Restructuring Businesses to Corporate Entities
There are compelling reasons to transfer businesses from trusts to companies. The major advantage of operating a business through a company is the ability to retain income. The income can be distributed to shareholders across different income years and therefore, companies provide a vehicle that can be used in a flexible manner for planning purposes.
Trusts need to distribute all their income to its beneficiaries to avoid trustee tax at 47% being payable. However, even when the income is distributed to beneficiaries, the tax payable at the beneficiary level could be as high as 47%. Another attractive feature of operating a business through a company is the lower corporate tax rate for base rate entities. The tax rate for such entities is currently 26% and will reduce to 25% on 1 July 2021.
Historically, the argument for using trusts rather than companies to carry on businesses has been the ability for a trust to utilise the 50% CGT discount upon the future sale of the business. This is still a relevant argument, but not as compelling as it used to be. For an individual at the top marginal tax rate of 47%, a discounted capital gain would be taxed at 23.5%. If we compare this rate against the corporate tax rate of 25% from 1 July 2021, the differential is not significant. In the long run, a company that is taxed at 25% annually on its business income could prove to be a more tax efficient vehicle.
So how could we restructure a business from a trust to a company?
Utilising the Small Business CGT Concessions could be the most beneficial option, as the value of business assets would be reset to market value upon transfer. However, in many instances the conditions to satisfy the Concessions cannot be met, or it would be impractical to use the Concessions if, for instance, the Retirement Exemption is utilised and funds are required to be transferred to a superannuation fund.
The other option to consider is utilising a CGT rollover. The two relevant CGT rollovers to consider are the following:
- Subdivision 122-A Rollover
- Subdivision 328-G Rollover
The 122-A Rollover is the ‘simplest’ rollover to utilise in the sense that satisfying the rollover conditions are fairly straightforward. The rollover simply requires the relevant trust to transfer its business across to a wholly owned company. The value of the shares in the company after the restructure must be substantially the same as the value of the business transferred. This is easily achieved by establishing a new company that is wholly owned by the trust (i.e. a company without any assets prior to the transfer of the business).
One important restriction under the 122-A rollover is that there cannot be any consideration other than shares in the company (and the assumption of liabilities of the trust) under the rollover. That is, there is no ability for the business to be transferred at market value to the company resulting in the company owing an amount to the trust which could either be available for future cash drawdowns or UPE offset.
The 328-G Rollover is available for a business being transferred from a trust to a company. Unlike the 122-A Rollover, the transfer can occur for consideration, which is a unique feature of this rollover. While the rollover itself can provide significant advantages, there are practical difficulties in satisfying the requirement that the restructure must be a ‘genuine restructure of an ongoing business’. The ATO’s takes a strict and narrow view of this requirement. For instance, if the restructure occurs for the purposes of succession planning or is a preliminary step to facilitate the sale of an asset, the genuine restructure requirement will not be satisfied.
If the genuine restructure requirement cannot be satisfied, the ‘safe harbour’ rule can be relied on. Under this rule, for a period of three years, there cannot be any change in the ultimate economic ownership of the asset transferred, the asset must continue to be an active asset and there cannot be any significant private use of the asset. While the safe harbour rule provides a three year period with certain restrictions, the ATO takes the view that Part IVA can apply if any of these restrictions to the relevant asset occurs after the three year period.
The restrictive nature of the genuine restructure requirement and the uncertainties around the safe harbour rule often leads to the 328-G Rollover not being utilised. The 122-A rollover can achieve the objective of transferring a business from a trust to a company in a much simpler manner.
If you have any queries in relation to the above please contact Gaurav Chitnis