Whilst the ability for a small business to change their legal structure without attracting a tax liability has been available for a little over 15 months, it may be one of those areas that small business and tax practitioners are still coming to terms with. This tax tip considers:
The eligibility criteria;
- How the provisions work; and
- What are the impacts.
Is My Business Eligible
To be eligible and to gain access to the rollover provisions, a number of tests must be satisfied as follows:
- Both the transferor and the transferee must be small businesses
This means that both the transferor and the transferee must be businesses each with an aggregated turnover of less than $10 Million. Note that this aggregated turnover not only relates to the subject entity, but also to entities that may be affiliated or connected with the subject entity. Care is required in determining the applicability of this test as the affiliated or connected with test can be quite complex.
- The restructure must be part of a genuine restructure and not part of a tax driven scheme
Whether or not a restructure is “genuine” will depend on the specific circumstances surrounding the restructure. The guidelines that accompanied the restructure legislation provide some details on what may be considered a “genuine restructure” and include:
- A bona fide commercial arrangement has been undertaken to enhance business efficiency;
- The business continues to operate following the transfer, through a different entity structure;
- Transferred assets continue to be used in the new business structure;
- The new structure that has been adopted has taken professional advice when setting up the business;
- The restructure is not artificial or unduly tax driven; and
- The restructure is not a divestment of assets or a preliminary step to facilitate the disposal of assets outside the business.
- Ultimate economic ownership must be maintained before and after the restructure
The ultimate economic owners of an asset are the individuals who, directly or indirectly, own an asset. Where there is more than one individual with ultimate economic ownership, there is an additional requirement that each individual’s share of ultimate economic ownership be maintained. Where a discretionary trust is involved, this means that there is no practical change to the individual beneficiaries who ultimately benefit from the assets before and after the transfer.
How The Provisions Work
A business can be operating either as a sole trader, a partnership, a company or as a trust. There may be a time when the business owners believe that they have “outgrown” their current trading structure and that the structure no longer meets their needs. This could involve asset protection issues, commercial requirements, public perception, etc. The Rollover Provisions provide opportunities for a business to restructure from one legal entity to another without incurring a range of tax liabilities that would normally arise when such a transaction is performed.
It is important to note however that the rollover provisions only apply to certain “active assets” of a business. Such assets are normally CGT assets, depreciating assets, trading stock and other assets that form part of the operating business being restructured. The rollover does not apply to certain assets such as shareholder or beneficiary loans or passive assets held in a structure.
What Are The Impacts
There are a number of impacts that you should consider before applying the restructure rollover measures including:
- Assets are taken to be transferred at their tax cost and as such will not result in an income tax liability to either the transferor or the transferee.
- There is no requirement for any consideration (market value or otherwise) to be provided by the transferee in exchange for those assets.
- In relation to specific asset classes, the following should be considered:
- Pre-CGT assets retain their pre-CGT status.
- Post-CGT assets are taken to be acquired by the transferee at the date of transfer for their cost at that time. This means that to be eligible to claim the CGT discount on any subsequent sale from the new structure, you will need to wait at least 12 months.
- Access to the 15 year exemption however as part of the small business CGT concessions is not affected as the transferee will be taken to have acquired the asset when the transferor acquired it (different to the CGT discount).
- Trading stock can either be transferred at the transferor’s cost or at the market value of that stock held by the transferor at the start of an income year.
- Revenue assets take the cost which will result in no profit or loss to the transferee.
- Depreciating assets will be transferred at the written down value of those assets at the date of the transfer and then continue to depreciated using the same method and effective life that the transferor was using.
- There may also be issues to consider in relation to GST or stamp duty on the restructure so professional advice should be sought when utilising the rollover measures.
- The restructure provisions can have a very positive outcome for small businesses looking to restructure their affairs, but ensure you seek appropriate professional advice as there may also be some other implications that result in unwanted outcomes..
Small Business Restructure Rollover
The increased SBE threshold of $10 million also applies to the rollover for restructures of SBEs. To recap, this measure allows SBEs to change their operating structure without incurring capital gains tax or other income tax liabilities. It does this by providing an optional rollover (deferring any CGT liability or income tax liability until the asset is eventually sold) where an SBE transfers an active asset of the business to another SBE as part of a genuine business restructure, without change the ultimate economic ownership of the asset. The rollover may also be available for assets that are used by the SBE but held by an entity connected or affiliated with the SBE or, if the SBE is a partnership, a partner of that partnership. This ensures that partners and other ‘passive entities’ within an SBE that are not themselves SBEs (because they do not carry on a business themselves) can access the new rollover. Under the rollover, specifically, from a CGT standpoint:
- No capital gain or loss will accrue to the Transferor. The Transferee will be treated as acquiring the asset on the date of transfer for an amount equal to the cost base of the asset.
- Pre-CGT assets will retain their pre-CGT status post-transfer.
- For the purposes of the 50% CGT discount, the ’12-month clock’ will be reset, such that the Transferee will need to hold the asset for a further 12 months following the restructure to avail themselves of this discount.
- For the 15-Year Exemption however, the Transferee will be taken to have acquired the asset back when it was originally acquired by the Transferor.
As the $10 million increased threshold is backdated to1 July 2016, tax returns may need to be amended in respect of capital gains made and declared from restructures after this date. Amendments may result in refunds where any capital gains liabilities have been paid.
CGT Small Business Concessions – No change
Unfortunately, the increased $10 million SBE threshold does not apply to the CGT Small Business Concessions (i.e. the Active Asset Reduction, Retirement Concession, Rollover, 15-Year Exemption). To access these concessions, the standard criteria must be met, namely you and connected entities must be met, namely you and connected entities must have net assets to the value of less than $6 million or your annual turnover (including connected entities and affiliates) must be less than $2 million.
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