Growing Tax Pains: An Ultimate Guide to Restructuring Your Business

Business Structuring
  • When changing your business structure, you may incur a hefty capital gains tax bill, such as from a sole trader to a separate legal entity or company.
  • However, the ATO has provided a rollover relief when you transfer assets during a business restructuring.
  • Consult a tax accountant or business adviser on matters such as CGT, rollover costs, transfers of ownership and leases.

change your business structure

As businesses grow and change, it’s possible that their structure will change. Many new businesses start out as sole traders or partnerships of individuals, but as they grow, the owners may look to incorporate or introduce trust into their structure. There can be various reasons for that:

  • Asset protection to separate personal assets like the family home from a different type of business creditors
  • The ability to stream income to other family members, which a trust allows but which can’t be done as a sole trader
  • The desire to introduce new stakeholders and investors to the business which is better done through a corporate or unit trust structure than a sole tradership

Whatever the reason for the desire to change, the problem, until recently, has been that changing your business structure could trigger some unwanted tax liabilities. Tax law often regarded a change in structure as a change in ownership. And, as a general rule, where there is a change in ownership, there is a capital gains tax bill.

How the taxman can help: Small business restructure rollover relief

When you change your business structure, it is likely that assets used in the business will be transferred from the old business to the new one. From July 1 2016, small businesses can change the legal structure of their businesses without incurring any income tax liability when assets, which are used in the business (“active assets”) are transferred from one entity to another. 

This rollover applies to active assets that are CGT assets, as well as trading stock, depreciating assets, and other revenue assets like work in progress.

Active assets are essentially those which are used or held ready for use, in the course of carrying on a business (such as buildings, plant and machinery).

Small businesses qualify for the new provisions if they have an estimated turnover of less than $10million for the current year, or if their turnover for the previous year was less than $10 million. Affiliates, connected entities and partnerships of qualifying the small type of businesses are also eligible for the rollover.

The relief applies where small business taxpayers transfer an active asset of their business to another small business entity as part of a genuine business restructure, as opposed to an artificial or inappropriately tax-driven scheme.

Determining whether a business restructure is 'genuine'

Determining whether a restructure is 'genuine' depends on all the facts surrounding the restructure. The Australian Taxation Office (ATO) has stated that that the restructure must be such that it “could be reasonably expected to deliver benefits to small business owners in respect of their efficient conduct of the business going forward.” It further provides that the roll-over “is not available to small business owners who are restructuring in the course of winding down or realising their ownership interests.”

Examples of an ingenuine business restructure 

They go on to provide specific examples of transfers of business assets that are not genuine restructures of an ongoing business, such as:

  • where the restructure happens so that assets can be transferred from a company to an individual in order that the 50% CGT discount can be claimed when the asset is sold (individuals can claim the discount, companies can’t),
  • where the restructure happens so that wealth can be taken out of the business for the owners to use for their personal enjoyment,
  • where artificial losses are created which can be offset against profits,
  • where the restructure causes a tax liability to be artificially deferred or wiped out; and
  • there are other tax outcomes that do not reflect economic reality.

In short, the ATO is looking to block schemes which involve a restructure that is not implemented to help your business grow and adapt to changing circumstances but is being implemented largely to produce some sort of a favourable tax outcome, either to the business or the business owners. If you are implementing a restructure for the “right” reasons, you’ll be able to enjoy the tax rollover.

The "safe harbour" criteria set by the ATO

Crucially, the ATO has set out what it calls a “safe harbour” - a pre-defined set of criteria, which, if met by your business, will be taken as proof that your restructure is legitimate. So, the ATO says that if no significant assets, apart from trading stock, are disposed of or used for private purposes by the small business for a period of three years after the restructure, and the assets continue to be active assets of the business, then the restructure will automatically be considered a genuine restructure of an ongoing business.  

To be eligible for the rollover, the “ultimate economic ownership” of the transferred asset must not change. The ultimate economic owners of an asset are the individuals who, directly or indirectly (through a company or trust, for instance) own the asset. Where there is more than one individual with ultimate economic ownership, there is an additional requirement that each individual’s share of the ultimate economic ownership is maintained.

A simple example of that might be where a sole trader transfers a business into a new company whose shares are 100% owned by the original sole trader – the ultimate economic ownership of the business rests with the same person.

In order to avoid direct tax consequences occurring over the transfer of assets under these rules, the acquirer of the assets – the new business entity, will be treated as having acquired the asset for its rollover cost. This is the amount that ensures that the old entity makes neither a gain, nor a loss on its disposal and will usually be its original cost.

For example, if the cost base of an asset is $100, and the market value of the asset is $200 when the restructure takes place, the rollover cost is equal to $100.

Note that you and your business won’t be exempt from any other tax consequences other than those associated with income tax, which arise from the restructure. For example, a small business will not be exempt from any stamp duty arising from the transfer of a lease on a building or piece of equipment.

Summarising all that, provided the restructure is genuine, the tax effect of the restructure will be as follows:

CGT assets

  • No capital gain or loss accrues to the old entity,
  • The new entity acquires the asset at the date of transfer for its original cost,
  • Pre-CGT assets remain pre-CGT in the new entity (Quick reminder, assets which were acquired before the introduction of CGT on 20 September 1985 are typically completely exempt from CGT),
  • In relation to the 50% discount, the 12-month clock is reset. You normally need to hold a CGT asset for 12 months in order to claim the 50% discount. So, the new entity must hold the asset for 12 months after the restructure in order to benefit from the discount (remember that companies can’t claim the discount in any event),
  • There’s a different CGT concession which allows active assets held for 15 years to be disposed of tax-free (provided numerous conditions are met). For the purposes of this exemption, the new entity is treated as having acquired the asset on the same date as the old entity.

Trading stock: The new entity inherits the trading stock at the old entity’s cost.

Depreciating assets (such as plant and machinery): The new entity can continue to deduct the decline of the value of the asset using the same method and effective life as the old entity. The asset is transferred at such a value that a balancing adjustment event doesn’t occur in the old entity.

If you need advice on the best structure for your growing business (and the potential tax implications of changing), talk to your accountant or tax adviser.

Mark Chapman

Director of Tax Communications at H&R Block

Mark is a regular commentator on tax matters for a variety of Australian broadcast and print media outlets. In addition to his columns in Money Magazine and My Business Magazine, he has written for a variety of national publications such as the Australian Financial Review, The Daily Telegraph, The Age and The Business Spectator. Previously, Mark was a tax adviser for over 20 years, specialising in individual and small business tax, in both the UK and Australia.