Who Owns What? And Why Does It Matter?
An entity that is established to own and operate a business at some point is unlikely to be appropriate for long-term or changing objectives. In acknowledging that, whilst it is possible to simply pick up assets of a business from one entity and transfer them to another, duty and income tax considerations often mean that once a cost-benefit analysis is undertaken, business owners choose to maintain the status quo.
It is not necessarily correct however to assume that duty and income tax consequences are of an amount that would prohibit a restructure.
New South Wales (NSW) has brought itself into line with Victoria and abolished duty on business assets (but not land or interests in land). Historically the duty costs associated with moving business assets was seen as too big a hurdle for most businesses to overcome when it was levied at rates of approximately 5% of unencumbered market value. With that hurdle now removed, controllers of business are now beginning to reconsider their options.
The abolition of duty, when taken into account with current available Capital Gain Tax (CGT) concessions, means that the only hurdles left to consider when restructuring the business are the commercial ones involved in moving employees, renegotiating third party contracts and agreements and applying for new Tax File Numbers (TFN) and Australian Business Numbers (ABN).
For entities eligible to apply the current range of CGT concessions:
- it is possible to shelter gains of up to $2 million for an individual (or $4 million for a couple) where they are over 55 or money equal to one-quarter of the gain can be put into superannuation; or
- where owners are under 55 and money is not put into superannuation the effective tax rate should be less than 12.5% and can be deferred for two years or rolled over into replacement business assets.
Not only does this provide an opportunity for a business to move into a more appropriate entity to accommodate changed or long-term objectives, there is also the opportunity to lock in a cost base for the goodwill of that business at a time when the CGT concessions continue to be available and generous so that when a business is faced with a realisation event, there is some certainty as to the amounts that can be extracted by the controllers of the business notwithstanding a change of law in the meantime.
John Smith, Jane Smith and Rodney Jones (shareholders) operate an engineering business in NSW called Smith Engineering Pty Ltd (Smith Engineering), through a company in which they are the only shareholders. John and Jane are married, and each own 35% of the shareholdings in Smith Engineering respectively and Rodney holds the remaining 30% of shares.
Smith Engineering has assets valued at approximately $1,700,000 and an annual turnover of approximately $3,000,000 and is looking to restructure its affairs in a way that affords greater asset protection both to the business and to the shareholders. In particular, John, Jane and Rodney have recently become concerned that in the event the business is sued, the company could be stripped of its assets in order to pay its creditors. They would also like the flexibility to distribute the profits of their business to a broader range of people.
Assuming the shareholders meet the ‘maximum net asset value’ test, the shareholders and Smith Engineering can restructure their shareholding and current business structure by:
Step 1 – Transferring the shares held by the shareholders for market value to a newly established holding company (New Pty Ltd), which is owned 70% by a discretionary trust established for John and Jane, and 30% by a discretionary trust established for Rodney. The CGT small business concessions can be claimed to shelter the capital gain on this transfer, and no duty will be payable (assuming that Smith Engineering is not a landholder for landholder duty purposes).
Step 2 – Incorporating a subsidiary of New Pty Ltd (Smith Assets).
Step 3 – New Pty Ltd, Smith Engineering and Smith Assets form a tax consolidated group.
Step 4 – All fixed assets of Smith Engineering are transferred to Smith Assets. The transfer can be done by way of gift or market value consideration noting that no income tax consequences flow as a consequence of the transfer as it is an inter-group transfer and no duty will be payable assuming there is no real property included. If that is not the case, then the transfer ought to satisfy the NSW conditions for corporate reconstruction relief, but that will be required to be applied for.
This results in a restructure of the business in a way that provides asset protection to the shareholders and the assets from the trading activity of Smith Engineering. It also provides a market value cost base of the shareholdings and assets of Smith Engineering. Provided the entirety of the capital gains can be sheltered by the small business CGT concessions, the restructure can be implemented in a way in which no duty and tax consequences arise (assuming that Smith Engineering is not a landholder for landholder duty purposes).
The time to review your ownership structures of business and related assets is now – asset protection is an important aspect of planning.
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