Restructuring Without the Tax Sting: The Small Business Restructure Rollover Explained

0:00
You're listening to Explain That by Velocity Legal, the podcast that keeps business owners and professional advisers ahead of the curve in an ever-changing legal landscape.

Your business has grown, but your structure hasn't.

The problem? Changing structures can trigger big tax bills.

0:18
The good news? There's a way to restructure without the tax sting.

That's known as the Small Business Restructure Rollover.

To explain, I'm joined by Tyson Bateman, a lawyer within Velocity Legal's Tax team.

So the Small Business Restructure Rollover, it's a confusing name, it's a bit of a mouthful, and it's not to be confused with some other things that have similar names.

0:42
Yeah, unfortunately the way the Tax Act works, we tend to put a lot of letters everywhere. It can get quite confusing.

But the Small Business Restructure Rollover is a very specific rollover in the Tax Act, which is often a little bit misunderstood, but can be used quite powerfully if done correctly.

0:58
It's almost like the free-form change, whereas your other rollovers are very prescriptive on where you've got to go to and how you've got to do it.

But this one is a bit different, isn't it?

Yeah, that's right.

The other rollovers, typically you're putting everything into a corporate form.

1:15
This one's a lot more free-form. So it is possible to take stuff even out of a corporate structure and put it into a new one.

I guess taking it back to the first point of this restructure, it was designed for people that perhaps didn't get the structure right at the start.

Perhaps a mum and dad business that didn't get the right advice or they didn't anticipate that business was going to grow this big.

1:37
Parliament thought these people shouldn't be penalised for having a structure that hasn't optimised.

That's really the basis for this. How do we help people get the correct structure that they would have put in had they known they were going to be at the point now?

So they were sole trader and now they want to go to a discretionary trust.

1:54
Yeah, that was the intention.

We'd say it was sole traders, perhaps a trust or a company or something that was outside the other usual rollovers in the Tax Act.

But its application is much broader than that. Clearly, the intention was for sole traders to discretionary trust or similar.

2:11
But the way that it is set up, it's a lot more flexible in that way.

Tyson, I just wanted to walk through, I guess, if there is no rollover, what are the typical sort of tax imposts that a business could be looking at on a restructure?

Yeah. So if you're doing a restructure and there's no relief available under any sort of rollover or exemption, you're looking at, for your CGT assets, possible capital gains.

For your depreciating assets, you've got balancing adjustments, and that can come out as ordinary income.

2:40
And then finally disposals of your trading stock, and that comes out as ordinary income as well.

So anytime where you're moving assets between entities or changing the ownership, you can have quite significant tax implications of doing so.

You must hear it as well that sometimes there's a misconception that, well, because they're not being sold, they're getting no cash, etcetera, that there shouldn't be tax.

And maybe philosophically those people should be right.

3:05
That's just not how it works in practice.

No, unfortunately the tax laws have recognised that if you've got the same controlling mind and the same people behind it and you're just changing the name perhaps on the ownership sheet, that there hasn't been a transfer or a change of ownership.

But if you are moving entities, then yeah, there's a trigger, the disposal, and tax at that point.

3:23
Well, let's get into the nuts and bolts of the restructure. What are the core requirements?

Who are the types of businesses that could qualify for this?

Yeah. So like all things in tax, there's a number of prescriptive requirements.

3:38
The ones that generally get the most attention are that it's got to be part of a genuine restructure.

And I guess we'll come back to what that means shortly.

You can't materially change the ultimate economic ownership of the assets.

And again, that's a concept fraught with a bit of technicality.

3:55
And the entities need to be small businesses as defined in the Tax Act.

So typically you're looking at aggregated turnover of under $10 million.

Broadly, if you can get in those three things, you're okay.

But the other ones to keep in mind are only Australian residents, no concessionary taxed entities.

4:12
So those are the key core requirements.

So we've got businesses less than $10 million of turnover. Is it a genuine restructure, and is there a change in ultimate economic ownership?

That's right. That's right.

So they are your headline issues, and then when you dive into more of them, that's where you start to see the technicalities and the nuance with some of these concepts.

4:30
Yeah. Well, before we dive into some of those concepts, what are the sort of common things you see as the examples?

We mentioned the sole trader going to a company or discretionary trust, but what are the types of common situations, or even uncommon situations, that you can see this applying in?

4:48
Yeah, it's not intended, or perhaps the way that it's drafted, it wasn't meant to be used for succession planning.

But the way we see it a lot is in farming, particularly with pre-CGT plots of land.

That pre-CGT status is super valuable in the tax world.

5:06
All the other restructures and rollovers, you lose that status.

But the SBRR is one of the few that lets you keep that.

So that's probably where we see the strongest of, perhaps it's been an individual, it's passed down from grandparents, grandparents, grandparents.

But now there's a situation where you've got father and his wife and they're saying, how do we put this into a trust for the benefit of the family moving forward without losing our pre-CGT status?

5:31
So that's probably a common one that we've seen.

I think that's the most powerful version.

Other ones we see is also, perhaps it is in a company structure, but it's just not working.

There's Division 7A issues, there's complications that come from extracting money out of a company.

And if the system is set up right, they can then move that into perhaps a trust or another structure that suits their practice.

5:51
So it could be assets going into a discretionary trust, could even be land, just saying.

Or it could be going the other way, going from a company to a non-company structure, or perhaps just simplifying a group generally.

Yes, simplification's a good one.

6:07
Sometimes you've got a situation where you've had a very ambitious adviser and they've set you up with all these different entities, and there's perhaps too many things that are peeled off from one another.

Sometimes the SBRR just lets you pull it all back to nuts and bolts and get the right structure in the right spot.

Well, let's dive in now to those two core requirements that I think have the most uncertainty, which is the genuine restructure and the ultimate economic ownership.

6:33
Let's start with the genuine restructure. What is a genuine restructure?

Yeah, it's funny. It's not defined in the Tax Act, so we don't have any indication of what it means.

Unfortunately, it hasn't been considered by the courts or tribunals either.

6:49
So we're left with the words in the legislation and, to some extent, the explanatory memorandums and some of the ATO materials that have supported that.

It's always funny when you've got nothing else to rely on from courts and tribunals.

7:04
There's a long line of statutory interpretation that says it starts and ends with what's in the legislation, but we just don't have much to go by.

And what are they getting at with this term? That's the crux. Why use the term in the first place?

The way I see it is what isn't it?

A genuine restructure isn't a preliminary step for sale.

7:23
It isn't a wealth extraction.

It isn't a system for parties to do something other than continue to operate the business ongoing.

At its core, it is a change in the structure of an entity, but it's not a change in what's actually happening.

7:41
So I think that's the way to characterise it. What isn't it? Because it's difficult to say what is a genuine restructure without looking at what it is.

Yeah. And I guess that gets it.

If the concern was that this was going to be used in ways that weren't really intended, that if it was really all about, look, maybe you're in the wrong structure, we can clean that up.

7:59
Yeah, that's right. This is a concession, and so there had to be some integrity measure to say, all right, what we're intending to do is to allow people to get into the right structure.

Now, certain structures allow people to realise assets a lot better.

And so we don't want that to be the reason for doing so.

8:15
So this is, I guess, their integrity measure for doing that, but we just have such little guidance on what that means sometimes.

So it's notoriously grey.

Thankfully, we do at least have a safe harbour that can be relevant.

Yeah, perhaps drafting is, they recognised a bit how nebulous the concept was and they put a safe harbour rule in to say if the ownership of the assets and I guess the characterisation of the assets haven't changed within three years of the restructure, then you're deemed to have a genuine restructure.

8:44
Now, importantly, that doesn't necessarily mean if the ownership of the assets changes within two years, you aren't a genuine restructure.

Doesn't go the other way.

No, but this is perhaps a pretty good indication of what Parliament was intending by putting the genuine restructure requirement in there.

It's a good one if you are a little bit unsure on if it is a genuine restructure.

9:04
If you are able to make sure that the assets and the ownership all remain the same for three years, it's the best thing to rely on.

It's the only black and white test in there.

And then moving to the ultimate economic ownership, it's an unusual word, ultimate economic ownership, because that's not really a term found in many other places, and it perhaps doesn't work well with some type of structures.

9:30
But I guess what's the test and then what's the issues?

Yeah. So the ultimate economic ownership, it's described as tracing up all the way to individuals.

So let's start with the easiest one, a company.

So you've got a company with four individual shareholders, all equal shareholding.

9:46
You'd say the ultimate economic ownership is each individual to 25%.

That's the intention, that when you trace it up to individuals, no matter what structure you've got, there's some people that are sitting behind this.

What the SBRR says is that you can't materially change that ultimate economic ownership before and after the restructure.

10:06
Now, as I said there with a company, that's a little bit easier to work out with individual shareholders, but it fundamentally struggles when you get to a discretionary trust.

No one owns the assets of a discretionary trust.

You know, the trustee holds it for the benefit of the beneficiaries.

10:22
They've got wide discretion to send the assets or use the assets however they wish.

And so this idea of being able to trace it up to a person and give them a percentage ownership just doesn't work.

Doesn't exist.

Yeah, yeah.

But there are some deeming rules, and specifically in the Tax Act, because it is so difficult, they introduce a deeming rule where you use family trust elections for trusts.

10:51
Family trust elections, a bit in the media recently, there's a lot of focus on family trust distribution tax.

But luckily for us, it's helping here.

If you've got a trust that has a family trust election in place, that's deemed as almost being like you can find the ultimate economic owner of those assets.

So it does help.

So that situation you said earlier about the farming property owned by an individual, say they transfer and clearly that individual has the ultimate economic ownership, transfers it to the discretionary trust, you would have probably a problem unless you rely on the family trust election.

11:22
Yeah, that's right. In the examples the ATO has put out, they say that it would be difficult to satisfy the ultimate economic ownership test for any discretionary trust and that you need to use that family trust election in order to satisfy that.

So yeah, using that example, before discretionary trust, you'd have a husband or the wife perhaps as the test individual.

11:43
And then that's fine from the perspective of the deeming rule.

I mean, it hasn't been tested at law, but there's some questions around if you're transferring it from a trust, but then to a company that has a trust as a shareholder.

Has that ultimate economic ownership changed?

It's still the trust, the same trust, but just the way the technical tax rules work out, it doesn't seem to work.

12:03
But it's unclear at this stage.

Yeah, that's an interesting point.

And I know the ATO has pretty strict views, pretty narrow views on that question.

As you said, from a company owned by a trust directly to the trust, you'd think, well, the trust still owns it both sides, or trust A to trust B that have the same identical beneficiaries or something like that.

12:27
Yeah. So I guess the point to make is that whenever you've got some trust in this situation, you've just got to be really careful about making sure that you're either looking to satisfy the deeming rule and using family trust elections correctly or you're confident in your position.

Yeah, look, it's really interesting because what I'm hearing is the ATO is taking a pretty narrow view on the ultimate economic ownership, perhaps the genuine restructure points.

12:52
What I think's interesting is that at the same time you've got other comments of courts about where you've got tax provisions that are supposed to be a concession or an allowance, essentially, that you should be kind of generous in how you interpret those provisions, and Eichmann's the best statement of that.

13:15
So as you said, these haven't come up in cases or tribunals, but when they do, it would be interesting to see where the dice would fall there.

Yeah, it's interesting.

There's a bit of a conflict, it seems, with perhaps the court's interpretation on some things and the ATO's changing interpretation on the black letter law of some of these rollover requirements.

13:38
It is very strict. But you're right that there is case law that suggests that if it's a concession, it should be interpreted that way.

I would sit here and say the Small Business Restructure Rollover is a concession.

It's meant to facilitate genuine restructures.

And I'm not sure that a technicality on family trust elections was the intention of undoing this.

14:00
So it'd be interesting to see if and when it ever gets tested.

It's interesting though, because if you're giving advice to a client or a professional adviser that they're contemplating it, they don't have to do it, but if they do it, there's a risk that it won't work.

I mean, what are you going to do?

14:17
Yeah. It's difficult and often it comes down to the profile of the client.

There's some clients that really look for absolute certainty, and there's others that are more happy with your judgement.

Unfortunately, in this area, when you're getting to the concepts of genuine restructure and ultimate economic ownership, it is difficult to provide as much certainty as perhaps some clients would like.

14:40
You tend to find that sometimes, confronted with that option, they just prefer not to do it.

Well, let's get into, I guess, assuming this rollover does apply, what are the tax consequences?

Yeah, it's very powerful.

It actually turns off all direct income tax consequences.

14:55
So that means no capital gains on your CGT assets.

There's special deeming rules for your depreciating assets and for your trading stock, but importantly, the straight transfer won't trigger any of those.

Importantly as well, if you are transferring assets out of a company, it does turn off the direct Division 7A.

15:15
So in other situations, if you were transferring from a company to a shareholder, individual or associated trust, you're potentially looking at a deemed dividend.

We aren't if you're under the SBRR, which can be quite powerful.

You could have land in a company, let's say, and you might say, okay, well, we're going to transfer it out.

15:35
But normally we would have all the normal Division 7A consequences, meaning that basically you'd have to pay market value for it.

Yep. Yeah, that's right.

Here you've got a way of saying, no, no, you're not going to have a Division 7A problem.

Yeah, that's right. So the direct ones are turned off.

15:51
I guess the point to make is, well, you've still got the other taxes to worry about.

So if you're looking at land, always be aware of transfer duty.

SBRR won't get you out of that.

But yeah, GST and some other tax rules also do still apply.

But the direct income tax consequences, they're turned off.

16:08
And then we also have some other deeming rules around small business concessions and pre-CGT status, but pre-CGT you mentioned earlier.

Yeah, it's very powerful.

If you are planning or looking to use the 15-year exemption at some point in the future, the other rollovers in the Tax Act will reset the timer of ownership for the purpose of the 15-year exemption.

16:29
The SBRR won't.

And so it's a very powerful tool, one to preserve pre-CGT, but also for that 15-year exemption status.

So it preserves that.

What it doesn't preserve is the timing for the 50% discount.

I'd suggest that because they didn't want you selling stuff too quickly.

16:46
Twelve months anyway.

They didn't want to have that, so take that as an indication that they're not looking for you to sell anything very quickly.

But yeah.

Tyson, as we've been discussing, there are some uncertainties here with the Small Business Restructure Rollover.

17:02
What I thought would be helpful is going through some of the more frequently asked questions from individuals looking at the Small Business Restructure Rollover in a bit of a lightning format, question and answer type format.

First one, is it really as easy as it sounds using the Small Business Restructure Rollover?

17:23
I'll give you the lawyer's answer. It depends.

It does read very easy and it can be in a simple situation.

But as you've heard, there's complexities around some trusts and some timing.

So it can appear quite easy, but these things can get very hairy very quickly.

Now, I guess that really depends on what type of business you're talking about.

17:42
Is it a very small micro business or are we talking about something quite significant?

Yeah, definitely.

The size of the business, complexity of the business, that always adds complexity to these sorts of restructures.

Next question, what type of documentation would you recommend?

17:58
What type of evidence does the ATO expect you to have done if you're considering doing one of these?

Yeah. Well, the first one is you've obviously got your implementation documents.

So typically some transfer documents of assets and whatnot.

It is quite funny in that because you've got the genuine restructure requirements, the ATO is moving towards this idea that everyone should have contemporaneous records at the time of what's going on.

18:22
I would be recommending perhaps having some written planning, depending on how sophisticated the business is, some board minutes or some planning about this and the basis for doing so.

The evidence at the time you do the restructure is always going to be so much stronger than reconstructing it years down the line in an audit.

18:38
So perhaps putting in writing the reasons for the restructure, the reasons you're doing it, that's probably the best thing I can recommend.

That with the genuine restructure requirement.

Definitely the other one, of course, is the ultimate economic ownership. If you've got trusts involved, making sure your FTEs are all in place, effective and have the right people.

These are the sort of documents you should be looking for.

18:57
Next question, what if I do sell within the three years?

What if I've done the restructure and what if I sell within the three years?

Yeah. So the starting point is that you no longer get that safe harbour rule.

So sadly, we're out of that territory and now you're relying on the fact that it was a genuine restructure.

19:19
It's a bit of a funny concept because it's arguable it's tested at the time of the restructure.

Was it a genuine restructure at the time you effected it?

Now, there are some circumstances that may, perhaps it was at that time, and you've sold after two years for very good reasons.

But perhaps if this was a restructure done knowing that sale in two years was coming, it's probably a different question to ask.

19:39
So that one, again, it depends, but I would be looking and saying what was your intention at that time of the restructure?

What if ownership structures aren't perfectly aligned?

What if it's not individual to individual?

Are we completely shot or do we have any hope?

19:57
You've got hope, but it will be difficult if there's misalignment, particularly if perhaps you've got quite a broad business and you've got different ownership percentages across different assets.

It's very difficult to overcome that ultimate economic ownership if there's mismatches.

Yeah.

20:12
How does the rollover affect other concessions?

Yeah. So for the small business CGT concessions, as I said, it keeps that 15-year timer going for the purpose of the 15-year exemption.

Very valuable tool compared to the other rollovers in the Tax Act.

Yeah.

And then if we're talking about land, I guess one thing you mentioned earlier is that we're only talking about the federal tax consequences.

20:37
I guess you'd have to look at the state-based thing and whether there's any relief.

Yeah, exactly.

If we're looking at farming, there's family farming exemptions in various jurisdictions.

Perhaps there's a corporate restructure one that might work, but the blanket rule is that the SBRR itself doesn't provide relief.

20:54
Yeah. Well, it's interesting.

We're in Victoria now. We've got this phasing out of stamp duty on commercial properties, and there's other things in other states that are moving kind of in that direction.

So maybe it's not going to be as much of a barrier, but it still can be at the moment.

21:09
Yeah, I think that's what the stated intention is, at least to not disincentivise people moving properties around.

But yeah, something to keep in mind.

Can I include passive or investment assets if I'm doing a Small Business Restructure Rollover?

So one of the requirements is that the asset is active, and it's important to have a look at how it's used in a business, or perhaps used in a business that's related to you.

21:31
So purely investment and passive assets, it won't work for.

So things like your goodwill, your plant and equipment, your trading stock.

That's right. If you're looking at land, perhaps just keep going back to the farmer.

It is used in the farming business carried on by the farmer.

But otherwise, straight investment and passive assets, it won't work for.

21:48
Yeah. And what about shares in a business?

Let's say I want to restructure, I run the business through a company now, and I want to restructure the share ownership of that business.

Can I get relief?

Shares are an interesting one.

22:03
So they've got some funny rules around making sure they are active.

So first of all, there's the look-through into the underlying assets to make sure that 80% of the assets of the company are active.

But where we see more issues with shares is that there's a requirement that the transferor and transferee will be small business entities, which requires carrying on a business.

22:22
It's pretty rare, although not impossible, for a shareholder to be carrying on a business in its own right.

Often you'll need something else there, like it is doing some business operations.

If the transferor or transferee is only holding the shares, it would be pretty rare to pass that requirement.

Yeah.

22:38
Because the shareholder just holding shares in a company and the company carries on a business, that shareholder doesn't.

Yeah. So there's an issue with shares usually, but it's not impossible.

Final question, when you've got a client or adviser come to you and say, okay, we want to do this restructure, what's your typical process?

22:56
Are you looking at this? Are you looking at other concessions? Are you looking at other rollovers?

How do you typically approach those situations?

Typically you're trying to see everything.

You want to try and see if the small business concessions can apply, whether there's any of the other rollovers that can apply.

It's pretty rare someone comes along and says, I just want the SBRR to stand alone.

23:13
It's part of a full restructure suite.

So we would be checking off everything else to see if there's anything that might suit the structure better.

And it depends really on the assets in the business and what's going on.

Some situations you'd rather the small business concessions, some situations you'll need to use the restructure rollover.

23:30
So often we look at everything available before jumping in.

Final, final question. Small Business Restructure Rollover, powerful tool or pointless rollover?

Powerful tool, but significant limitations if you're not careful.

23:46
Well, we've been chatting about the Small Business Restructure Rollover.

Thank you so much for your time today, Tyson.

If any listeners do have any questions about the Small Business Restructure Rollover, please feel free to reach out to Tyson.

Thanks, Andrew. Appreciate it.