Trust restructures – relief from capital gains tax

Capital gains tax (CGT) is applied to and calculated on the realisation of “capital gains”.  If a business wants to transition from a Unit Trust to a company structure (for example) and the value of the Units in the Trust has increased then it’s likely that the sale or transfer of the Units will result in a capital gain by the Unitholder.  In circumstances where the Unitholder may not have actually received any cash to pay the capital gains tax, surely there must be an exception?

What is CGT?

CGT applies to CGT Events, which are defined in Division 104.10 of the Income Tax Assessment Act 1997 (Cth) (Act).  The definition of CGT Event includes the disposal (sale) a CGT Asset (CGT A1 Event).  CGT Asset is defined in section 108.5 of the Act as:

“(1) (a) any kind of property; or

(b) a legal or equitable right that is not property”.

Selling the Units in a Unit Trust is likely to attract CGT, as it involves a CGT A1 Event happening to a CGT Asset, namely the Units in the Trust.

What are the exceptions or exemptions to CGT?

There are a number of exceptions that apply to CGT Events, which in effect, allow the deferment of a CGT Event to a later time.  These are referred to as “rollovers”.

The CGT Events that apply to a sale of Units may be capable of being rolled over pursuant to:

• section 128.870 of the Act (Trust Restructure Rollover); or
• section 124.780 of the Act (Scrip for Scrip Rollover).

This article only considers the law in relation to Trust Restructure Rollovers.

Trust Restructure Rollover

There are essentially two (2) paths that can be taken to restructure a trust to comply with the CGT rollover requirements, these are:

• the disposal of assets by the Trustee to the wholly-owned Company pursuant to subdivision 122-A of the Act (122-A Rollover); and
• the disposal of assets by the Trust to the Company pursuant to subdivision 124-N of the Act (124-N Rollover).

Obtaining an 124-N Rollover

The requirements for obtaining a 124-N Rollover are set out in division 122-N.

Requirements of section 124.860

To obtain a rollover:

• all assets of the Trust must be sold to the Company (124.860(1));
• the Company must be a company that:
  • has never traded (124.860(4)(a));
  • has no assets (124.860(4)(b)); and
  • has no losses of any kind (124.860(4)(c));
• all unitholders in the Trust must obtain a replacement, proportionate, interest (Replacement Interest) in the Company (124.860(6)(a)); and
• the Replacement Interest must have a market value that is substantially the same as the units were immediately prior to the sale (124.860(6)(b)).

Requirements of section 124.865

A rollover is only available for one entity if the other also chooses to obtain a rollover.  In other words, both the Unit Trust and the entity which acquires the assets must choose to obtain the rollover.

Requirements of section 124.870

Section 124.870 sets out the requirements that must be satisfied for the Unitholder to obtain rollover relief if:

• the Trust undergoes a trust restructure (124.870(1)); and
• pursuant to the restructure, the Unitholder receives shares in the Company (124.870(1)).

Requirements of section 104.195

Where a 124-N Rollover is obtained and the Trust does not vest within six (6) months of the trust restructure period, the rollover may be reversed.  This is an important section to comply with as it can lead to catastrophic cost consequences if the rollover is not completed by this time.

Takeaways on trust restructure relief and Division 124-N

Regardless of the commercial reason for wanting to engage in a trust restructure, care must be taken to avoid or minimise problems associated with CGT and other taxes.  A Trust Restructure Rollover pursuant to subdivision 124-N of the Act is an efficient way to avoid CGT problems as it effectively allows a Unit Trust to be replaced by a Company without any CGT consequences to either the Unitholders or the Unit Trust.  That said care must also be taken to consider any issues with State based transfer duty.  Implementing, a 124-N Rollover involves a number of steps that must be properly executed, so it is best to seek legal and accounting advice when implementing the rollover.

Links and further references

Legislation

Income Tax Assessment Act 1997 (Cth)

Other links

ATO Class Ruling CR2007/116

Further information about capital gains tax

If you need assistance with trust restructure relief and capital gains tax, contact us for a confidential and obligation-free discussion: 

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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