5 Ways to Restructure from a Discretionary Trust to a Company

Why Operate a Business in a Trust?

Following on from the article Is It Time for a Company Structure? there are a number of reasons to operate a business from a company structure over a discretionary trust structure. 

There are many options available to advisors and clients to move their business operations to a company structure in a tax efficient manner. This article will address five common ways that the restructure can occur.

Subdivision 122A Rollover?

The subdivision 122A Rollover, can be considered the original rollover. This rollover can apply where a trustee disposes of a CGT asset, or all assets of the business to a company in which it owns all of the shares.

If the parties choose to use this rollover, any capital gain made on the disposal of the asset (or assets) is disregarded until an eventual sale of the assets.

The requirements to access the subdivision 122A are fairly non-controversial. These include:

1. the market value of the shares must be substantially similar to the market value of the assets;
2. the transferee company cannot pay consideration for the assets (unless it is assuming a liability in connection with the assets);
3. the shares must be non-redeemable shares; 
4. the company cannot be exempt from tax;
5. both parties must be tax residents (or the asset is taxable Australian property); and
6. finally, the trustee must own all shares in the company just after the rollover.

These can be satisfied easily in most restructures undertaken.

The main downsides to using a subdivision 122A rollover to move business operations to a company is that it does not apply to trading stock, depreciating assets, an interest in the copyright of a film or a registered emissions unit.

However, whilst the rollover does not apply to depreciating assets rollover relief can apply to depreciating assets when used in conjunction with a subdivision 122A rollover.

Subdivision 122A can also apply to real property, so if there is real property in a trust (business premises, residential or otherwise), the rollover can be used to move this property without triggering any CGT consequences.

Where a person may have a trading stock heavy business, they may wish to consider using the 328G rollover (also known as the Small Business Restructure Rollover) to move their operations to avoid any adverse consequences on the disposal of the trading stock.

328G Rollover (Small Business Restructure) 

This restructure must involve a small business (less than $10 million in aggregated turnover) or entities that are connected or affiliated with the business.

Unlike the subdivision 122A rollover (or utilising the small business CGT concessions), this rollover allows the direct rollover of non-CGT assets, including trading stock, depreciating assets and revenue assets.

The eligibility requirements are far more onerous than subdivision 122A and include outside of the turnover test:

1. that there must be no change in the ultimate economic ownership of the transferred assets;
2. the assets must be active assets (i.e., business assets); and
3. the restructure must be a genuine restructure.

There are a few traps to be aware of when utilising a 328G rollover to move from a trust to company structure and consideration must be given to ensuring family trust elections are in place and serious consideration to satisfying the “genuine restructure” requirements.

The legislation does provide a “safe harbour” approach in relation to the restructure being a genuine restructure. In order to be eligible for safe harbour there must be no change in ultimate economic ownership of the assets being transferred, the assets continue to be active assets and the assets are not being used for private purposes for a three-year period following the restructure.

Therefore, if the restructure was a preliminary step to facilitate the sale of the business assets, extract wealth, bring on new equity owners, consideration should be given to utilising one of the other options discussed in this article to restructure.

Small Business Capital Gains Tax Concessions

Where an entity is a small business entity (turnover of less than $2 million) or satisfies the maximum net asset value test (total assets of the company and related entities less than $6 million), the small business concessions may be used to mitigate and minimise the tax consequences when restructuring.

There are a number of other requirements to meet when assessing eligibility for the small business CGT concessions, including that the assets are an active asset (fairly simple when transferring the whole business), and the significant individual test is met.

 The three main concessions used are:

1. 15-year exemption;
2. 50% Active Asset Discount; and
3. Small Business Retirement Exemption.

Each of the above concessions (or exemptions) has their own requirements to utilise. However, with careful planning and consideration of circumstances, utilising the small business CGT concessions can restructure the business operations without CGT consequences.

There can be other useful benefits to utilising the small business CGT concessions when restructuring. These include, providing a market value cost base for the shares, allowing for the share ownership to be changed (i.e., from individuals to trusts, multiple trusts for succession purposes) and the repayment of division 7A loans.

However, unlike the subdivision 122A and 328G rollovers there is no mirrored rollover for depreciating assets and therefore the balancing adjustment consequences of transferring plant and equipment would need to be considered. Similarly, there is no rollover when transferring trading stock to the new company. Where these tax consequences may be prohibitive, there may be alternate mechanisms that can be used to mitigate these consequences.

Replacement Asset Rollover

The small business CGT concessions also offer a replacement asset rollover, if the basic conditions are satisfied. This rollover allows a person to postpone the taxation of a capital gain for a two-year period in which in that time they must acquire a “replacement asset”.

This rollover effectively allows a business owner to transfer its operations to a company and acquire the shares in the company as the” replacement asset”. The replacement asset must also be an active asset and cannot just be a CGT asset.

Again, there is no such relief for depreciating assets or trading stock.

A trustee may wish to consider utilising the replacement asset rollover in circumstances where they would like to retain use of the small business retirement exemption for potential future sales.

Double Shuffle

The double shuffle is a restructure that is predominately used in trading stock and plant and equipment heavy businesses that hold no goodwill (for example, primary production enterprises).

There are specific rollovers in the tax legislation in relation to depreciating assets and trading stock that allow the deferment of any tax consequences when a partner enters or leaves a partnership.

Provided there is no goodwill in the business, the restructure can occur over a number of years, without any transfer duty or income tax consequences.

This restructure mechanism can also be useful when considering the succession of family-owned enterprises (again usually primary production), to bring new family members into the business.

Transfer Duty

Depending on the state or territory the business is operated, transfer duty needs to be considered when transferring or disposing of business assets.

New South Wales and Victoria do not apply transfer duty on the transfer of business assets (excluding real property). However, Queensland and Western Australia still levy transfer duty on the transfer of business assets.

Queensland in 2020 implemented a small business restructure duty exemption when restructuring (amongst other things) from a discretionary trust to a company. In order to be eligible for the exemption, the following conditions must be met:

1. the assets being transferred have an unencumbered value of not more than $10 million;
2. are being transferred from an entity with a turnover of not more than $5 million;
3. the assets are transferred to a company that has never traded; and
4. the ownership structure remains the same before and after the restructure. 

The Queensland small business restructure exemption can be used in conjunction with the restructures discussed above to negate any transfer duty consequences on the acquisition of the business assets. 

Where the business does not meet the requirements for the exemption, there may be alternate options available to mitigate any transfer duty consequences depending on the circumstances.

Conclusion

The restructure of a discretionary trust to a company can be achieved using a number of different rollovers and/or concessions to suit all businesses size, needs and asset base. Depending on the value of the assets being transferred (and the state), there ought to be no transfer duty payable on the restructure.

Therefore, a trustee can restructure from a trust to a company and gain the benefits of operating in a company structure without incurring any tax or duty consequences.

Our next article will discuss how a restructure from a unit trust to a company can be achieved in a tax effective manner.