurring on or after 1 July 2016. It does not apply to transfers to an exempt entity or superannuation fund. The restructure of a business which creates a CGT liability would impact on cash flow and available capital, so the Government has recognised that a roll-over removes this impediment to restructuring.

What is the roll-over?

The roll-over relief will mean that the transferee will pick up the tax cost base or attributes including acquisition date, on the transfer of business assets that are CGT assets, depreciating assets, trading stock or revenue assets as part of the restructure of a small business. Any pre-CGT assets will retain their pre-CGT status.

It provides small businesses with the flexibility to change their legal structure without realising an income tax liability on the transfer of those assets.

Who will it apply to?

To be eligible for the roll-over, you must be:

  1. an entity that is as a ‘small business entity’ in the income year in which the transfer takes place; and
  2. an entity that is an affiliate, or that is connected with, a small business entity for the income year that satisfies the maximum net asset value test at the time of the transfer, and which passively 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, or with a maximum net asset value which, when combined with that of its affiliated and connected entities, is less than $6 million.

Requirements for the roll-over

The roll-over is only available where a number of conditions are met, including:

  1. the transferor transfers a CGT asset or all of its business assets that are CGT assets, depreciating assets, trading stock and revenue assets;
  2. the transferor chooses to apply the roll-over;
  3. the transaction is a restructure that has the effect of changing the type of any or all of the entities and/or the number of entities through which all or part of the business is operated;
  4. no consideration is provided for the transfer;
  5. the transferor, transferee and the ultimate owners of the assets transferred are Australian residents;
  6. the transfer does not have the effect of changing the ultimate economic ownership of the asset or assets transferred; and
  7. the transferee is not an exempt entity or a complying superannuation entity.

No consideration makes no sense

The requirement that there be no consideration 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 espoused in the EM is that, because there is (to be) no change in the underlying economic ownership, there is no need for any consideration. At paragraph 1.34, the EM goes on to say, ‘This removes the need for complex cost base and integrity rules in respect of new membership interests issued as part of a restructure.’

Certainly, such complexities are to be avoided but there needs to be some commercial realism.

The examples in the EM don’t make sense. Example 1.2 considers the transfer of a property from a mum and dad company to a discretionary trust. The property cost $300,000 and has a market value of $600,000. Under the roll-over, the trust picks up the $300,000 cost base and there is no capital gain or loss. If that transfer is to occur for no consideration, the company many have a deficiency. If the purchase was funded by debt, how is the debt repaid? If the trust in this example wants/needs to continue the finance, how can it do so, and on what basis can it claim a deduction for interest costs?

Some more thought needs to be put into this draft legislation if the roll-over relief is going to be of benefit to many.

Discretionary trusts and the roll-over

One important point to highlight is the ultimate economic ownership requirement. The transaction must not have the effect of changing the ultimate economic ownership of the transferred asset or assets. This is interesting in the case of a transfer to a discretionary trust, as beneficiaries generally do not have an interest in any asset or income of the trust until the trustee exercises its discretion. The explanatory materials note that where discretionary trusts have made a family trust election to be administered for the benefit of a specified family group, for the purposes of the roll over, members of this group will be the ultimate economic owners of the business assets.

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, 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.

Get in touch with us

The closing date for submissions on the draft legislation is 4 December 2015.

If you’d like to discuss the draft legislation with us or how the roll-over might be applicable to you or your clients, please call us.


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