FEATURE

Tax effective restructuring

for SMEs
by Stephen Holmes, CTA, Partner, WMS Chartered Accountants

Abstract: Business and investment structures which may have been appropriate for the business and personal
circumstances of particular taxpayers when first established may become less efficient and appropriate as
those circumstances change over time, and may require adjustment or restructuring. This paper sets out some
structuring options and techniques that can be used when changes in circumstances occur and the clients
structure or structures may require some modification. The paper discusses a range of changes in circumstances
and/or client-driven behaviour that are commonly encountered in practice. They include legislative and Australian
Taxation Office change, particularly in the treatment of unpaid present entitlements, growth and asset protection,
streamlining a complex structure, and preparing for a sale and injection of equity.

Introduction Legislative/ATO driven change The possible restructuring options that

As our clients grow, fail, sell, divorce, age
and have families, it is common that the
business and investment structures that
once suited, lose their lustre and efficacy.
The nature of any change that might occur
is rarely able to be predicted with any
degree of accuracy. What we must do as
tax professionals is to be able to adapt to
these developments.
The purpose of this article is to set out
some structuring options and techniques
that can be used when changes in
circumstances occur and the clients
structure/s may require some modification.
This article focuses on the following
changes in circumstances and/or client-
driven behaviour that are commonly
encountered in practice:
(1) legislative/ATO change treatment of
unpaid present entitlements (UPEs);
(2) growth/asset protection;
(3) streamlining a complex structure; and
(4) preparing for sale/equity injection.
The application of Pt IVA of the Income
Tax Assessment Act 1936 (Cth) (ITAA36)
is crucial to any restructuring activity.
The author has (conveniently) assumed
that for any restructure proposed in this
article, that this is sufficient commercial
objective to warrant the restructure. Where
the restructure may involve some tax risks,
the author has attempted to identify that
risk and suggest an appropriate mitigation
strategy.
UPE stance
Possibly the most significant challenge
to the efficacy of our structures in
recent years were the Commissioners
announcements in 2009 and 2010
regarding the treatment of unpaid present
entitlements (UPEs) owing by trusts to
companies. This change has been more
than adequately covered in other articles.
Suffice to say, that prior to 2009 it was
considered best practice for small-to-
medium enterprise (SME) structures to
involve a discretionary trust conducting
the business and distributing profits to a
corporate beneficiary. Provided that those
profits were reinvested into the business
and not extracted by loans, then Div7A
ITAA36 was completely manageable.
With the advent of TR 2010/3 and PS LA
2010/4, clients that continue to distribute to
corporate beneficiaries must either:
(1) cashflow the distributions to the
corporate beneficiary;
(2) enter into a sub-trust arrangement as
set out in PS LA 2010/4; or
(3) let the UPE convert into a section three
loan (subject to Div7A).
Given than many businesses are unable to
cashflow the distribution to the corporate
beneficiary, it is likely that items (2) and
(3) are commonplace in the SME space
in Australia. The author has found a
surprisingly low uptake for the sub-trust
option with most practitioners opting for
the section three loan approach for UPEs.
might suit both the sub-trust and section
three loan strategies will be briefly
discussed.
As is well known, the ATO have been
generous to provide interest-only loans over
either seven or 10 years. With this option,
the UPE must be put onto a sub-trust
arrangement by the time that the income tax
return for the year in which the distribution
occurs is lodged. The sub-trust allows that
the principal component of the UPE is not
required to be repaid to the company until
the end of the seven- or 10-year period.
Interest must be paid annually in arrears.
Where the trust makes annual distributions
to a corporate beneficiary and uses the
sub-trust option, the amount of principal
that will be required to be paid in the future
accumulates. The first issue in practice is
that it is imperative that you continually
inform your clients of this latent growing
liability. Second, you should consider if
there are any restructuring strategies that
may mitigate the cashflow impact of the
end of each sub-trust arrangement.
The author recently prepared some
modelling for a new client out to 2025 who
has, and will continue to use, the 10-year
sub-trust option (in this case, the sub-trust
is a productive option as the client does
not extract personal funds and reinvests
realised profits back into their business).
The outcome of the model was to ensure
the client understood the substantial and
growing sub-trust balance that this option
creates. Also, it is important that the client
is given some options on how the end

500 TAXATIONINAUSTRALIA | APRIL 2014


of the sub-trust will resolve itself for
example, is it a large dividend to offset the
sub-trust balance with the accompanying
top-up tax or is there a restructuring option
available? The client was concerned with
how will this all end?.
One restructuring solution that might be
suitable where the trust owned significant
plant and equipment would be to consider
transferring sufficient unencumbered
equipment to the corporate beneficiary
to repay (in part or in full) the sub-trust or
section three loan balance. The equipment
should then be rented back to the trust
as appropriate commercial rates. The rent
would need to be cashflowed or otherwise
you run the risk of creating a further Div7A
exposure on the rental debtor.
Another variation to this theme that has been
raised is the transfer of inventory owned
by the trust to the corporate beneficiary as
payment towards the sub-trust balance. The
corporate beneficiary could then become a
wholesaler to the trust.
Structured correctly, there should be no
duty on the transfers contemplated above.
Other commercial considerations such as
bank security and financing arrangements
would need to be considered before
implementing such a restructure.
Another more drastic solution may be
to ultimately transfer the business to the
company and offset the consideration
against the sub-trust loan. Unless the small
business concessions are utilised (which
are discussed in detail below), then this is
potentially a costly alternative before any
stamp duty costs are factored in.
The author has noticed quite a push around
the profession for this type of restructure
the trust has served its purpose so
lets transfer the business to the company.
The author does not necessarily share the
eagerness for this approach as he believes
trusts still have a lot to offer.
Growth/asset protection
restructuring
The funny thing about asset protection is
that clients generally dont become too
concerned until there are actually significant
assets that require protection. In the early
stages of most businesses, the focus is
on simplicity, cost effectiveness and tax
efficiency. Asset protection is often a residual
concern that is sometimes overlooked.
In an ideal world, the goal is to ensure that
the accumulated wealth that accumulates
from a business is kept separate from the
FEATURE
ongoing risks that also emanate from the
business. Diagram 1
Where a client operates through a
discretionary trust, the assets (up to a level) Pre-roll-over Post-roll-over
can be protected without necessarily the
need to restructure by having any UPEs
converted to loans and having the relevant
beneficiary take appropriate security over
the assets of the trust. Of course this or trust or trust
approach needs to be considered in light
of any adverse outcomes in converting a
UPE. For example, it would not be desirable
to convert a UPE that arose prior to 16
Trading co NewCo
December 2009 which is currently afforded
concessional treatment under PS LA 2010/4.
However, this can prove challenging when
clients have operated their businesses
through companies. In many cases, the Trading co
client has reinvested the retained earnings
back into the business. These retained
profits/accumulated assets are now
potentially at risk should a claim arise Diagram 2
against the company.
There are several strategies that can be
Pre-roll-over Post-roll-over
considered in these circumstances.
SH1 SH2 SH1 SH2
Extract dividends and secure
entitlement
The company could declare a dividend. On
SH1 co SH2 co
the basis that the retained profits are fully company
franked, then the shareholders would be
liable to the top-up tax. The quantum would
obviously depend on the effective marginal
tax rate available to the shareholders. company
Where the shareholders remain keen to
leave the cash in the company, then the
shareholders could loan the cash back to
the company and take appropriate security
over the assets of the company. the extent that the dividend is franked, Newco
should have no further tax liability. Newco
This strategy often is not practical where
would then securitise its entitlement to the
the shareholders are individuals as the
top-up tax liability on the dividends can dividend and obtain appropriate security over
be significant. The bringing forward of this the assets of the operating company.
top-up tax will unwind many of the past tax As profits are derived into the future by
benefits of operating through a company. the operating company, they should be
routinely paid to Newco and appropriate
Subdivision 122-A roll-over single loan/security documents updated.
shareholder
In essence, the individual shareholder
Under this strategy, the net worth of the
trading company should be able to be kept
would dispose of their interest in the
operating company to a new wholly-owned to a minimum other than the unrealised
company. The shareholders would utilise growth on assets such as goodwill.
roll-over relief under Subdiv122-A of the
Income Tax Assessment Act 1997 (Cth) Subdivision 122-A multiple
(ITAA97) (refer to the appendix to this shareholders
article for a discussion on the roll-over) if This roll-over can also work well when the
they were a trust or an individual. This is operating company has more than one
best shown by diagram 1. shareholder. Each shareholder can use the
After the roll-over, the operating company roll-over to dispose of their shares to their
could then declare a dividend to Newco. To own wholly-owned company in exchange
TAXATIONINAUSTRALIA | VOL 48(9) 501
 FEATURE
for shares in Newco. The new structure
would resemble diagram 2.
The operating company would then
declare the appropriate dividend to each
shareholder company. Each shareholder
company would then take the appropriate
security over the unpaid dividend
entitlement.
Concerns and complexities
The above type of restructures should not
be undertaken without consideration of the
possible disadvantages and complexities.
These are examined below.
Stamp duty considerations
As the Subdiv122-A roll-over involves the
disposition of shares in private companies,
the main area of concern for duty is where
the company is regarded as land rich.
Where a company is conducting a trading
business and holds no freehold interest
in land, it is unlikely that duty should be a
major concern. Nonetheless, it is worthy of
consideration.
PartIVA and dividend stripping
Although the dividend stripping provisions
of s177E ITAA36 were originally designed
to counteract the classical dividend
stripping arrangements of the early 1980s,
the provisions are wide enough to warrant
consideration.
On the surface, a payment of a dividend
from the operating company to the new
individual shareholder company would
not appear to be a dividend strip per se.
However, the ATOs controversial views
in TR 2013/D5 regarding dividend access
shares has confirmed that some of the
more traditional elements of the classical
dividend strip do not need to be present in
order for s177E to apply.
The ATO has issued a number of private
binding rulings to taxpayers who were
seeking to utilise Subdiv122-A to interpose
a corporate shareholder and the payment
of a dividend. In those rulings, the ATO has
indicated that neither, Pt IVA and s177E,
would apply. However, in each ruling
referred to below, the intention was that the
existing company was to be liquidated after
the roll-over.
In PBR 37296, the shareholder using the
Subdiv122-A roll-over was seeking to do
so to receive a liquidators distribution
from an operating company. The operating
company was to be liquidated and this
particular shareholder wanted to continue
holding his interests through a company.
502 TAXATIONINAUSTRALIA | APRIL 2014
In the ruling, the ATO made the following
statement:
Is the arrangement a scheme having
substantially the effect of a scheme by way
of or in the nature of a dividend stripping for
the purposes of subparagraph 177E(1)(a)(ii)
of the ITAA 1936?
3. Your dominant purpose in entering the
arrangement is to continue to operate using a
company structure. Therefore the scheme does not
have substantially the effect of a scheme by way of
or in the nature of a dividend stripping.
In PBR 1011948219931, a company
had three shareholders. The trading
company had ceased trading and was to
be liquidated. Two of the shareholders
did not want to extract the dividends
from a corporate structure whereas the
other shareholder was keen to access
the funds. The two shareholders utilised
the Subdiv122-A roll-over to interpose
a company to own their shares in the
trading company. The trading company
was then liquidated, dividends paid to the
three shareholders. The shareholders who
utilised the roll-over paid a portion of that
dividend to themselves and retained the
balance in the interposed companies. The
ATO ruled that this process did not attract
Pt IVA or s177E (dividend stripping).
Given that such a strategy does contain
a risk that s177E may have a theoretical
application, consideration should be given
to obtaining a private ruling in relation to
the application of the dividend stripping
provisions where the dividend to be paid is
substantial. The commercial driver of such
a restructure is clearly for asset protection
and it would be difficult to accept that it is
a logical outcome that the anti-avoidance
provisions would apply.
Unlike the dividend access schemes
referred to in TR 2013/D5, the profits
remain in the corporate structure owned
by the same original economic owners. It
would be a common sense outcome that
the above restructures would not attract Pt
IVA and s177E.
Tax consolidation issues
The interaction of a roll-over under
Subdiv122-A and the tax consolidation
regime does in most cases result in an
adverse and anomalous outcome. In most
instances, forming a tax consolidated
group will result in a capital gain derived by
the head company (Newco).
This outcome is best illustrated by the
following example.
Example 1
TradingCo is a successful wholesale
business. It is owned by a single
individual shareholder. There is only one
share on issue with a cost base of $1.
The balance sheet of the company is as
follows:
$
Cash 500,000
Stock 500,000
Debtors 500,000
Plant (WDV) 250,000
Total Assets 1,750,000
Creditors 300,000
Chattel mortgage loan 100,000
Total liabilities 400,000
Retained profits 1,350,000
The sole shareholder is becoming
concerned regarding the equity
represented by the retained profits that
have been derived by the business.
He seeks advice on how to protect the
retained profits without causing a tax
liability. In other words, he is loath to pay
any top-up tax on a dividend as he is
already at the highest marginal tax rate.
There are sufficient franking credits to pay
a dividend of $1.2m. The shortfall is due
to a previous R&D claim and investment
allowance write-off.
You suggest that he rolls his share in
TradingCo into a new holding company
using Subdiv122-A.
As soon as the restructure is effected,
TradingCo declares a dividend of $1.35m.
Due to the shortfall of the franking credits
and generally because it is tidier, you elect
to form a tax consolidated group between
NewCo and TradingCo effective from date
of the roll-over.
When you sit down and prepare the
allocable cost process, you determine that
the formation allocable cost amount (ACA)
for TradingCo is as follows.
Step 1 Cost base of member interests
($1)
The roll-over under Subdiv122-A
effectively transfers the cost base of the
original shares in TradingCo to NewCo.
 FEATURE

The original cost base of the shares is $1.
That amount becomes the cost base of the
shares in TradingCo now owned by NewCo.
Step 2 Liabilities of TradingCo
($400,000)
Step 3 Undistributed franked profits that
have accrued to the group ($nil)
Only profits that have been earned by
the company since it was owned by the
head company are included. As we are
consolidating immediately, there are no
profits to be included in step 3. A common
error is to include the retained profits of
$1,350,000 that TradingCo had at the
restructure. This is not correct.
Steps 4 to 6 are not relevant.
The formation ACA is therefore $400,001.
The next step is to allocate the ACA against
the retained cost base assets being in this
case:
of the small business concessions should
not be affected. Where, for example, the
retirement concession is utilised by the
trading company, the ultimate shareholder
can still qualify as a significant individual
due to the indirect small business
participation percentage within
s152-75 ITAA97.
In any event, it should be considered and
discussed with the client what impact this
type of restructure will have on a future
sale of the business or company.
Subdivision 124-G (multiple
shareholders)
This particular roll-over is very helpful in
asset protection restructuring. It is also a
roll-over that is significantly underutilised.
The impact of the roll-over is shown in
diagram 3 below.
the profits from the business and pay any
tax on a dividend.
The shareholders could use a
Subdiv124-G ITAA97 roll-over to interpose
a holding company. As outlined in appendix
1 to this article, each current shareholder
will need to own the same shareholding
in the holding company as they held in
the trading company prior to the roll-
over. The policy logic of this roll-over is
to maintain the same economic owners
of the companies throughout the roll-over
transaction. The new structure would
resemble the following.
Diagram 3
Pre-roll-over Post-roll-over
SH1 SH2 SH3 SH1 SH2 SH3

$ The effectiveness of the roll-over is best

explained by way of practical example
Cash 500,000 Hold Co
based on the facts of example 1, which have Trading Co
Debtors 500,000 been reproduced below.

Total 1,000,000
As the value of the retained cost base
assets ($1,000,000) exceeds the ACA of
$400,001, then the head company will
derive a capital gain of $599,999 as a result
of CGT event L3.
In addition, as the ACA has been exhausted
on the retained cost base assets, there
is no ACA left to allocate towards the tax
value of the stock and plant. Therefore after
consolidation, the written down plant for
tax purposes is now $nil and the opening
stock value for the consolidated group is
now also $nil. A loss of $750,000 in future
tax deductions.
Example 2 Trading Co
TradingCo is a successful wholesale
business. There are three ordinary
shares on issue. Each share has a cost
base of $1. The shares are owned by
After the roll-over, the trading company
three unrelated family trusts.
would pay a dividend of the retained profits
The balance sheet of the company is as to the holding company. The group should
follows:
consider consolidation to ensure no tax on
the unfranked component of the dividend.
$
Refer comments below regarding the
Cash 500,000 consequences of forming a consolidated
group.
Stock 500,000

An horrific outcome, but one that the
author has seen in practice on more than
one occasion.
Therefore, the harsh lesson here is
that after a Subdiv122-A roll-over, it is
very unlikely that you would form a tax
consolidated group. If you take on a new
client who is looking to form a consolidated
group, you should enquire whether a
Subdiv122-A roll-over has been utilised
historically.
Future sale
Before proceeding with this restructure,
it is important that the impact of the new
structure on any future sale is considered.
For an asset sale by the trading company
(the most likely outcome), the availability
Debtors 500,000 Concerns and complexities
This restructuring technique is not
Plant (WDV) 250,000
without some issues that require further
Total assets 1,750,000 consideration. Some of the relevant
considerations are below.
Creditors 300,000
Chattel mortgage 100,000
PartIVA and dividend stripping
loan As discussed above, the interposition
of a holding company and payment of a
Total liabilities 400,000 dividend to extract retained profits may
Net assets 1,350,000 warrant consideration of the anti-avoidance
provisions.
Retained profits 1,350,000
The analysis above is also valid for a
Subdiv124-G interposition. However in the
authors opinion, it is less likely to attract
The shareholders are concerned regarding those provisions as no profits have been
the equity that has accumulated within the moved to the original shareholder level,
company. None of them are keen to extract as the profits remain within the corporate

TAXATIONINAUSTRALIA | VOL 48(9) 503

 FEATURE
group. In addition, as discussed below it is
more likely that a tax consolidated group
can be formed than would be the case if a
Subdiv122-A roll-over was used.
Tax consolidation
As outlined above, forming a consolidated
group after a Subdiv122-A roll-over
results in some horrific outcomes when
the cost bases are reset. These outcomes
are largely avoided when a Subdiv124-G
roll-over is used. This is best explained by
reproducing example 1 with some minor
fact modifications.
Example 3
TradingCo is a successful wholesale
business. It is owned by two individual
shareholders. There are two shares on
issue each with a cost base of $1. The
goodwill of the company is internally
generated and currently worth $1.5m.
The balance sheet of the company is as
follows:
$ the company since it was owned by the
Cash 500,000
Stock 500,000
Debtors 500,000
Plant (WDV) 250,000
Total assets 1,750,000
Creditors 300,000
Chattel mortgage loan 100,000
Total liabilities 400,000
Retained profits 1,350,000
The shareholders are becoming concerned
regarding the equity represented by the
retained profits that have been derived by
the business. They seek advice on how to
protect the retained profits without causing
a tax liability. In other words, they are loath
to pay any top-up tax on a dividend.
There are sufficient franking credits to pay
a dividend of $1.2m. The shortfall is due
to a previous R&D claim and investment
allowance write off.
You suggest that they roll their shares in
TradingCo into a new holding company
using Subdiv124-G.
As soon as the restructure is effected,
TradingCo declares a dividend of $1.35m.
Due to the shortfall of the franking credits
and generally because it is tidier, you elect
to form a tax consolidated group between
504 TAXATIONINAUSTRALIA | APRIL 2014
NewCo and TradingCo effective from date
of the roll-over.
When you sit down and prepare the
allocable cost process you determine that
the formation ACA for the TradingCo is as
follows.
Step 1 Cost base of member interests
($1.35m)
Under Subdiv124-G, the cost base of
the shares in the subsidiary acquired
by the new holding company is the sum
of the cost base of the CGT assets of
the company less its liabilities. This is
determined at the time of the roll-over.
Based on the balance sheet above, that
would be $1.35m.
Step 2 Liabilities of TradingCo
($400,000)
Step 3 Undistributed franked profits that
have accrued to the group ($nil)
Only profits that have been earned by
head company are included. As we are
consolidating immediately, there are no
profits to be included in step 3.
Steps 4 to 6 are not relevant.
The formation ACA is therefore $1.75m.
The next step is to allocate the ACA
against the retained cost base assets being
in this case:
$ view that trusts have become a problematic
Cash 500,000
Debtors 500,000
Total 1,000,000
There is sufficient ACA to allocate towards
the retained cost base assets. Therefore,
no gain from CGT event L3 will arise.
However, we need to then ensure that
Option 1 is discussed below and in
there is no adverse outcome that will arise
referred to as the goodwill skew.
$
Formation ACA 1,750,000
Less retained cost base
(1,000,000)
assets
Remaining ACA 750,000
This must then be allocated on a
proportionate basis against the reset cost
base assets. The reset cost base assets are:
$
Stock 500,000
Plant (WDV) 250,000
Goodwill at value 1,500,000
The ACA is then apportioned against the
reset cost base assets as follows:
Reset Value Reset cost
asset base
Stock $500,000 $166,667
(500/2250)*750
Plant $250,000 $83,333
(250/2250)*750
Goodwill $1,500,000 $500,000
(1,500/2250)*750
Total $2,250,000 $750,000
What has occurred above is that goodwill
now has a tax cost base of $500,000 to
the detriment of the tax cost of plant and
stock. The effect of this skewing as it is
called is to reduce future tax deductions
for the company in respect of depreciation
and cost of sales.
Prior to consolidation, this analysis needs
to be undertaken to ensure no adverse
skewing occurs.
Trust to company roll-over
As discussed above, there is a growing
structure in light of the ATOs stance on
UPEs. As such, consideration is often given
to restructuring from an existing trust to a
company. This can occur in the following
ways:
(1) sale of business and utilise the small
business concessions; and
(2) use CGT roll-over under Subdiv122-A.
particular what the current complexities/
issues are for accessing the small business
concessions. In addition, there is the
cost base uplift benefit of transferring the
business using this approach.
Using roll-over relief under Subdiv122-A
obviously does not create any tax issues
but the downside is that there is no
cost base uplift for the future sale of the
business by the company. A future sale of
the goodwill by the company will also not
attract the CGT discount.

Transfer of business without
CGT roll-overs (using the small
business concession)
The small business concessions have been
with us for almost 15 years and it is no
secret that when applied correctly, they
can result in a significant reduction in tax
liability on the sale of a business. In some
cases, when all available concessions are
used in conjunction with one another, the
tax liability can even be $nil.
As a result, a restructure should not be
contemplated without consideration to
using the small business concessions as
opposed to the CGT roll-overs discussed
above.
The benefits of restructuring using the small
business concessions are as follows.
Cost base uplift
A restructure that involves a sale of the
business into a different entity such as a
sale of a business from a trust to a company
will inevitably result in an uplift to the cost
base to the acquiring entity for that asset.
An example of this benefit is set out in the
following example.
Example 4
The Sunline Trust conducts a successful
online retail business. The business
goodwill currently has a value of $2m.
After lengthy discussions with you, it has
been agreed that due to the ongoing
Div7A issues with distributions to a
corporate beneficiary, the business will
be restructured into a company. Your
clients are both aged 56.
You calculate that the small business
concessions can be used to reduce the tax
liability on the sale to $nil.
The trust disposes of the business to a
new company for $2m. The trust vendor
finances the purchase price and takes
appropriate security.
The company now has a cost base for the
goodwill of the business of $2m. As the
company derives profits, it is able to apply
excess cash towards the loan payable to
the trust. When the company eventually
sells the business, it is able to use the cost
base of $2m.
As the parties to the restructure are not
at arms-length, it is important that a
formal valuation for the relevant asset is
undertaken. This may also be required
by the Office of State Revenue as well as
serve as protection in the event of an ATO
review of the restructure.
Obviously a major disadvantage (at times a
deal breaker) is the stamp duty that would
arise from such a transaction.
Use of small business concessions
before it is too late
As mentioned above the impetus for
restructuring often is knocked off course
because of the duty costs.
When that discussion with the client takes
place and the client advises that they
do not wish to restructure, it is prudent
to ensure that the ongoing availability
of the small business concessions is
also addressed. The relevance of this
conversation is best described by the
below example.
Example 5
The Knope Family Trust operates
a successful food manufacturing
business. The trust has habitually
distributed its profit to a corporate
beneficiary. Distributions since 16
December 2009 have been converted to
section three loans. The ongoing burden
of meeting the required principal and
interest payments has caused the client
to revisit the structure.
You have prepared an analysis of the
value of the business and the value of the
net assets of the trust is $4m. You have
also determined that for the purposes of
the net assets test for the small business
concessions that the trust and connected
entities is $5m.
The client considers the option of
disposing of the business to the corporate
beneficiary as payment of the section three
loans and pre-December 2009 UPEs, but
the duty bill is significant. The client is
unwilling to proceed at this point in time.
It is essential that the client is made aware
that the small business concessions may
not be available to them in the short to
medium term, due to the imminent failure in
the net assets test as the business grows.
If the net assets test is failed in the future
then:
(1) a future restructure as planned will
involve a significant CGT liability; and
(2) a future sale will not benefit from the
small business concessions and as the
cost base was not uplifted through the
FEATURE
restructure process, the CGT bill will be
significant.
Small business concession
issues
In preparing for a sale or a restructure
where the small business concessions are
to be utilised, there are many issues that
can trip the unwary and could potentially
deny the concessions.
Set out below is a list of issues that you
may encounter and provide some thoughts
on how these issues may be managed or
solved.
Dividend only shares
While the use of dividend only shares can
add significant flexibility to a corporate
structure, their very existence jeopardises
the availability of the small business
concessions if not addressed at the
appropriate time.
Specifically, where Div152 ITAA97 requires
for there to be a CGT concessional
stakeholder/significant individual, the
presence of dividend only shares is often
fatal. For completeness, a CGT concession
stakeholder/significant individual is
required for:
(1) retirement concession from a company;
(2) 15-year exemption through a company;
and
(3) sale of shares.
To be a significant individual, that person
must have a small business participation
percentage (SBPP) of at least 20%. To
determine the SBPP for a shareholder in a
company you take the lower of the following:
(1) the % of voting power held;
(2) the % of any dividend that the
company may pay; or
(3) the % of any distribution of capital that
the company may make.
Where a dividend only share is held by
a shareholder and a dividend may be
declared in respect of that share to the
exclusion of the other shareholders, then
the other shareholders have a percentage
in relation to item 2 above of 0%.
Consider if you have one individual
shareholder who owns all of the ordinary
shares in a company. Some years ago, the
company issued a dividend only share to a
discretionary trust to enable the streaming
of dividends. If that share remains on
issue at the time of the CGT event, then
for the purposes of the small business
concessions the shareholder will have
TAXATIONINAUSTRALIA | VOL 48(9) 505
 FEATURE

an SBPP of nil%. He is not entitled to the
small business concessions because of
one $1 share.
So what can be done before the sale?
Simply put, the dividend only share should
be either:
(1) acquired by the ordinary shareholder; or
(2) bought back by the company.
The same analysis above applies to any
shares with differing rights. There might be
shares that are voting only shares.
Offset accounts
The use of offset accounts by clients to
save interest on their home mortgage is
very common. As was found in Bell v DCT
[2013] FCAFC32 in 2013, the existence of
a credit amount in an offset account is to
be included in the net asset calculation.
It was argued by the taxpayer in Bell that
the credit account was in essence one
account combined with the loan with the
bank so that net credit amount only was to
be included. This was not accepted by the
unfamiliar with this type of transaction, it
involved:
(1) individual borrowing from the bank
$1m;
(2) the individual gifts the funds to a trust;
and
(3) the trust enters into a loan with the
individual so that the bank is repaid.
The trust takes a mortgage over the
principal place of residence of the
individual.

Regardless of the facts, it is essential that
the share register and company statement
be examined prior to any sale where it is
likely that the small business concessions
are to be accessed.
Net asset test issues
When the ATO inevitably reviews a
taxpayers claim for the small business
concessions, it seems that their main
focus is whether the net asset value test is
met. For a good read on how the ATO are
currently interpreting what is a connected
entity, refer to Gutteridgeand FCT ([2013]
AATA 947 (24 December 2013)).
Some traps relating to the net asset value
test include the following.
The you in the test
The first step when the net asset test
is applied is to start with the taxpayer
deriving the gain. That person is the
you in s152-15 ITAA97. It is important
to start from the correct reference point
to determine the entities that need to be
included in the calculation.
tribunal and the Federal Court.
It is essential that when assisting the
client in determining their net assets that
offset accounts are identified and where
appropriate dealt with. For example, in Bell,
the taxpayer could have easily taken money
from the offset account and repaid the loan
account prior to the CGT event.
Another word of caution clients do not
always understand if they have an offset or
a redraw facility. Always get them to check
with the bank.
Gift and loan back
The author recently encountered the
following issue that caused some
significant concern for the application of
the net asset test. This issue involved the
commonly used gift and loan back strategy
that is often recommended by solicitors for
asset protection purposes.
Some years ago, a client undertook one
of these transactions which purportedly
had the effect of shifting the equity in his
home into a discretionary trust. For those
The alleged effect is that the equity in the
home is now protected. A prudent strategy
is to update the transaction as the value of
the exposed asset increases.
Normally these transactions have no tax
controversy.
However when applying the net asset test,
what has been created is an asset in the
trust. The liability owing by the individual
to the trust is not a liability that relates to
an asset that is included in the test so it
cannot be taken into account. Therefore,
where the trust is controlled for the
purposes of Div152 (and Div328 ITAA97)
by an entity that is included in the test,
then the net equity in the trust will need to
be included.
In the case encountered, the appointor of
the trust was a person whose assets were to
be included in the test. So the value of the
trust represented by the home equity was to
be included. This was a difficult conversation
to have with the particular client but my
home is excluded, isnt it?.

Assets of entities connected with you Table 1

You are connected with an entity if you

control it, the other entity controls you or Entity Connected to
you are both controlled by the same entity.
In plain English, this is best described by Discretionary any entity that received a distribution in four years prior to the CGT
the Table 1. trust event of 40% or more of income or capital;

Too often it is easy to overlook an entity as

it is assumed that there is no connection.
Therefore, the author generally undertakes
the analysis with the clients structure
diagram close at hand so that control (both
direct and indirect) can be identified.
Of particular concern is the pattern of
distribution test as it includes beneficiaries
over the past four years. An innocent
distribution to the wrong beneficiary four
years ago can have a significant impact on
the calculation.
Discretionary any entity that controls the actions of the trustee. In ATO ID
trust 2008/139, the ATO consider that the appointor of the trust (person
who can remove the trustee) is in the position to control the trustee.
Note in Gutteridge, the ATO argued that the director of the trustee
company controlled the trust and therefore was connected. The AAT
held that the person who controlled the appointors actions was the
actual controller;
Company a shareholder who owns at least 40% of the shares in the company;
Partnership a partner who has an interest in the partnership of at least 40%.

506 TAXATIONINAUSTRALIA | APRIL 2014


To the extent that this transaction could be
unwound, this should be considered prior
to any relevant CGT event.
Restructure at an age
approaching 55
As is widely understood, when the
retirement concession is utilised and the
relevant stakeholder is under the age of 55
at the time when the tax return for the gain
year is lodged, then that stakeholder must
contribute the gain into a superannuation
fund.
What is often overlooked is the use of the
replacement asset concession to defer the
time at which the retirement concession is
utilised.
Consider a client who just turned 52 on
14 February 2014 and who is considering
a restructure of their business by way of
sale to a company. A gross capital gain of
$800,000 will be derived if the business is
transferred on that day.
The business could be sold on that day.
The gain would be reduced to $200,000
after application of the CGT discount and
the active asset reduction. The tax return
for the 2014 year is due on 15 May 2015.
At that time the client will be 53.
The trust could choose that the
replacement asset roll-over in Subdiv152-E
when it prepares its 2014 return. When
the trust had not acquired an eligible
replacement asset by 14 February 2016,
it will trigger CGT event J5. The capital
gain of $200,000 will re-emerge. The trust
can then apply the retirement concession
(provided it makes the appropriate
distributions to ensure the client is a
stakeholder). The relevant return for the
trust for 2016 will be due on 15 May 2017.
At that point in time, the client will be 55.
As a result, there will be no requirement for
a contribution into superannuation.
This strategy may assist in effectively
restructuring with no tax impost and
no cashflow drain of a superannuation
contribution.
15-year exemption and restructuring
It is important to note that any sale or
restructure will constitute a break in the
ownership period for the purposes of the
15-year exemption.
The ATO confirmed this view in the National
Tax Liaison Group meeting of 27 November
2002. A CGT roll-over of an asset will
constitute a break in the 15-year
ownership period.
FEATURE
Combining multiple operating
Diagram 4
entities
There are times when a client accumulates
different standalone structures that SH1 and SH2 own 50% each of all companies
conduct different businesses. As these SH1 SH2 SH1 SH2
businesses grow and intermingle, clients
often find that the structure is unwieldy and
cost inefficient.
Coy A Coy B
Consider the structure in diagram 4.
The shareholders have approached you
to determine if there is a way in which the SH1 SH2
structures can be streamlined due to the
inefficiencies of the current structure
Coy C
A solution could be to utilise roll-over under
Subdiv124-G to achieve the outcome in
diagram 5.
The fact that Subdiv124-G roll-over is Diagram 5
available for this type of restructure was
confirmed by a 2005 addendum to TR SH1 SH2
97/18. Prior to this addendum, the ATO
had considered that a Subdiv124-G
roll-over could only ever involve the
interposition of a holding company New Coy
between the shareholders of a single
company and that company. However in
the addendum, the ATO confirmed that
their current interpretation of the wording Coy A Coy B Coy C
in the subdivision included the interposition
of a holding company over several sister
companies, provided the shareholding in
the sister companies are the same. Restructuring for a sale
It is essential that the market value of There is often a requirement to consider
the shares issued as consideration for a restructure in the lead up to a sale or
each separate tranche is equal to the equity injection.
respective market value of each tranche. This is less likely when the business
This is required to meet the stringent ratios or asset being sold is owned by a
required to be met to obtain the roll-over. discretionary trust. Obviously the
transaction will inevitably be an asset
Where this type of restructure is being
rather than an entity sale.
considered and the shareholders are
Where the business is operated through
not the same as between the various
a company, then restructuring is often
companies, then a Subdiv124-G roll-over
required.
is not available (as outlined above). In
these cases, the only roll-over potentially Consider a trading business that has been
available is Subdiv124-M ITAA97 quite profitable. Your clients own the shares
scrip-for-scrip roll-over. through a discretionary trust. You have
Extreme caution needs to be taken when calculated that there would be a significant
using scrip-for-scrip roll-over and then CGT saving if a purchaser was willing to
forming a tax consolidated group. The purchase shares in the trading company.
same outcome arises that was analysed The client has identified a purchaser who
in Tax consolidation issues earlier in is somewhat interested in acquiring the
this article. The outcomes of the allocable shares. The only reservations they have
cost setting process under a Subdiv122-A relate to the trading risks of the existing
roll-over is similar to the outcomes under operating structure. You propose the
scrip-for-scrip roll-over where there is a following restructure.
significant shareholder, which is generally A new holding company is formed and
the case for a closely held SME group. roll-over relief under Subdiv124-G is used.
TAXATIONINAUSTRALIA | VOL 48(9) 507
 FEATURE
A tax consolidated group is formed. The
business is transferred to the new holding
company. You would need to seek advice
on whether the exemption for duty under
ss 406 and 407 of the Duties Act 2001 (Qld)
would be available.
The purchaser can then acquire the
shares in the new holding company. The
old subsidiary can then be liquidated in a
sensible fashion.
The author has simplified this process for
ease of explanation. Nevertheless, it is a
useful tool to restructure for this type of
transaction.
Appendix I glossary of
roll-overs
There are several important CGT roll-
overs that assist greatly in restructuring
that are referred to in this article. There
are many excellent Tax Institute articles
that have addressed the mechanics and
conditions that must be met to qualify for
the respective roll-overs. The author has
explained what he regards as the important
ones below and attempted in plain English
to distil the relevant conditions and logic of
the roll-overs.
The important roll-overs that have been
referred to in the above articles are:
Subdiv122- A Roll-over by an
individual/trust to a wholly-owned
company;
Subdiv124-G interposition of a
holding company; and
Subdiv124-M scrip-for-scrip roll- sometimes referred to as a top-hat
over.
Subdivision 122-A individual/trust
to company roll-over
This roll-over should be the most familiar of
the roll-overs discussed here. This roll-over
allows the tax efficient transfer of an asset
or all of the assets of a business owned by
an individual or trust to a company.
The end result of the roll-over is that the
individual or trust must wholly own the
shares in the company immediately after
the transfer.
The only consideration that is allowed for
the transfer is non-redeemable shares
in the company. There is actually no
requirement for shares to be issued. All
that is required is that where shares are
issued, the market value of the shares must
be equal to the market value of the asset
transferred.
Certain assets of a business are precluded
from the roll-over including trading stock
508 TAXATIONINAUSTRALIA | APRIL 2014
and depreciable assets. The transfer of
these assets can still occur as part of the
transaction but the tax consequences
of those particular transfers should be
considered. Where depreciable plant
is transferred, no sale occurs for tax
purposes by virtue of s40-340 ITAA97. The
company inherits the depreciable profile for
the assets from the individual or trust.
The cost base for the shares issued as part
of the roll-over transaction is the sum of
the cost base of the assets transferred plus
the market value of the precluded assets
transferred.
The company inherits the cost base of
the CGT assets transferred as part of the
roll-over.
Where the shares are sold within 12
months, the CGT discount is available by
virtue of ss 115-30 and 115-34 ITAA97.
The sale of the assets to the company
constitutes a break in the 15-year
ownership period as required by
Subdiv152-B ITAA97 (15-year exemption).
Subdivision 124-G interposition of
holding company
This roll-over is perhaps one of the most
useful available roll-overs, yet seldom used
or understood.
involves the sale of shares in a company
In essence, the roll-over allows the
shareholders (must be more than one
shareholder) of a company to interpose
end up owning 80% or more of the target
another company between them and
the original company. This process is
restructure.
The shareholders and the interests they
own in the original company and then the
holding company must be maintained
from the time prior to the restructure to
immediately afterwards.
The number and value of shares issued
must equal the interests held in the original
company. The formulas are quite stringent.
The mechanics of the roll-over are outlined
in TR 97/18. In a 2005 addendum to that
ruling, the ATO confirmed that the roll-over
may be used to interpose a company over
multiple companies provided all companies
are owned by the same entities in the same
percentages. Prior to 2005, the ATO held
the view that the wording of the provision
limited the roll-over to a singular company.
In addition, the ATO confirmed that
the new holding company has to be a
shelf company, although not expressly
mentioned in the statute. For the provision
to work, the ATO consider that the holding
company cannot have any significant
assets or value prior to the roll-over.
The cost base of the shares issued to
the shareholders is equal to the cost
base of the original shares held by that
shareholder.
Importantly, the cost base of the shares
acquired by the holding company is
calculated by reference to the cost base of
the net assets (after allowance for liabilities).
This is a better outcome when compared to
roll-overs under Subdiv122-A. This is a
relevant consideration where a tax
consolidated group is formed after the
restructure as discussed above.
Subdivision 124-M scrip-for-scrip
roll-over
The provisions of Subdiv124-M are hard
work and contain complexities at every
turn. The author does not intend to analyse
them in any great detail as this is outside
the scope of this article. Where you are
considering advising on scrip-for-scrip,
it is important that you work through the
provisions carefully.
In general, the roll-over allows for relief on
the sale of shares when they are sold in
exchange for shares in another company.
The essence of scrip-for-scrip roll-over
in exchange for shares in another
company. The acquiring company must
company. In closely held groups, the
transactions must be on arms-length
terms. The roll-over is limited to the shares
received and does not extend to any cash
or other consideration.
In the SME space, it is vital to appreciate
that the cost base transfer rules in s124-
782 ITAA97 will generally apply. These
rules are targeted at closely held groups
using the roll-over. The effect of the cost
base transfer rules can result in some
significantly adverse tax outcomes as
outlined elsewhere in this article.
Stephen Holmes, CTA
Partner
WMS Chartered Accountants
This article was originally presented at The Tax Institutes
SME Structures and Restructures Seminar held in
Brisbane on 27 February 2014.