Will the proposed transfer of assets held by the partnership to a new company be part of a genuine restructure of an ongoing business for the purpose of paragraph 328-430(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?
No. This ruling applies for the following period: Year ending 30 June 20XY The scheme commences on: 1 July 20XX
Persons A and B are partners in a partnership that operate a primary production business. The business commenced in the 20YY income year. It first generated revenue in 20YY. The partnership structure was setup on advice from their former tax agent, who was engaged by the partnership from its commencement. The partners maintain other jobs and family outside the partnership. From 20YY, the partnership has been growing its business by leasing and preparing land; preparing soil for planting; purchasing and planting trees; and caring for them as they mature to the producing stage. The land used by the business is owned by the partners' parent and is intended to be passed to the children under their will. The business leases the land. The partners built and installed irrigation and a shed on the leased land to conduct the business. The land leased by the business is directly adjacent to a public golf course and driving range, on an increasingly busy road. Ongoing concerns include stray golf balls injuring contractors or visitors; and members of the public trespassing for stray golf balls, which could put the golfers at risk. There have been no incidents to date.
The current tax agent was engaged from 20YY. Upon engagement and initial discussions about their business goals, the current tax agent identified that the partnership structure was not conducive to achieving their goals, and that the partnership structure is ineffective compared to a company structure. The partners propose to restructure their business into a company during the 20XX-XY financial year. The brothers will both be joint directors and shareholders of the company. The brothers will continue to run the business as they always have. All assets owned by the partnership and used in the business will be transferred to the new company at cost. This includes the major business assets such as the trees, the farm infrastructure (including the machinery/workshop shed and irrigation systems), and the key farming equipment and machinery, including a tractor, mulcher and folding wing slasher. All other operational assets, tools, materials and consumables necessary for the ongoing conduct of the business will also be transferred. The lease will be changed to reflect the company's use of the land. The partnership will close once the business has been transferred to the company.
Income Tax Assessment Act 1997 section 328-430 Income Tax Assessment Act 1997 paragraph 328-430(1)(a)
Law Companion Ruling LCR 2016/3 Small Business Restructure Roll-over: genuine restructure of an ongoing business and related matters (LCR 2016/3) explains the meaning on the term 'genuine restructure of an ongoing business'. Paragraph 7 of LCR 2016/3 lists factors indicative of a genuine restructure: • It is a bona fide commercial arrangement undertaken in a real and honest sense to o facilitate growth, innovation and diversification o adapt to changed conditions, or o reduce administrative burdens, compliance costs and/or cash flow impediments. • It is authentically restructuring the way in which the business is conducted as opposed to a 'divestment' or preliminary step to facilitate the economic realisation of assets. • The economic ownership of the business and its restructured assets is maintained. • The small business owners continue to operate the business through a different legal structure. For example, there is: o continued use of the transferred assets as active assets of the business o continuity of employment of key personnel, and
o continuity of production, supplies, sales or services. • It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business. Paragraph 10 lists factors indicative that a restructure is not a 'genuine restructure of an ongoing business': • where the restructure is a preliminary step to facilitate the economic realisation of assets, or takes place in the course of a winding down to transfer wealth between generations • where the restructure effects an extraction of wealth from the assets of the business (including accumulated profits) for personal investment or consumption or otherwise designed for use outside of the business • where artificial losses are created or there is a bringing forward of their recognition • the restructure effects a permanent non-recognition of gain or the creation of artificial timing advantages, and/or • there are other tax outcomes that do not reflect economic reality.
Example 1 of LCR 2016/3 (paragraphs 17 to 23) describes a genuine restructure for asset protection purposes. Example 1 involves an individual (Mark) who is expanding his sole trader bookkeeping business into the riskier operations of financial advice after being sued by a client for negligent financial advice. Mark transfers assets from himself to quarantine his business from his personal assets. This is a benefit to Mark in terms of his ability to grow the riskier operations and enhance its profits. The restructure is a response to his business needs, facilitates further growth and is not unduly tax driven. The economic ownership of the business is maintained. Accordingly, the 'genuine restructure of an ongoing business' condition is satisfied. Example 3 in the LCR considers a restructure for the purpose of raising new capital. In this example, a local investor has expressed interest in making a capital contribution in return for an equity stake into the business. The partners transfer their active assets to a newly incorporated company where they each own shares in the same proportions as their interests in the partnership assets. It states: Relevant considerations
33. Operating a business through a company more readily allows Melvin and Jenny to attract the necessary investors needed to raise cash and facilitate growth of the business. 34. The potential new investment from Steve is not part of the restructure and will represent a fresh source of capital for the entity post restructure. On these facts the restructure is not a mechanism by which Melvin and Jenny are realising their interest in the business, which they continue to operate. Conclusion 35. Restructuring in this manner provides benefits to Melvin and Jenny in their ongoing efficient conduct of the business. Melvin and Jenny are undertaking the arrangement to facilitate growth of the business, and not as a preliminary step in divesting the business to Steve. Accordingly, this is a 'genuine restructure of an ongoing business'. 36. However, the Commissioner will be concerned if Steve's capital contribution is used to facilitate a divestment of the business, as this would be inconsistent with it being a 'genuine restructure of an ongoing business'.
Paragraphs 37 to 44A of LCR 2016/3 provide Example 4 which describes restructuring a business with a view to simplifying tax affairs. In this example, a business operator restructured from a company and trust structure to a sole trader structure. It was concluded that significant benefits were achieved to the ongoing efficient conduct of his business. On the evidence, the restructure had relieved the business operator from additional outlays, and administrative and compliance burdens in running his business, and is a 'genuine restructure of an ongoing business'. Example 6 in LCR 2016/3 (paragraphs 53 to 59) describes restructuring for succession planning purposes, whereby a business operator transfers shares in the business to his sons, breaking up the business to enable a tax-effective inter-generational transfer of wealth. As stated in paragraph 59, where the restructure is undertaken to facilitate an inter-generational transfer of wealth as opposed to a bona fide restructure of an ongoing business, the rollover will not be available. Application to your circumstances
Having regard to all of the facts and circumstances surrounding the proposed restructure and the factors that would indicate that a transaction is, or is part of, a 'genuine restructure of an ongoing business', it is considered that the proposed restructure is not a 'genuine restructure of an ongoing business' as contemplated by the legislation and does not satisfy the requirement in paragraph 328-430(1)(a) of the ITAA 1997. There has been no evidence provided of the restructure of the ongoing business being undertaken to facilitate growth, innovation and diversification, adapt to changed conditions, or reduce administrative burdens, compliance costs and/or cash flow impediments. Nor is there any evidence of restructuring the way in which the business is conducted. The proposed restructure introduces additional compliance costs and administrative burdens by incorporating a new company.
We acknowledge example 3 in the LCR is like the proposed transaction, however it is noted in that example the partnership decided to undertake the restructure in response to an opportunity to grow the business. This can be distinguished from the current circumstances where there is no clear plan, or emerging business need that has been identified. Instead, the Commissioner has been provided with general statements about undetermined future plans. It was also explained that the land (currently owned by an individual outside the partnership) would pass to the partners under a will should the individual pass away. It was further stated to the Commissioner that the company may, in the future, need to secure financing to purchase or formalise rights to the land to support further business expansion. There are no clear or certain arrangements in place and the need to secure finance appears to be speculative.
In the absence of other reasons, asset protection is not considered to deliver benefits in respect of, or to enhance, efficiency of the ongoing business. In the absence of specific diversification proposals or plans the ongoing business has in place, the proposed restructure does not demonstrate that efficiency benefits will arise. The Commissioner does not accept your contention that the proposed restructure is a genuine restructure of an ongoing business that is expected to deliver benefits to the business owners in respect to their efficient conduct of the business by providing greater asset protection. The facts and circumstances provided do not provide clear understanding of the commercial rational but rather being an initial step in a broader reorganisation of your affairs.
The Commissioner acknowledges that tax considerations are factors that can be taken into account under a genuine small business restructure. For example, a sole trader subject to the highest marginal rate moving to a company structure to access the lower corporate tax rate. However, there has been no evidence provided of the restructure of the ongoing business being undertaken to facilitate growth, innovation and diversification, adapt to changed conditions, or reduce administrative burdens, compliance costs and/or cash flow impediments. In the absence of this evidence, the Commissioner is unable to establish the proposed transaction is a genuine restructure. We note that a restructure undertaken as 'preliminary step to facilitate the economic realisation of assets, or takes place in the course of a winding down to transfer wealth between generations' is a factor which tends to indicate that a restructure is not a genuine restructure of an ongoing business. While we acknowledge there does not appear to be any immediate plan to pass on the business, in the absence of the evidenced discussed previously, this appears to be a driver for the transaction.
The Commissioner does not consider that genuine needs for the efficient conduct of an ongoing business will, or have, been fully addressed or articulated. Therefore, the Commissioner is unable to conclude that the proposed transaction is a genuine restructure.