In 2008 I was approached by a potential new client with a successful manufacturing business that he wanted to pass to his two sons. The problem was the business was operated through a company, which was owned by a unit trust, with all of the units owned by a family trust with a limited life expectancy.
The limited life expectancy came from the fact that the trust had been formed with a vesting date of June 30, 2017, rather than the usual vesting date of 80 years after the trust was formed.
As is usually the case, the potential client wanted to transfer the business to his sons and not pay any tax. Had the family trust not had the vesting date problem, this could have been achieved by passing control of the family trust to the two sons. With this not being an option, an alternative had to be worked out.
Because the business operated by the company had a turnover of more than $2 million, it did not pass the small business entity test and therefore, if we wanted to use the small business capital gains tax concessions, someone needed to qualify under the $6 million net asset test.
When an assessment was done of the assets owned by the father, taking into account the market value of the business owned by the company of $2.9 million, the total value of his net assets were well in excess of $6 million.
Keeping it ‘all in the family’
Upon closer examination of the value of the business, it was discovered that only $900,000 was the value placed on the goodwill of the business, with the balance of $2 million being made up of accumulated profits.
Because the two sons were both employed by the company, the total value of their net assets was under the $6 million limit, and they were also beneficiaries of the family trust. As long as the other small business capital gains tax concession rules were met, the task of passing the business tax effectively to them could be met.
The first step in the process was to form two new family discretionary trusts, that went into partnership together to buy the business from the company. The profit made by the company on the sale of the business, plus the operating profit for that year, was distributed through to the unit trust, and then on to the family trust with the looming vesting date.
In the year that the business was transferred to the partnership that the two sons controlled, each received slightly more than 20 per cent of the distributions from the family trust. This meant they qualified as significant individuals, under the capital gains tax (CGT) concession rules, and therefore could access the retirement exemption. This was done by rolling the capital gain of $900,000 directly into the self-managed super fund (SMSF) for the family.
Mission accomplished
Because the rollover of the capital gains tax concession amount had to actually be paid to the SMSF, a short-term borrowing arrangement was entered into by the company to fund the $900,000 contribution. The family trust owned a factory leased to the company that had considerable unrealised capital gains that would be a problem at vesting time. It was decided that the SMSF would purchase this factory from the trust using the $900,000 rolled in from the CGT retirement exemption.
The family trust then paid out the $900,000 to the two sons that then lent this to their trusts. These funds were then contributed as capital to the partnership, which paid out the loan to the company for the purchase of the business, which then repaid the bank loan.
