Small Business Restructure Roll-Over: In Need of Its Own Restructure?

The choice of business structure is a difficult decision for small businesses, especially if they do not seek full professional advice. Even if professional advice on business structures is sought at the inception stage, there may be no ‘perfect’ structure, given that each structure has certain advantages and disadvantages, and circumstances can and will alter.

Indeed, due to changing circumstances, what is the appropriate business structure should not be a one-off consideration, and at various points it may be important to review the business structure adopted and, consequently, to change the business structure.

Despite the possible benefits of restructuring, it can be a costly and a complex process. The transfer of business assets from the original business structure to the new one may give rise to significant tax liabilities, both state and federal. Such transaction costs may be seen as too prohibitive for, or may otherwise detract from, the restructure of a business.

The Australian Government has tried to provide some tax relief through the small business restructure rollover (SBRR) relief in subdivision 328-G of the Income Tax Assessment Act 1997 (ITAA 97). This provision has operated from 1 July 2016 and, where applicable, the SBRR allows small businesses to transfer active assets from one entity to another entity without incurring an income tax liability.

The purpose of such relief is to allow small business to adopt appropriate structures, reduce risk, reduce complexity, promote growth, provide tax neutral consequences, and assist cashflow. However, there are concerns that these provisions are less than ideal.

Is the SBRR effective in helping small businesses to restructure?

Our recent study has sought to assess the actual and perceived effectiveness of the SBRR by analysing submissions lodged to the Board of Taxation’s review of small business tax concessions, the Board’s 2019 report from the review, as well as the findings of a small pilot study with professional advisors.

From the overall analysis of the SBRR, in terms of the consistency between the Government’s stated policy objectives and the SBRR law, advisors generally perceive the SBRR as complex and limited in scope. In particular, the SBRR restricts the ability for small business to adopt an appropriate structure, which is made more problematic due to the ATO’s law companion ruling LCR 2016/3. Details on some of these limitations, and the law companion ruling are discussed below.

The findings indicate that there is a perception that most small and medium enterprises (SMEs) do not seek professional advice when commencing their business, and many of them have not adopted an appropriate structure. These findings support the need for some roll-over relief to allow businesses to restructure to a more appropriate structure.

The findings also indicate a low level of take-up of the SBRR, as advisors can be reluctant to use the roll-over for their clients. Some of the reasons provided for not using this roll-over were the lack of awareness by advisors and businesses, the complexity of the rules, the non-application for business succession planning, and the problematic application of the safe harbour rule, which made it unsafe to rely on.

In regard to an appropriate business structure that enhances business efficiency, results from the interviews were consistent with the Board’s observations, which suggest that the SBRR is unlikely to apply to a restructure involving a sole trader transferring to a company owned by a discretionary trust. Such a structure is considered by some advisors to be the optimal business structure from both a tax and commercial perspective. The difficulty for the SBRR to allow for such a restructure, could potentially inhibit business growth, which is contrary to one of the Government’s stated objectives for the SBRR.

One of the objectives of the SBRR was to reduce risk. But it appears from the results that the approach taken by the ATO, particularly in terms of the potential of the general anti-avoidance rule in Part IVA of the Income Tax Assessment Act 1936 (ITAA 36) to apply to restructures that the ATO considers not to be genuine, even if the safe harbour rule is met, is seen as increasing risk rather than reducing it. This and other uncertainties with certain aspects of the law may dissuade deserving cases, as the risk is seen as too high. Furthermore, part of the preference for the company owned by a discretionary trust structure is for asset protection and reduced risk, and the likely non-application of the SBRR for this structure is problematic.

It is unlikely that the SBRR reduces complexity, especially in relation to accessing the provisions. The associated complexity concerns the practical application of the SBRR, the high compliance costs in obtaining professional advice to use the provision, and the technical limitations and restriction on its use. It appears that the only potential way to obtain certainty is to apply for a private ruling from the ATO, but this then adds to the cost.

The purpose of the SBRR is to help business to ‘continue to develop and grow’. Succession planning is an important factor in assisting the business to develop and potentially grow from the current owner to either the next generation or a third party. However, the SBRR does not apply to restructures involving ‘succession planning’, which are currently not considered to be a genuine restructure.

Improving the SBRR relief

To enhance how the SBRR relief operates, our study also provided recommendations that target the eligibility criteria and address the technical limitations of the roll-over.

An apparent area of concern is the lack of awareness by SME advisors and small businesses of the SBRR itself. For advisors, it is critical that they keep updated on changes to legislation. Professional bodies, such as CPA Australia, Chartered Accountants Australia & New Zealand (CA ANZ) and the Tax Institute, need to promote educational seminars and articles about it. Advisors may, as part of the annual checklist, need to raise the SBRR with clients in terms of considering the appropriateness of their business structure.

A submission to the 2019 small business tax concessions review recommends that the ultimate economic ownership tracing rule for discretionary trusts in section 328- 440 of the ITAA 97 needs to be amended due to a defect in its current wording; as the tracing rule does not allow for a multi-level roll-over from an individual to a company owned by a discretionary trust. It is argued in the submission that this was incongruous to preventing an individual from rolling over to a commonly used combination of structures—a company owned by a discretionary trust that offers limited liability and access to the lower company tax rate, with the discretionary trust as a shareholder offering an extra layer of asset protection.

In order to promote and assist small businesses to adopt a structure that is optimal to conducting their commercial activities, we recommend that the scope of SBRR relief be extended to restructuring that involves trading companies owned by discretionary trusts.

Uncertainty about whether the SBRR is technically available to a proposed restructure is of concern, given the amount of potential tax involved, and, in turn, the penalties and interest if it is incorrectly applied. It is evident that this has been addressed via the application of private rulings from the ATO, and while such private rulings are useful, they are indicative of the complexity and uncertainty of the SBRR. It would be worthwhile to provide more certainty to the provisions.

In order to facilitate the transfer-on of a mature business, succession planning should be recognised as a genuine restructure, whether the transfer is to the next generation or to third parties. This is warranted, particularly if the intention is to continue the business, otherwise many mature businesses may not be able to be effectively transferred to enable the business to continue successfully.

Small business restructure matters for the economy

If implemented, these recommendations will provide greater flexibility, optimism, and certainty for small business owners wishing to restructure to an optimal structure. The choice of business structure is important, and it is of concern that many small businesses may not have chosen the most appropriate structure initially.

While the Government should be commended for attempts to address this by providing some roll-over relief with the SBRR, it appears that the measures are yet to fully realise their potential due to some deficiencies. The ability to provide restructure relief will reduce the transaction costs in adopting a more appropriate business structure, which is beneficial for businesses and, arguably, for the economy overall.

 

For the full article see:

Barbara Trad, Brett Freudenberg and John Minas (2022), Small Business Restructure Roll-over: In need of its own restructure? Australian Tax Forum, 37(1): 105 – 145.