Starting a small business involves a multitude of decisions, but none is as crucial as selecting the right structure for your business. Your chosen structure can impact your tax obligations, reporting requirements, legal liabilities, and how you operate your business.
For example, sole traders and companies have entirely different tax requirements and reporting obligations.
However, as your business grows, your initial decision might not suit your current circumstances. As a result, you may need to change your structure, which can be a daunting process, largely because it means a heap of new implications.
Fortunately, the Australian Tax Office (ATO) offers relief through the Small Business Restructure Rollover.
In this guide, we will delve into the small business restructure rollover and explain how it can help you achieve your business goals.
Why Would Small Business Owners Want to Restructure Their Business?
There are several reasons why you may want to restructure your business. Some of the most common reasons include:
- Tax efficiency: One of the primary reasons for restructuring a business is to aid in lowering the tax payable to the least amount required by law.
- Asset protection: Restructuring your business can help protect your assets from legal liability. By separating your personal assets from your business, you can limit your personal liability in the event of a lawsuit or bankruptcy.
- Growth and expansion: As your business grows, restructuring may be necessary to bring investors into the mix.
For example, the ATO taxes sole traders at their individual tax rate, and they’re personally liable for all debts and legal issues that arise in the business, which might suit you as you’re starting out. But as your business grows, so does your income. And the higher your income, the higher your tax bracket.
There’s also more risk involved as your business expands. So you need to put plans in place to protect your personal assets, leaving many sole traders to restructure as a company.
The ATO taxes companies at a flat rate, and shareholders have limited liability, meaning they are only responsible for the company’s debts up to the amount of their investment.
You may be interested in reading a Side by Side Comparison of a Sole Trader and Pty Ltd Company.
How Does the Small Business Restructure Rollover Work?
The Small Business Restructure Rollover is a relief measure introduced by the ATO to help small businesses restructure without incurring unnecessary tax liabilities. The rollover enables small businesses to transfer active assets from one entity to another without triggering any capital gains tax (CGT) consequences.
To qualify for the rollover, the transfer must occur as part of a genuine restructure of the business, where there is no change in the ultimate economic ownership of the assets. The ATO must also consider the assets to be active assets.
Where Does the ATO Collect Its Data for a Tax Audit?
The Small Business Restructure Rollover is a relief measure introduced by the ATO to help small businesses restructure without incurring unnecessary tax liabilities. The rollover enables small businesses to transfer active assets from one entity to another without triggering any capital gains tax (CGT) consequences.
To qualify for the rollover, the transfer must occur as part of a genuine restructure of the business, where there is no change in the ultimate economic ownership of the assets. The ATO must also consider the assets to be active assets.
What Does the ATO Consider To Be a Genuine Restructure?
Several criteria must be met for them to consider a restructure to be “genuine”. These criteria include:
- Expect growth, innovation, diversification, reduced administrative, compliance costs and cash flow constraints
- Continuing the business operations under the new structure and utilising the assets it transfers as part of the restructure
- Obtaining professional advice regarding the restructuring
- Not being motivated solely by tax benefits (substantial evidence must be available to support this.)
- Not promoting the disposal of business assets outside the business entity.
The ATO will generally assess each restructure of an ongoing business on a case-by-case basis.
When is there No Change in the Ultimate Economic Ownership of an Asset?
According to the ATO, ultimate economic ownership is the direct or indirect ownership of an asset.
Specifically, for small business entity tax concessions, the ATO considers that a taxpayer has ultimate economic ownership of an asset if they have the right to the income from the asset, bear the risk of loss associated with the asset, and have the power to decide how they use the asset.
In the context of the small business restructure rollover, the ATO requires that the ultimate economic ownership of the transferred assets remain the same before and after the restructure for a minimum of three years.
If there is a change in the ultimate economic ownership, the ATO will exclude the transaction from the tax concessions.
The reason for this is that the purpose of the concessions is to provide relief to small business owners who are genuinely restructuring their businesses, not to facilitate the transfer of ownership or disposal of assets outside of the business entity.
How Does The ATO Define “Active Assets”?
The ATO defines “active assets” as assets used or held for use, mainly for the purpose of carrying on a business.
These assets can include tangible assets such as:
- Plant and equipment (i.e. depreciating assets)
- Trading stock
- Capital gains tax assets (e.g. property)
- Revenue assets
An example of a non-active asset would be shares in another company or interests in a trust (unless they meet the 80% inherent connection test).
So, How Does the Restructure Rollover Affect CGT and Income Tax Liability?
Provided that you satisfy the three requirements under the safe harbour rule (i.e. genuine restructure and no change of economic ownership of active assets), the new business structure takes over ownership at the assets’ tax cost without generating any gain (or loss):
- The 15-year exemption in the small business CGT concessions is not affected.
- To qualify for the 50% active asset reduction, the new structure must hold the asset for at least 12 months from the date of transfer – as this will be the new date of acquisition.
- Revenue assets will take on the cost, resulting in neither a profit nor a loss to the new business entity.
- The depreciating assets will continue to depreciate at the same rate as the written-down value.
- The trading stock’s opening value will depend on the applicable rate on the transfer day.
Key Takeaways
The small business restructure rollover relief provides a valuable opportunity for small businesses to reorganise and adapt to changes while minimising tax consequences. However, for the relief to apply, you must prove to the ATO that it is a genuine restructure.
It’s also essential to remember that although it may offer relief from CGT and income tax, it could activate other obligations like duties and GST, which is why you should seek professional advice before making any decisions.
Beyond being one of the rules of restructuring, obtaining professional advice can help small businesses navigate complex legal requirements and optimise the benefits of restructuring your business.
KNS Accountants and Business Advisors have a team of experienced tax consultants who can offer tailored advice to help you make informed decisions regarding restructuring your business. We understand that every business is unique and provide customised solutions catering to each client’s specific needs.
Contact us today if you want to enquire about our business accounting services.
