The release of draft legislation to implement a 2015-16 Budget announcement to provide roll-over relief for small businesses that change their legal structure gives rise to five big issues for SME taxpayers and their advisers.
Issue 1: the effect on the structure and coherence of the Act(s)
While the ITAA 1997 has been a mixed blessing, the one shining light in the plain English rewrite has been the redrafting of the CGT provisions from a mess of deemed disposals and tortured language into the "comparative clarity" of the various families of CGT events.
However, first with the replacement of the 124-G and 124-H CGT rollovers with the more generic Division 615 rollover, the CGT provisions are no longer a one-stop shop. This position is now even worse with the new small business rollover proposed to be set out in Subdivision 328-G of the ITAA 1997, albeit with signposts from within Parts 3-1 and 3-3.
In addition, the proposed new rollover, despite purporting to cover trading stock and "*revenue assets" (itself a definition I was previously unaware of), will not itself cover UCA assets ‒ although the UCA rollover in section 40-340 will nonetheless, we are told, apply.
It appears that the ITAA 1997 is itself becoming due for a rewrite.
Just as importantly however is the way that it is becoming increasingly difficult to discern any underlying purpose to various provisions of the Act. At the Taxation Institute 21st National Tax Intensive Retreat at Noosa, ATO Deputy Chief Tax Counsel Peter Walmsley gave a presentation in which he stated that Part IVA would and should apply to a discretionary trust which undertook a 122-A CGT rollover into a company the day before its shareholder accepted a scrip-for-scrip offer to acquire 100% of the shares in the newly incorporated company. While it is submitted that reasonable minds might differ upon the correctness of this approach, it appears to be undercut by the Exposure Draft's explanatory notes which provide that one of the factors relating to the ownership structure of a business might be "access to equity capital", and that tax impediments should not get in the way of restructuring.
In other words, the new rollover provision would provide an express rationale of maintaining underlying economic ownership of an asset (albeit with some modifications when it comes to discretionary trusts), which allows you to then treat that new structure as if it had been the old structure all along. Moreover, the rollover would only operate when looking at the effect of a transaction ‒ there is nothing in the provisions about purpose being an element of obtaining the rollover.
How this will in fact interrelate with Part IVA remains to be seen.
Issue 2: trust cloning is back
About a decade ago, trust cloning was one of the bêtes noires of the Tax Office and now, with the stroke of a pen, it is proposed to allow an asset to be transferred from one discretionary trust to another discretionary trust where both trusts are "family trusts" around the same family group as defined in the trust lost provisions in Schedule 2F to the ITAA 1936.
In addition to trust cloning, the transfer also allows an individual to transfer an asset to a discretionary trust of which that individual is a member of the family group, or a discretionary trust can transfer the entirety of the benefit of an asset to a particular individual who is a member of the family group. There are possibilities here for restructuring the ownership of assets quite significantly so that the future application of the small business CGT concessions in Division 152 may have multiple application in the future.
Issue 3: private company demergers are back
For some time now, the ATO has been using sections 45A and 45B, together with section 44, to effectively take the demerger provisions in Division 125 of the ITAA 1997 outside the reach of SME companies. The proposed small business rollover now seems to provide a handy shortcut which avoids many of the fiddly mechanics around a demerger which can go wrong.
Moreover, it is not at all clear that sections 45A or 45B can have any application to the transfer of property from one company to another company where the owner(s) of those companies are the same, especially since it is a condition of the rollover itself that no consideration can be paid.
Of course, that gives rise to the next issue.
Issue 4: commercially undertaking the transaction
As a solicitor, the mechanics of accounting for these transactions are well and truly beyond me, but I imagine that it is not straightforward. From a legal point of view, how a company or trust can transfer assets for no consideration (as is a requirement of the rollover) raises interesting questions also. A trustee would need a specific power to effectively gift property to an associate (without that transfer being a distribution of income or capital by the trustee) for the rollover to have effect. This power is not commonly found in many trust deeds. Reading the Deed, and possibly amending it, will have to take place prior to carrying out the transaction.
It appears some carve out from section 97, Division 6E, and the E series of CGT events will be required to give any force to the provision.
The question of how a company might make a gift to shareholder, without that transfer of value being a dividend at general law is another question. One assumes that some specific exemption will be needed to state that a transaction that takes place under Subdivision 328-G is not a dividend or a frankable distribution, or a multitude of problems might start to arise.
It should also be noted that the rollover does not cover the liabilities of a business, only the assets.
Issue 5: is there a role for Division 7A?
There are obvious potential Division 7A issues here with the transfer of property to an associate at an undervalue ‒ which is potentially a payment caught by section 109C if there is a corporate transferor. However, with the multitude of documents required where there are companies and trusts together in a structure, the potential for problems affecting distributable surpluses also seems likely.
Finally of course, what happens to the built up loan account of a company or trust structure upon the relevant business being moved into a new entity (or even the debtors themselves)? Will those debts be treated as forgiven by virtue of debt parking when they are transferred to a related entity, assuming that section 109C does not apply in the first place?
Of course, how Division 7A, Subdivision EA and the approach taken TR 2010/3 interrelates with anything else is a difficult issue but it certainly appears that little thought has been given to the impact of this new rollover on those provisions.
It appears that Division 7A and FBT exceptions are required to enable to the rollover to function as intended.
Presumably the consultation process will flush out some of these issues and provide more clarity for taxpayers.
Thanks to David Marks of counsel for his comments on a draft of this article.
This article was first published in Thomson Reuters Weekly Tax Bulletin, Issue 48, 13 November 2015