SMEs can now restructure their businesses without a tax penalty

Legislation has been passed in Federal Parliament that will allow small businesses to change the legal structure of their business and have the capital gains tax (CGT) liability disregarded and deferred until eventual disposal. The changes generally apply from 1 July 2016.

Below is a snapshot of the changes. No one will be particularly surprised to learn the new rules are rather technical in nature!

What the amendments mean

The changes provide an optional rollover for small business owners who change the legal structure of their business on the transfer of business assets from one entity to another.

The effect of the rollover is the tax cost(s) of the transferred asset(s) is rolled over from the transferor to the transferee. The changes are designed to provide greater flexibility for small businesses to change legal structures.

The legislation – the Tax Laws Amendment (Small Business Restructure Roll-over) Bill 2016 – was passed by the Federal Parliament without amendment.

The amendments apply to:

• transfers of depreciating assets, where the balancing adjustment event arising from the transfer occurs on or after July 1, 2016;
• transfers of trading stock or revenue assets, where the transfer occurs on or after July 1, 2016; and
• transfers of CGT assets, where the CGT event arising from the transfer occurs on or after July 1, 2016.

The new rollover is in addition to existing rollovers where an individual, trustee, or partner transfers assets to, or creates assets in, a company in the course of incorporating their business.

The optional rollover will be available where a small business entity transfers an “active asset” of the business (i.e essentially, an asset used in the business) to another small business entity as part of a genuine business restructure, without changing the ultimate economic ownership of the asset.

The rollover will apply to gains and losses arising from the transfer of active assets that are CGT assets, depreciating assets, trading stock or revenue assets between entities as part of a genuine restructure of an ongoing business.

Does your business qualify?

To qualify for the rollover, the transfer of the asset(s) must be part of, a “genuine” restructure of an ongoing business, as opposed to “inappropriately tax-driven schemes”.

Whether a restructure is “genuine” will be determined based on all of the facts and circumstances. Relevant matter include whether it is a bona fide commercial arrangement undertaken to enhance business efficiency, whether the transferred assets continue to be used in the business and whether or not it is a preliminary step to facilitate the economic realisation of assets.

To be eligible for the rollover, each party to the transfer must be either:

• a “small business entity” with $2 million or more in turnover for the income year during which the transfer occurred;
• an entity that has an “affiliate” that is a small business entity for that income year;
• “connected” with an entity that is a small business entity for that income year; or
• a partner in a partnership that is a small business entity for that income year.

The asset transfer must not change the ultimate economic ownership of transferred assets in a material way. The ultimate economic owners of an asset are the individuals who, directly or indirectly, beneficially own an asset and only natural persons can hold ultimate economic ownership of an asset. Therefore, where a company, partnership or fixed trust owns an asset it will be the natural person owners of the interests in these interposed entities that will ultimately benefit economically from that asset.

If there is more than one individual who is an ultimate economic owner of an asset, there is an additional requirement that each of those individuals’ shares of that ultimate economic ownership be materially unchanged, maintaining the same proportionate ownership in the asset.

In the case of discretionary trusts, they may be able to meet the requirements for ultimate economic ownership “on their facts”. For example, where there is no practical change in which individuals economically benefit from the assets before and after the rollover, there will not have been a change in ultimate economic ownership on the facts.

The effect of the rollover

The rollover provides for tax neutral consequences for a transfer by “switching off” the application of the existing income tax law. However, this only occurs for the purpose of the transfer and not for the purposes of goods and services tax, fringe benefits tax or stamp duty.

The rollover provides that the transfer takes place for the asset’s “rollover cost”, which is the transferor’s cost of the asset for income tax purposes, such that the transfer would result in no gain or loss for the transferor. The transferee will be taken to have acquired each asset for an amount that equals the transferor’s cost just before the transfer.

For the transfer of a CGT asset, the tax law will apply under the rollover as if the asset had been transferred for an amount equal to the cost base of the asset. Further, pre-CGT assets transferred under the rollover will retain their pre-CGT status in the hands of the transferee.

Assets that are trading stock of the transferor will be held as trading stock by the transferee. The transferee will inherit the transferor’s cost and other attributes of the assets as the transferor just before the transfer.

Needless to say, obtaining professional advice would be prudent to enable an SME to take advantage of the restructure rollover.

Terry Hayes is the editor-in-chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.