2021 Local Tax Club Series - How to approach business structures and restructures in 2021
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2021 Local Tax Club Series How to approach business structures and restructures in 2021 Victorian Division Presented on 18 March 2021 at Leonda By The Yarra, Melbourne Presented on 19 March 2021 at Rydges, Geelong Written by: Rob Warnock, CTA Presented by: Rob Warnock, CTA Harwood Andrews © Rob Warnock 2021 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.
Rob Warnock 2021 How to approach business structures and restructures in 2021
CONTENTS
1 INTRODUCTION ............................................................................................................................. 4
2 CHECKLIST..................................................................................................................................... 6
2.1 Step 1: The Client ..................................................................................................................... 6
2.1.1 Client Details: .................................................................................................................... 6
2.1.2 What Comprises the Asset Pool of the Business?............................................................ 6
2.1.3 What are the Liabilities of the Business? .......................................................................... 6
2.1.4 Documentation in Place .................................................................................................... 7
2.2 Step 2: The Process ................................................................................................................. 7
2.2.1 Set the Scope .................................................................................................................... 7
2.2.2 Identifying the Issues Part 1 – Tax Efficiency ................................................................... 7
2.2.3 Identifying the Issues Part 2 – Asset Protection ............................................................... 8
2.2.4 Identifying the Issues Part 3 – Succession Planning ........................................................ 8
2.3 Step 3: The Restructure ........................................................................................................... 9
2.3.1 Consider Options ............................................................................................................... 9
2.3.2 Prepare Documentation .................................................................................................... 9
2.3.3 Execute and Finalise ....................................................................................................... 10
3 IS THE STRUCTURE TAX EFFCIENT? ....................................................................................... 11
3.1 Overview ................................................................................................................................. 11
3.2 Tax treatment of different business structures ....................................................................... 11
3.2.1 Partnership ...................................................................................................................... 12
3.2.2 Company ......................................................................................................................... 12
3.2.3 Discretionary Trust .......................................................................................................... 13
3.3 Key tax aspects of structures ................................................................................................. 14
3.3.1 Division 7A ....................................................................................................................... 14
3.3.2 Section 100A ................................................................................................................... 15
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3.4 Tax factors to consider when restructuring ............................................................................ 16
3.4.1 Can you access the small Business CGT concessions on the restructure? .................. 16
3.4.2 Can you access roll-over reliefs on the restructure?....................................................... 17
4 ASSET PROTECTION .................................................................................................................. 19
4.1 Overview ................................................................................................................................. 19
4.2 Review directorships and shareholding .................................................................................. 20
4.3 Loan and security strategies ................................................................................................... 21
4.3.1 Individual and gift, loan and mortgage strategy .............................................................. 21
4.3.2 Paying profits out of a trading company .......................................................................... 23
4.3.3 Discretionary trust............................................................................................................ 24
4.3.4 What happened in Fischer v Nemeske ........................................................................... 26
4.3.5 Conclusion - extracting capital from trusts ...................................................................... 28
5 SUCCESSION PLANNING ........................................................................................................... 30
5.1 What is Succession Planning? ............................................................................................... 30
5.2 Constituent Documents .......................................................................................................... 31
5.3 Useful Supporting Documents ................................................................................................ 31
5.4 Trusts ...................................................................................................................................... 31
5.4.1 Approaching Succession Planning of Trusts .................................................................. 32
5.4.2 Step 1 – Who manages and controls the Trust? ............................................................. 33
5.4.3 Step 2 – Who are the beneficiaries? ............................................................................... 34
5.4.4 Step 3 – Do any parties have equitable entitlements in the fund of the trust? ............... 35
5.5 Company................................................................................................................................. 36
5.5.1 Buy-Sell Agreement ........................................................................................................ 36
5.5.2 Employee Share Schemes .............................................................................................. 39
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1 INTRODUCTION
COVID-19 has taught us to expect the unexpected. Australians are generally positive people with
a ‘she’ll be right’ attitude to all aspects of life including in business. However, COVID-19 has caused
many people to question that attitude and as a result many are now understanding the importance
of planning for the worst-case scenario.
The impact of COVID-19 has been felt across businesses in many different ways. For example:
• Where there has been a significant decrease in turnover this may have led to a significant
reduction of profits in the business or the business making a loss;
• By contrast some businesses may have thrived in the period as demand for their goods and/or
services have increased or a forced pivot to their offering has led to such a demand and as
such they have made additional profits;
• Reality for many businesses will have been financial difficulty and needing to deal with creditors.
For many owners this may have led to the business closing or being sold with the associated
ramifications including losing personal assets; and
• Many owners have reflected on their personal needs and find themselves wanting a sea or tree
change and so wanting to sell the business or pass it onto their children.
Whatever the impact COVID-19 has on our clients, many are now looking to review their structure
generally. This review will often concentrate on three main areas:
• The tax efficiency of the structure;
• How well are assets protected; and
• Can the business be passed to the next generation easily and tax effectively.
Any review must also keep in mind what the key issues will likely be in the short term as well as the
long term. In 2021 three key tax issues are likely to be the ongoing reform of Division 7A, how the ATO
applies (or does not apply) section 100A and the ATO’s compliance approach in relation to the allocation
of professional firm profits.1 Given the uncertainty of reform in each of these three areas it is not possible
to consider them in detail in this paper other than to say that taxpayers need to keep an eye on
developments and possibly make changes to their business structure depending on what occurs.
Whilst there are many different types of business structures, for small and medium businesses a
company or trust is generally preferred and so most of the discussion in this paper and the related
presentation will relate to those two types of entities.
1 Refer ATO Draft Practical Compliance Guideline PCG 2021/D2.
© Rob Warnock 2021 4Rob Warnock 2021 How to approach business structures and restructures in 2021
From the onset, as part of developing an efficient structure it is important to understand, and convey to
clients, that:
• It is a balancing act. There is no magic formula that can tell an advisor the exact measures
to be taken within a structure to ensure that it is as efficient and as effective as possible for
clients. Rather it is a balancing act where advisors weigh up what the client is seeking to achieve
against the cost of such goals. Advisors need to familiarise themselves with the many important
aspects of structures in order to get the balance right. This includes understanding the
structure’s current and/or proposed tax efficiency, asset protection features and succession
planning mechanisms.
• There is no “one size fits all”. Unlike a standard trust deed or untailored constitution, a
business structure or restructure and the related documents cannot simply be taken off the
shelf and the blanks filled in. For many business owners this may be a frustrating reality that
leads them to move their structure planning into the “too hard basket”. However, as advisors
we need to communicate to our clients the importance of addressing these issues sooner rather
than later (before it’s too late). It may be that the process is split into parts (ensuring all are of
course attended to in due course) in order to make it more manageable from a time and cost
perspective.
• The focus needs to be on both now and in the future. You may be approached by clients to
consider their structure and how efficient it is right now and whether a restructure should be
undertaken. However, clients may sometimes forget the future and importantly what
mechanisms are within the structure that allow for the succession of the business. Advisors
need to look at the requirements holistically - what is needed now and what is wanted in the
future.
In this Paper we start with a “Structuring Checklist”. This list is not exhaustive (advisors should add
to it and personalise it for their own needs) but is intended to provide a framework for advisors to
approach business structures and restructures. We will then address the key aspects of the
process in more detail.
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2 CHECKLIST
2.1 Step 1: The Client
2.1.1 Client Details:
☐ 1. Understand who your client is and the key persons in their business and succession plan.
☐ 2. Consider:
☐ a. Full name and address
☐ b. Spouse details
☐ c. Details of children (including children of partners)
☐ d. Other dependants
2.1.2 What Comprises the Asset Pool of the Business?
☐ 1. Consider, and seek full details of assets that comprise the asset pool of the business.
☐ 2. Real estate or physical assets?
☐ 3. Bank accounts.?
☐ 4. Investments?
☐ 5. Digital Assets?
☐ a. How are they accessed?
☐ b. Where are they stored?
☐ c. Is two-factor authentication enabled?
☐ 6. Insurance policies?
☐ 7. Interests in a trust or company?
☐ 8. UPEs or loans?
☐ 9. Overseas assets?
2.1.3 What are the Liabilities of the Business?
☐ 1. Consider, and seek full details of liabilities of the business.
☐ 2. Consider:
☐ a. UPEs or loans owed;
☐ b. Tax liabilities; and
☐ c. Employee entitlements.
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2.1.4 Documentation in Place
☐ 1. Personal:
☐ a. Will
☐ b. Executor’s details
☐ c. Powers of Attorney
☐ d. Binding financial agreements
☐ e. Statement of Wishes
☐ 2. Business
☐ f. Constitution
☐ g. Shareholders’ Agreement
☐ h. Trust Deed
☐ i. Unitholders’ Agreement
j. Business Succession Agreement
k. Employment Agreements;
l. Finance Agreements
m. Supply Agreements
2.2 Step 2: The Process
2.2.1 Set the Scope
1. What are the reasons behind the review of the structure? Is there any issue they are intending to solve
or is the business going in a new direction?
☐ 2. When is the restructure to be achieved by? Is this feasible?
☐ 3. What are the objectives?
2.2.2 Identifying the Issues Part 1 – Tax Efficiency
Where the business is operated via a discretionary trust consider:
☐ 1. What beneficiaries receive distributions and what are their tax rates?
☐ 2. Are distributions actually paid to the beneficiaries?
☐ 3. Are distributions actually paid to the beneficiaries?
☐ 4. Are there outstanding UPE’s?
☐ 5. Do any beneficiaries not receive the benefit of the distribution such that section 100A could be an issue?
☐ 6. Are there any Division 7A issues?
☐ 7. Does the trust deed permit income streaming?
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☐ 8. Would the trust be eligible for the small business CGT concessions if it sold its business?
☐ 9. Is a Family Trust Election in place? If so, who is the test individual?
Where the business is operated via a company consider:
☐ 1. Who are the shareholders and what are their tax rates?
☐ 2. Is the company a base rate entity?
☐ 3. What classes of shares does each shareholder hold?
☐ 4. Are there any Division 7A issues?
☐ 5. Can flexibility be obtained with the payment of dividends?
☐ 6. Is an Interposed Entity Election in place? If so, who is the test individual?
2.2.3 Identifying the Issues Part 2 – Asset Protection
Matters to be considered include:
☐ 1. Who is at risk? The business entity? It’s directors? It’s owners? It’s employees?
☐ 2. From what are they at risk? Suppliers and/or customers? Clients suing for professional negligence?
Financiers?
☐ 3. What protection does the structure currently provide? Are the business’s assets held in the trading
entity?
☐ 4. Are the owner’s personal assets at risk if the business gets into financial difficulty?
☐ 5. Is the business and its assets at risk if an owner gets into financial difficulty?
☐ 6. What liabilities (e.g. loans and UPEs) does the business entity have to associated parties?
☐ 7. In the case of a trust what are the implications if the appointor and/or guardian dies, becomes
incapacitated or is made bankrupt?
☐ 8. In the case of a company what are the implications if a director dies, becomes incapacitated or is made
bankrupt? Is there only one director?
☐ 9. Are profits being accumulated in the trading entity?
☐ 10. What insurances does the business have and is the cover sufficient?
☐ 11. Are loans from related parties secured?
2.2.4 Identifying the Issues Part 3 – Succession Planning
☐ 1. Firstly, understand who the successor is to be. Is it to be a family member or unrelated parties? Do they
work in the business?
Where the business is operated via a trust consider:
☐ 1. Is there a unitholder agreement in place that deals with the exit of parties on voluntary bases?
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☐ 2. Who is the appointor (and/or guardian) of the trust and are there succession clauses in place for that
role?
☐ 3. Who is the trustee of the trust and are there succession clauses in place for that role?
☐ 4. Are those who are intended to be beneficiaries clearly accounted for and not unintentionally excluded?
☐ 5. Do any parties under the trust deed hold a veto right?
☐ 6. Do variations need to be made to the trust deed to facilitate the succession plan?
Where the business is operated via a company consider:
☐ 1. What does the company constitution say about exits from the business?
☐ 2. Is there a shareholder agreement in place that deals with the exit of parties on voluntary bases?
☐ 3. Is there a buy-sell agreement in place for the exit of business participants?
☐ 4. In the absence of these documents how will a participant’s exit occur and be funded?
☐ 5. Do any parties under the company documents hold a veto right?
☐ 6. Are there any employee share schemes (ESS) in place, or to be put in place? Have appropriate
measures been made in the shareholders agreement if the ESS shares are to have voting rights.
2.3 Step 3: The Restructure
2.3.1 Consider Options
It is a balancing act. Consider:
☐ 1. Potential tax bill (are rollover reliefs or tax concessions available?)
☐ 2. How well assets are protected and will be protected after the restructure
☐ 3. The mechanisms in place for succession
2.3.2 Prepare Documentation
Documentation across all areas should clearly state the obligations of the parties, the rights of the
parties and how parties will enter and exit the business. Consider whether the following documents or
updates to these documents are required:
1. Company constitution;
☐ 2. Shareholders’ Agreement;
☐ 3. Unitholders’ Agreement;
☐ 4. Trust Deed;
☐ 5. Deeds of Variation;
☐ 6. Statement of Wishes
☐ 7. Will
☐ 8. Power of Attorney
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☐ 9. Binding Death Nomination
☐ 10. Other
2.3.3 Execute and Finalise
Once documentation is prepared ensure it is correctly executed and attend to establishing or dissolving
entities. Tasks may include:
☐ 1. Applying for new TFNs, ABNs and/or ACNs.
☐ 2. Register for relevant taxes at state and federal levels.
☐ 3. Execute agreements or deeds.
4. Update contracts and agreements if required and notify suppliers and customers where needed.
☐ 5. Notify ASIC of changes to the structure including changes to shareholdings and directorships. Ensure
the correct ASIC forms are used for this purpose.
☐ 6. Notify the ATO of changes, whether by formal notification or via the manner in which tax returns are
lodged.
☐ 7. Lodge final returns for entities being would up and attend to deregistration of those entities.
☐ 8. Execute vesting deed and associated resolutions, ensuring assets are distributed in accordance with
the terms.
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3 IS THE STRUCTURE TAX EFFCIENT?
3.1 Overview
Advising on business structuring and restructuring is a balancing act. Client’s objectives are paramount
and competing interests need to be balanced. This part of the paper provides an overview of the tax
implications affecting the choice of business structure and highlights some of the important factors to
consider when reviewing the current business structure and considering the need for a restructure. In
particular we will consider:
• The ability to access small business capital gains tax concessions;
▪ The use of roll-over reliefs to undertake tax efficient restructures;
▪ The application of Division 7A; and
▪ The application of Section 100A.
3.2 Tax treatment of different business structures
Below is a brief comparison of the tax rates of different business structures for the 2020-2021 income
tax year
Individual Partnership Company Trust
0 - $18,200: Nil Each partner pays tax Base rate entities: Each beneficiary pays tax
at the partner’s tax 26% at the beneficiary’s tax
$18,201 - $45,000: 19 rate. rate.
cents for each $1 over Otherwise: 30%
$18,200
Note: tax rate for
$45,001 - $120,000: base rate entities
$5,092 plus 32.5 cents for will reduce to 25%
each $1 over $45,000 in 2021-22.
$120,001 - $180,000:
$29,467 plus 37 cents for
each $1 over $120,000
$180,001 and over:
$51,667 plus 45 cents for
each $1 over $180,000
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3.2.1 Partnership
A partnership provides a simple way of running a business operation. There are several advantages of
using this structure including:
▪ Income splitting: partners can agree on the basis for the allocation of partnership profits and
losses provided the allocation is undertaken at the start of the income year.
▪ No tax at the partnership level: a partnership is not a taxable entity. The net profit or loss of the
partnership is included in each partners’ tax return on a ‘flow through’ basis. Each partner
reports their share of profits and losses and are taxed at their individual marginal rate (in the
case of individuals).
▪ Direct access to partnership losses: the partnership losses can flow through to each partner
and be used to offset against the partner’s other assessable income. When reviewing a
business structure in light of COVID-19 the ability for tax losses to be utilised by the partners
can be a significant advantage.
▪ CGT discounts: individual and trust partners can access the CGT discount as they hold an
underlying interest in each partnership asset. 2
▪ Distribution flexibility: a partnership has the ability to return capital easily.
Disadvantages include:
▪ Unlimited liability: partners are jointly and severally liable. A partner’s personal assets are not
protected. When reviewing a partnership business structure serious consideration should be
given to the exposure of each partner’s assets. If they are at risk consideration should be given
to restructuring to a company or trust.
▪ If it is a partnership of individuals there is little scope for income splitting.
▪ Exit flexibility: there are CGT consequences when there is a change of ownership interest (i.e.
when a new partner is admitted to the partnership or an existing partner exits the partnership).
3.2.2 Company
Compared to a partnership structure, a company is a separate legal entity which ensures that the
shareholders’ personal assets are protected. Other advantages of using a company structure include:
▪ Lower tax rate: using a company structure caps the tax at the corporate tax rate (usually lower
than individual marginal tax rate). The rate has been progressively lowered throughout the
decades. Base rate entities are taxed at 26% in 2020-21 and at 25% in 2021-22.
▪ Working capital: profits can be retained in the company to fund ongoing working capital
requirements without it needing to be paid out to the shareholders. However, if the company
2 Section 106-5 of the ITAA 1997
© Rob Warnock 2021 12Rob Warnock 2021 How to approach business structures and restructures in 2021
gets into financial difficulty the retained earnings will be at risk. This is considered further in Part
3 of this paper.
▪ Exit flexibility: a company gives more flexibility to exit at either the shareholder level or the asset
level whereas discretionary trusts are limited to the asset level.
▪ Deferring the taxing point: a company can control the timing of when dividends are paid to
maximise tax savings at the shareholder level over time.
▪ Utilisation of tax losses: when there is a change in ownership at a company level, a corporate
structure may still allow for the utilisation of the underlying tax losses of the business through
the same business test.
▪ Distribution flexibility: different classes of shares may be used to manage distributions to
different family members although having different classes of shares also has its
disadvantages. A company whose shares are held by discretionary trusts is now a favoured
business structure.3
▪ Acceptability: companies, compared to trusts, seem to be understood by more people and are
more acceptable by financial institutions.
Disadvantages of using a company structure include:
▪ Higher CGT consequences: companies are subject to higher CGT due to the inability to access
the 50% general CGT exemption on the asset at the entity level. However, given that a base
rate entity’s tax rate is now 26% and soon will be 25% this difference is not so much a concern
as it once was.
▪ Division 7A of the ITAA 1936 issues: the attractiveness of companies may be unfavourably
affected by the application of Division 7A. Division 7A is discussed in more detail below.
▪ Distribution of profits: while the tax rate of base rate entities falls the franking of dividends is not
straight forward.
▪ Tax reporting: companies have greater and more complex tax reporting requirements than
partnerships.
3.2.3 Discretionary Trust
Compared to a company structure, a discretionary trust has several advantages including:
▪ Income splitting: a trust is not a taxable entity. The trustee of the trust distributes taxable income
(pre-tax amount) amongst its beneficiaries. Each beneficiary reports their distributions received
and are taxed at their tax rate.
3See Thomas Tulley and Catherine Parkinson ‘Trust versus company: Analysis for the new decade’ TTI 2021 Private Business
Tax Retreat 25-26 February 2021.
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▪ Streaming/distribution flexibility: trusts are able to identify particular classes of income or gains,
to separately distribute different classes of income or gain to one or more beneficiaries to retain
the character of those classes of income in the hands of those beneficiaries.
▪ Ability to flow through capital gain: trusts have an overall advantage in flowing out the capital
gains.
▪ CGT discount: trusts can access the 50% CGT discount.
Disadvantages include:
▪ Working capital: beneficiaries need to be presently entitled to 100% of the income of the trust
each year to avoid the trustee being liable to pay tax at the highest marginal tax rate (currently
45%). This is an issue when the business requires ongoing working capital.
▪ Section 100A of the ITAA 1936: the attractiveness of trusts may be unfavourably affected by
section 100A. Section 100A is discussed further below.
▪ Division 7A: distributions to a company to minimise tax can give rise to Division 7A issues.
▪ Utilisation of tax losses: losses are effectively trapped in the trust as there is no ability to pass
on the benefit of a tax loss to the beneficiaries.
3.3 Key tax aspects of structures
3.3.1 Division 7A
Division 7A prevents private companies from making a tax-free distribution of profits to shareholders or
their associates. Loans, advances and other credits to shareholders and associates are generally
treated as assessable dividends to the extent that there are realised or unrealised profits in the company,
unless specified exclusions apply. The definition of ‘associate’ is very broad, which means Division 7A
can apply to loans to discretionary trusts in the family group. Also, the definition of ‘loan’ is very broad
and can include a trust’s UPE in favour of a company.
As part of the 2016-17 Budget the Government announced targeted amendments to Division 7A. The
Division 7A changes were originally set to apply from 1 July 2019, but the Government deferred this.
Under the proposed changes, a new loan model will apply to Division 7A loans. The maximum term of
the loan will be 10 years. Transitional rules will be introduced to allow taxpayers with existing 7 or 25
year loans to transition to the new 10 year loan model. 4
The proposed interest rate is set to change and will be significantly increased. The proposed
amendments will also remove the concept of distributable surplus. This means a loan from a company
with no distributable surplus will still be subject to Division 7A. Currently, Division 7A limits deemed
dividends to the amount of distributable surplus in the year the deemed dividend arises. Treasury also
suggests that all pre-1997 loans (currently exempt from Division 7A) must be put on complying 10-year
4 See Treasury ‘Consultation Paper – Targeted amendments to the Division 7A integrity rules’, 22 October 2018.
© Rob Warnock 2021 14Rob Warnock 2021 How to approach business structures and restructures in 2021 loan agreement terms to be repaid with the new benchmark interest rate. Businesses may suffer cash flow consequences as a result of the proposed loan repayment rule changes. Although the Division 7A reform has been deferred by the government, it continues to be an area of focus for the ATO. Assistant Treasurer Michael Sukkar announced that the start date for the changes will be to income years commencing on or after the date of royal assent of the enabling legislation. Advisors should be mindful of the potential impacts of the proposed amendments when reviewing and planning clients’ business structures. However, as with all announced changes, until the draft legislation is released it is very difficult to advise to clients with any certainty. In fact, as the final legislation that is passed by parliament is often different from the draft legislation certainty can only be obtained when it has been passed by both houses of parliament. 3.3.2 Section 100A Discretionary trusts have been utilised to gain access to the lower tax rates enjoyed by other family members. Section 100A of the ITAA 1936 is an anti-avoidance provision that overturns schemes with the broad purpose of allowing income derived by trusts to be passed on to beneficiaries who do not pay any, or any substantial amount of tax. When the provision applies, the distribution of income is disregarded, and the trustee is assessed on the amount at top marginal rate (45%). The ATO has increased its audit activity with respect to section 100A. It is examining activities where trustees distribute income to beneficiaries paying low or no tax (e.g. adult children, non-working spouses, beneficiaries with existing revenue losses and capital losses) where there is a reimbursement agreement with the intention of reducing the amount of tax payable of other beneficiaries in higher tax brackets. It should be noted that an assessment can be amended in relation to section 100A at any time (the 4 year time limit does not apply).5 Section 100A does not apply when a particular agreement constitutes an ‘ordinary family or commercial dealing’. An agreement between members of the same family group does not necessarily mean it has been entered into in the course of an ordinary family dealing. This is a particular concern for family trusts with adult children or non-resident family members. However, the term ‘ordinary family or commercial dealing’ is not defined under the section and there has been little guidance from the few available court cases. A draft ruling is currently being prepared which will set out the Commissioner’s preliminary views on the exclusions from a ‘reimbursement agreement’ for agreements not entered into with a purpose of eliminating or reducing someone’s income tax, and agreements entered into in the course of ordinary family or commercial dealings. This is a key area to be considered when reviewing the current trust structure and the utilisation of family members in future trust distribution strategies. 5 Section 170(10) item 17 ITAA1936. © Rob Warnock 2021 15
Rob Warnock 2021 How to approach business structures and restructures in 2021
3.4 Tax factors to consider when restructuring
3.4.1 Can you access the small Business CGT concessions on the restructure?
Division 152 of the ITAA 1997 provides capital gains tax concessions specifically for small businesses.
These concessions are particularly favourable and, where eligible, can provide a client with a great
opportunity to restructure.
A CGT small business entity is defined in sections 152-10(1AA) and 328-110 of the ITAA 1997 as an
entity that carries on a business with an aggregated turnover of less than $2 million. The small business
CGT concessions (SBCGT concessions) are very generous.
The four available SBCGT concessions are:
▪ 15-year exemption;
▪ 50% active asset exemption;
▪ $500,000 exemption; and
▪ Small business roll-over.
In order to apply the SBCGT concessions a taxpayer must first satisfy the basic conditions in section
152-10. A taxpayer can satisfy one of these conditions if it is a small business entity for the income year
($2 million turnover test) or it satisfies the $6 million maximum net asset value test.
Top Tip: Prior to COVID-19 your client may not have qualified for the SBCGT concessions on
the basis of their turnover or the net value of their assets. However, as a result of decreased
revenue and/or a decline in assets values as a result of the pandemic you may find that your
client does in fact now meet the criteria. Where this is reliant on the decrease in the value of
assets consider having independent valuations prepared to support the position.
Where a taxpayer can satisfy the basic conditions and qualify for the SBCGT concessions and wishes
to restructure then consideration should be given to utilising the SBCGT concessions rather than roll-
over relief. A significant advantage of using the SBCGT concessions is that the taxpayer will obtain an
uplift in the cost base of any CGT asset, unlike roll-over relief where the acquiring entity will generally
inherit the cost base of the CGT asset.
The requirements of the basic conditions will not be discussed in detail. There are many excellent TTI
papers on the topic. However, some relevant tips and traps when considering applying the SBCGT
concessions will be identified.
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Additional conditions for shares in a company or interest in a trust
It should be noted that if the CGT asset is a share in a company or interest in a trust (e.g. a unit in a
unit trust), there are additional tests to be satisfied to be eligible for the SBCGT concessions. The
Government changed the tests for applying the concessions to these types of CGT assets in 2018. In
addition to the basic conditions, a taxpayer must meet the additional conditions in subsection 152-10(2).
It is beyond the scope of this paper to consider those new conditions other than to say it is now harder
to qualify for the SBCGT concessions where the relevant CGT asset is a share or unit. When reviewing
a business structure that is a company or unit trust this issue will need to be considered.
Significant individual and CGT concession stakeholder
Sometimes when applying the SBCGT concessions it is important to identify that there is a significant
individual or a CGT concession stakeholder. These situations include:
• Additional basic condition if the CGT asset is a share or unit;6
• The 15-year exemption for companies and trusts; 7 and
• The retirement exemption for companies and trusts. 8
Therefore, when reviewing a business structure the significant individuals and CGT concession
stakeholders should be identified if it is expected that the SBCGT concessions may be wish to be utilised
in the future. This is particularly important in relation to the 15 year exemption as one of the conditions
that must be satisfied for a company or trust is that the entity had a significant individual for a total of at
least 15 years during which the entity owned the CGT asset. In the case of discretionary trusts the
trustee should take care when making distributions if this condition is to be satisfied.
This also needs to be considered when a restructure is considered because any change of entity, such
as where a discretionary trust rolls over its business to a company utilising subdivision 122-A roll-over
relief, will cause the 15 year period to start again.
3.4.2 Can you access roll-over reliefs on the restructure?
Restructures generally involve the disposal of a business, or assets of a business, to a new structure.
Roll-over reliefs that allow taxpayers to defer or disregard a capital gain or loss that results from this
disposal are contained in Part 3-3, Subdivision 615-A and Subdivision 328-G of ITAA 1997. The reliefs
are provided for certain involuntary asset disposals and business restructures where, generally, no
change occurs in the underlying ownership of the asset. For information on the roll-over reliefs available
when contemplating a restructure reference should made to the September 2020 TTI Breakfast Club
presentation “Restructuring with CGT roll-overs: tips for advisors” presented by Neil Brydges and Laura
Spencer.
6 Section 152-10(2)(d).
7 Sections 152-110(1)(c) and 152-125.
8 Section 152-325.
© Rob Warnock 2021 17Rob Warnock 2021 How to approach business structures and restructures in 2021
Tips and traps when considering roll-over reliefs
Prior to undertaking any roll-over consideration should be given to the specific requirements of each.
Whilst it is outside the scope of this paper to discuss these requirements some common issues that
arise are:
• Percentage or Market value: Subdivision 122-A, Subdivision 122-B, Subdivision 124-N,
Subdivision 124-M, Division 615;
• Trust Vesting: Subdivision 124-N – within 6 months;
• Residency requirements: Subdivision 122-A, Subdivision 122-B, Subdivision 328G;
• Small business restructures: Basic conditions
• Single arrangement: Requirement of Subdivision 124-M;
• Substantially the same terms: Subdivision 124-M;
• ‘Nothing else’ requirement: Subdivision 124-E, Subdivision 124-F, Subdivision 124I,
Subdivision 124Q, Division 125, Division 615;
• Restructuring period: Division 125, Division 615;
• Genuine Restructure: Subdivision 328-G;
• Ultimate economic ownership: Subdivision 328-G; Division 615;
• Back-to-back roll-overs; and
• Anti-avoidance provisions.
Back to back roll-overs
It is worth noting that back to back roll-overs can result in unintended tax consequences. The 2019 case
of Hart v FCT [2019] FCAFC 179 is an example. Further, in TD 2020/6 the Commissioner raises
concerns with back-to back roll-overs. For a detailed discussion of the issues relating to back-to-back
roll-overs, including TD 2019/D1 (finalised as TD 2020/6) reference should be made to Dung Lam’s
paper ‘Back-to-back rollovers – New ATO guidance’. 9
9 Presented at The Tax Institute’s ‘The Tax Summit 2020’.
© Rob Warnock 2021 18Rob Warnock 2021 How to approach business structures and restructures in 2021
4 ASSET PROTECTION
4.1 Overview
As business owners watched revenue fall as a result of COVID-19, leading to a significant decrease in
profits or resulting in a loss, many would have closely examined how well their wealth and assets were
protected. There are many businesses that closed due to COVID-19 and will not reopen. A walk around
any city or town in Australia reveals the extent of the damage with many ‘For Lease’ signs in the
windows of shops, cafes and restaurants that were once thriving small businesses and now will not
reopen.
Many people focus on taxation issues when establishing or reviewing a structure but asset protection
and succession planning are equally important. There is no point working extremely hard to build a
successful business and personal wealth to all of a sudden lose it due to something the owner cannot
control such as a pandemic.
‘Asset protection’ is about undertaking various strategies so that assets are protected from creditors
and others who may seek to obtain possession of those assets or to have them sold and the proceeds
paid to them.
Assets that need protecting include assets of the business such as business premises, intellectual
property, plant and equipment and personal assets such as the family home and investments such as
rental properties, shares, cryptocurrencies and collectables etc. Also, the business and its goodwill may
need to be protected from its controllers.
For example, three unrelated doctors may conduct their medical practice via a company. Whilst the
business appears to be protected from the doctors should they be sued personally, if they personally
own the shares in the practice company then the business is still at risk.
Asset protection strategies include:
• Do not acquire assets in the trading entity or other at-risk entity. For example, the business
premises, intellectual property, plant and equipment can be owned in a separate entity. This is
particularly relevant at the moment given the government’s current incentives for businesses to
buy plant and equipment;
• Transfer assets out of the trading or at-risk entity. Tax and duty implications must be considered
as well as the bankruptcy and insolvency claw back rules;
• Do not acquire assets in a person’s own name if they are ‘at-risk’ (e.g. a professional). The at-
risk person should also not be a trustee of the family investment trust;
• If using a company or unit trust as part of an asset protection strategy ensure the owner of the
shares or units is not an at-risk entity;
© Rob Warnock 2021 19Rob Warnock 2021 How to approach business structures and restructures in 2021
• Considering employing employees and engaging contractors in a special purpose entity rather
than in the trading entity. Thus, if there are any issues such as contractors being deemed
employees and there is an underpayment of SGC there is less risk to the trading entity (though
noting in the case of payroll tax liabilities all entities in the group will be jointly liable, even non-
employing entities);
• Continually paying out the business profits rather than letting them accumulate in the trading
entity. Thus, if all of a sudden the trading entity gets into financial difficulty the accumulated
profits from prior years will not be at risk. This is discussed further below;
• Ensuring any loan to the business entity from a related party is properly secured;
• Documenting any lease or licence of an asset by the asset owning entity to the trading entity
so that there is no doubt about who owns the asset or the terms under which the trading entity
is able to use the asset. For example, the asset owning entity has a right to terminate the lease
or licence upon 7 days’ notice;
• Having adequate insurance; and
• Utilising a gift, loan and mortgage arrangement. This is discussed further below.
4.2 Review directorships and shareholding
Often where an individual commences a business using a company they appoint themself as the sole
director as well as being the sole shareholder. However, this can create an issue from an asset
protection perspective.
Section 206B of the Corporations Act 2001 (Cth) (Corporations Act) provides that a bankrupt person
is automatically disqualified from ‘managing a corporation’. Therefore, if that sole director becomes
bankrupt they will be disqualified automatically from acting as a director of the company.
Often the business owner may also be the sole shareholder. Upon bankruptcy those shares will pass
to the trustee in bankruptcy.
Section 201F(3) of the Corporations Act states that a trustee of the bankrupt estate may, where the
bankrupt was the sole director and shareholder, appoint a person as the director of the company.
Additionally, subsection (4) allows the trustee to appoint themself to be the director.
As a result, in the event of bankruptcy the trustee in bankruptcy may take control of the company and
thus the business. The trustee in bankruptcy, as director, may call upon unpaid loans which in turn may
trigger financial stress for related parties.
If the company had a second director this would provide some protection from the trustee in bankruptcy
from taking control of the company. However, if the bankrupt owner was the sole shareholder then the
trustee in bankruptcy would obtain control of those shares and the voting power attached to them. When
assessing such situations for clients consider (subject to tax consequences if already established) the
© Rob Warnock 2021 20Rob Warnock 2021 How to approach business structures and restructures in 2021
asset protection benefits of having an additional shareholder with at least a 50% interest such as a
related, not at-risk, trust and two or more directors.
4.3 Loan and security strategies
4.3.1 Individual and gift, loan and mortgage strategy
This strategy can be used where an individual owns a valuable asset such as real estate or carries on
a successful business as a sole trader and is potentially at risk. For example, a professional who owns
a rental property, holiday house or home in their own name. Or a sole trader whose business has
valuable assets such as goodwill, business premises and/or plant and equipment.
The gift, loan and mortgage strategy can also be useful where an individual has significant assets in
the way of loans to the family trading entity (or UPEs in the case of a trading trust). If the individual gets
into financial difficulty they may have to call on the trading entity to repay the loan or pay the UPE.
How the strategy works
1. The Principal Individual (or relative or associated entity) unconditionally gifts an amount to a
protected discretionary trust (Protected Trust).
2. The Protected Trust lends the amount to the Principal Individual on security of a mortgage (or
charge) in its favour over the Principal Individual’s assets.
For example:
© Rob Warnock 2021 21Rob Warnock 2021 How to approach business structures and restructures in 2021 In the event the Principal Individual became bankrupt unsecured creditors of the Principal Individual would not be able to obtain payment until the loan owing to the Protected Trust (a secured creditor) has been repaid. If the Principal Individual had no other assets to satisfy outstanding liabilities, being a secured creditor (by virtue of having a mortgage over the assets in its favour), the Protected Trust would be able to “call in” the assets as payment of the outstanding loan ahead of any other unsecured creditors. In this way, even if the Principal Individual became bankrupt, the property would be protected from claims from unrelated third parties. However, it should be noted that this would not be the case if the provisions of the Bankruptcy Act (Cth) 1966 render the debt in respect of which the security is held, or the security, to be void against a trustee in bankruptcy. Sections 120 and 121 of the Bankruptcy Act can apply to effectively unwind the transaction. Section 120 of the Bankruptcy Act is limited in time, applying only to undervalued transfers (such as the gift made by the parents to the Property Trust) that take place within five years (where the individual was insolvent at the time of making the gift) or four years (where the individual was solvent at the time of making the gift) prior to the commencement of the bankruptcy. Section 121 is not so limited in time and applies to transfers that are undertaken with the main purpose of preventing assets being available to creditors who were creditors at the time of the transfer (i.e. there was a pre-existing liability from a claim against the bankrupt individual). If the Principal Individual does not have the funds readily available to gift to the Protected Trust they can borrow the amount needed from a bank or other financial institution. When the loan has been made by the Protected Trust to the Principal Individual, the Principal Individual then uses the money borrowed from the Protected Trust to repay the bank. © Rob Warnock 2021 22
Rob Warnock 2021 How to approach business structures and restructures in 2021
4.3.2 Paying profits out of a trading company
If a review of a client’s current structure reveals it has asset protection risks the next step is to identify
what can be done to reduce those risks. For example, if the trading entity owns the business premises,
intellectual property and other valuable assets, transferring those valuable assets out of the trading
entity could have significant tax and duty consequences.
One of the advantages of the trading entity being a company is that profits are taxed in the company at
the corporate tax rate and can be accumulated in the company rather than having to be paid out to the
shareholders. However, an asset protection strategy is to continually pay out the profits so that there is
not a large amount of cash in the company in case it gets into financial difficulty.
Paying out the profits could have adverse tax consequences. If the company’s shareholders are
individuals then they may be required to pay ‘top-up’ tax on any franked dividends received. This could
also apply if the shareholders are discretionary trusts, depending on the circumstances.
Example
Black Pty Ltd owns and operates a successful business. Alice and Ryan, who are unrelated, each
own 50% of the shares in the company. The company made significant profits in each of the five
years prior to COVID-19. Each year, after paying Alice and Ryan healthy salaries, the balance of
the profits were accumulated. As a result of COVID-19 the turnover of the business has
decreased substantially and Alice and Ryan are reviewing their business structure having
particular regard to asset protection. They are concerned that if their business gets into further
financial difficulty the accumulated profits will be at risk.
Alice and Ryan are each on the top marginal tax rate so that if the profits are paid to them as
unfranked dividends then they will be required to pay top-up tax.
One strategy Alice and Ryan can adopt is to each roll-over their shares into a new company
utilising subdivision 122-A. Alice will transfer her shares in Black Pty Ltd to a new company (White
Pty Ltd) in exchange for the allotment of shares in White Pty Ltd. Ryan will transfer his shares in
Black Pty Ltd to a new company (Blue Pty Ltd) in exchange for the allotment of shares in Blue
© Rob Warnock 2021 23Rob Warnock 2021 How to approach business structures and restructures in 2021
Pty Ltd. Alice and Ryan should each be able to satisfy the conditions in subdivision 122-A and
so obtain roll-over relief.
After the roll-over has been completed Black Pty Ltd can pay out its accumulated profits by way
of franked dividends to each of its new shareholders. No further tax will be payable at that time.
In the future Alice can decide, independently of Ryan, when, and of what amount, White Pty Ltd
will pay franked dividends to her as its shareholder. Also, in the future Ryan can decide,
independently of Alice, when, and of what amount, Blue Pty Ltd will pay franked dividends to him
as its shareholder.
If Black Pty Ltd makes profits in the future it can continue to pay them out as franked dividends
to its shareholders. If Black Pty Ltd gets into financial difficulty in the future as the prior year
profits have not been accumulated they will not be at risk.
If Black Pty Ltd needs funding in the future then each of its shareholders can make a loan to
Black Pty Ltd from the dividends that they have received. These loans should be secured by a
charge over the assets of Black Pty Ltd which is registered on the Personal Property Securities
Register (PPSR). It is important to register the security interest on the PPSR so that unsecured
creditors of Black Pty Ltd will not be able to obtain payment until the loans owing to the
shareholders, who are secured creditors, have been repaid.
4.3.3 Discretionary trust
A similar strategy can be employed where the entity is a discretionary trust. Given the way the tax
provisions apply to a discretionary trust taxable profits are rarely accumulated in the trust, they are
generally distributed to the beneficiaries. If the trust requires funding then it is best if the beneficiaries
fund the trust by way of loans so they can then take security over the trust’s assets. If the trust is funded
by gifts of cash from the beneficiaries those gifts become assets of the trust and are then exposed to
the trust’s creditors.
© Rob Warnock 2021 24Rob Warnock 2021 How to approach business structures and restructures in 2021 If a gift of cash is to be made to the trust then the terms of the trust deed should be carefully reviewed before the gift is made. Some trust deeds provide that a person who makes a gift to the trust is excluded from being a beneficiary. Where a trust has significant assets that are at potential risk it may be possible to implement an arrangement which involves the extraction of underlying capital value through a distribution or appointment to a Protected Trust. The Protected Trust then makes a loan equivalent to the capital value back to the discretionary trust under a loan agreement. This loan is secured over the assets of the discretionary trust. If funds are not readily available to be distributed it may be possible to create an entitlement in the hands of the beneficiary. In either case the amount owed to the beneficiary is secured by a registered mortgage or charge over the trust’s assets. The practical, commercial and tax issues must be considered in relation to the appointment of capital/creation of entitlement. In particular, consideration needs to be given to: the liquidity of the assets held by the trust; the validity of the entitlement created; the provisions of the trust deed in either permitting or prohibiting the structure; capital gains tax considerations; and Division 7A of ITAA 36 implications (among others). Some of these issues are considered in respect of the decision in Fischer & Ors v Nemeske Pty Ltd & Ors [2016] HCA 11 addressed below. © Rob Warnock 2021 25
Rob Warnock 2021 How to approach business structures and restructures in 2021
4.3.4 What happened in Fischer v Nemeske
The trust in Fischer v Nemeske was the Nemes Family Trust (the trust), the assets of which were the
settled sum of $1,000 and 10 B class shares in Aladdin Limited (the shares).
In 1994, the shares were revalued and an asset revaluation reserve of $3,904,300 was created in the
balance sheet of the trust as at 31 July 1994.
In September 1994, the directors of Nemeske Pty Ltd (the trustee) resolved as follows (the
resolution):
“RESOLVED that pusuant [sic] to the powers conferred on the Company as Trustee in the Deed of Settlement of
the Nemes Family Trust:-
That a final distribution be and is hereby made out of the asset revaluation reserve for the period ending 30 th
September, 1995 [sic] and that it be paid or credited to:- the beneficiaries in the following manner and order:
The entire reserve if any, to be distributed to:-
[Mr and Mrs Nemes]
as joint tenants.”
The balance sheet of the trust as at 30 September 1994 was as follows:
BENEFICIARIES FUNDS
1,000 Settlement Sum 1,000
REPRESENTED BY
INVESTMENTS
Shares in Public Companies
at Cost [sic]
Aladdin Ltd 10 “B” Class
1,000 Shares of $1 Fully Paid 3,905,300
NON-CURRENT LIABILITIES
Loan – Secured
- E.G. & M. Nemes 3,904,300
1,000 NET ASSETS 1,000
A charge over the shares was later given by the trustee as security for payment to Mr and Mrs Nemes
of $3,904,300.
No money was paid to Mr or Mrs Nemes pursuant to the resolution. Instead, the executors of the estate
of Mr Nemes called for payment nearly 20 years later.
© Rob Warnock 2021 26Rob Warnock 2021 How to approach business structures and restructures in 2021
The issues raised were:
1. whether the “capital distribution” resolution and the entries in the accounts of the trust were an
effective exercise of the trustee’s powers under the trust deed to advance and apply capital for the
benefit of certain beneficiaries; and
2. whether the resolution and the entries in the accounts of the trust showing a loan of $3,904,300
effectively created a debtor/creditor relationship so that Mr and Mrs Nemes would have been entitled
to bring an action against the trustee for payment.
The power that the trustee purported to exercise was in the following terms: 10
“4…The Trustee may…
(b) At any time or times to advance or raise any part or parts of the whole of the capital or income of the Trust Funds
and to pay or to apply the same as the Trustee shall think fit for the maintenance education advancement in life
or benefit of any of the Specified Beneficiaries …”
It was not in dispute that the resolution was “badly worded”. 11 It purported to make a “final distribution”
in reliance on a power “to advance or raise” and “to pay or apply”, and to create an entitlement to a sum
of money out of an asset revaluation reserve. There was no fund represented by the asset revaluation
reserve from which to make a distribution to give effect to the resolution. 12
The dissenting judges were critical of the resolution and accounts:
“50. The question whether the power given by cl 4(b) was exercised is a question which requires investigation of the
intention of the Trustee, which can be gleaned from the terms of the Resolution and the circumstances in which it
was made. Regard may also be had to how the Trust property was dealt with following the Resolution, as evidence
of what was intended to occur…
52. The Resolution does not identify cl 4(b) as the source of the power which is sought to be exercised by making
it. It does not identify the purpose of the power purporting to be exercised as one for the ‘advancement in life or
benefit’ of Mr and Mrs Nemes, which could be the only purpose in cl 4(b) relevant to them as adult Specified
Beneficiaries. Indeed, the Resolution does not mention the purpose of what is sought to be undertaken save that a
’final distribution’ is to be made.
53. The Resolution does not say that this ‘distribution’ is to be made out of the capital or income of the Trust, but
rather out of the ’asset revaluation reserve’. This does not identify any property of the Trust as the subject of the
exercise of any power. As previously explained, the ’asset revaluation reserve’ does not represent any asset of the
Trust as such, but merely the accounting treatment of the increase in value of the Shares at the time a new
revaluation was undertaken. 13
…
10 Fischer & Ors v Nemeske Pty Ltd & Ors [2016] HCA 11 at [5].
11 Ibid [32] per French CJ and Bell J.
12 Ibid.
13 Ibid per Kiefel J.
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