Edited version of private ruling

Authorisation Number: 1011643754868

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Ruling

Subject: Capital Gains Tax - Commissioners determination-'control' of an entity for the purpose of the maximum net asset value test; and, whether an entity is a 'connected with' another entity

Question 1

For the purposes of the 'maximum net asset value test' under section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997), does the Commissioner determine that the D Family Trust does not control A Unit Trust, under subsection 328-125(6)?

Answer

Yes

Question 2

Is the D Family Trust 'connected with' the H Family Trust within the meaning set out under subsection 328-125(1) of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The scheme

The two main operational entities in the Group are:

A Co Pty Ltd (A Co), as trustee for A Unit Trust (AUT), the main trading entity, and

H Pty Ltd (H Co), as trustee for H Family Trust (HDT), a discretionary trust.

Two of the three directors of A Co are also shareholders.

AUT has issued units, which are distributed among unit holders.

A Co has infrequent board meetings (approximately one per year) which are attended by directors and the family accountant, who acts as Chairman of the meeting.

The other operational entity, HDT, owns land, which is rented to AUT. The directors of H Co are also shareholders. The trust deed of HDT does not nominate an appointor or guardian. The trustee is the person who is entitled to appoint another trustee.

A Chief Executive Officer (CEO) has been in place for some time. It is acknowledged within the family and within an independent business report done on the AUT business, that the CEO makes all the strategic decisions in the business.

The Group has operated in loss for a number of years. There have been no distributions made out of either of the trusts in the last 4 years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Subsection 328-125(1)

Income Tax Assessment Act 1997 Subsection 328-125(2)

Income Tax Assessment Act 1997 Subsection 328-125(6)

Income Tax Assessment Act 1997 Section 328-130

Income Tax Assessment Act 1997 Subsection 328-130(1)

Income Tax Assessment Act 1997 Subsection 328-130(2).

Further issues for you to consider

We have limited our ruling to the questions raised in your application. There may be related issues that you should consider including:

Where the trustee has elected to nominate a beneficiary to be a controller of the trust for an income year, you must consider the effect of section 152-42 of the ITAA 1997, as this may impact upon whether an entity is 'connected with' you for the purposes of determining whether a CGT asset is an 'active asset' under section 152-40.

In particular, section 152-42 of the ITAA 1997 relates to the application of subparagraph 152-40(1)(a)(ii) and paragraph 152-40(1)(b) of the ITAA 1997. A nomination under subsection 152-42(2) of the ITAA 1997 has effect as if each nominated beneficiary controlled the trust for the relevant income year in a way described in section 328-125 of the ITAA 1997.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

In considering your circumstances, the Commissioner considers that it is reasonable to conclude that DFT does not control AUT, therefore DFT is not 'connected with' the AUT under subsection 328-125(1) of the Income Tax Assessment Act 1997 (ITAA 1997).

Therefore, for the purposes of the 'maximum net asset value test' under section 152-15 of the ITAA 1997, the Commissioner has determined that the DFT does not control AUT, under subsection 328-125(6).

Detailed reasoning

General discussion of the law

Section 328-125 of the ITAA 1997 provides the meaning of 'connected with' an entity, this section reads in part as follows:

(1) An entity is connected with another entity if:

(a) either entity controls the other entity in the way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

Direct control of entity other than a discretionary trust

(2) An entity (the first entity) controls another entity if the first entity, its *affiliates or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company beneficially own, or have the right to acquire the beneficial ownership of, *equity interest in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

Direct control of a discretionary trust

(3) An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its *affiliates, or the first entity together with its affiliates.

(4) An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's *affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

………………….

Commissioner may determine that an entity does not control another entity

(6) If the control percentage referred to in subsection (2) or (4) is at least 40%, but less than 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its *affiliates.

* denotes a term defined in section 995-1 of the ITAA 1997.

This means that an entity is connected to another entity if either entity controls the other entity or both entities are controlled by the same third entity. It also means that another entity is connected with an entity, if the entity, its affiliates or both of them beneficially own, or have the right to acquire the beneficial ownership of interests in the other entity that give them the right to receive at least 40% of the distribution of income or capital by the other entity.

Section 328-130 of the ITAA 1997 provides the meaning of 'affiliate' as follows:

328-130(1)

An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the *business of the individual or company.

328-130(2)

However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Note:

For small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47 of the ITAA 1997.

Example:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

Directors of the same company and trustees of the same trust, or the company and a director of that company, would be in a similar position.

Application of the law

You acknowledge that the DFT would prima facie control AUT under Section 328-125(2)(a) of the ITAA 1997.

In applying subsection 328-125(2) of the ITAA 1997, based on the facts of the scheme, the first entity are unit holders of AUT (another entity), which indicates that they beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40 percent of any distribution of income by the other entity; or any distribution of capital by the other entity. In this case the first entity owns >50 percent of the interests in AUT.

Further, the first entity appears to be responsible for all decision making, including day-to-day operations and strategic management of the AUT business.

For these reasons it is considered that the first entity are affiliates within the meaning set out in subsection 328-130(1) of the ITAA 1997. In particular that the first entity could reasonably be expected to act in accordance with each other's directions or in concert with each other in relation to the business of AUT.

As the DFT owns <50 percent of the issued units of AUT, being greater than 40 percent but less than 50 percent, the Commissioner may make a determination under Section 328-125(6) of the ITAA 1997 as to whether DFT controls AUT.

In view of the circumstances, the third entity's position appears diminished to the extent that it may not have sufficient influence over the first entity so that they act in accordance with, or in concert with, its directions in relation to the operation of the business. Further, board meetings are infrequent and appear to be used as a communication medium in relation to action already taken, rather than a business administration and planning process.

In addition, the third entity's role as director of DFT does not necessarily indicate that he controls DFT. If the assumption was made that he does control DFT and he attempted to exercise the apparent control that DFT has over a decision relating to the operation of AUT, as provided under paragraph 328-125(2)(a) of the ITAA 1997, in practical terms it is likely that attempt would be unsuccessful.

In considering your circumstances, the Commissioner considers that it is reasonable to conclude that DFT does not control AUT, therefore DFT is not connected with the AUT under subsection 328-125(1) of the ITAA 1997.

Therefore, for the purposes of the 'maximum net asset value test' under section 152-15 of the ITAA 1997, the Commissioner has determined that the DFT does not control AUT, under subsection 328-125(6).

Question 2

Detailed reasoning

DFT is not connected with AUT, as determined elsewhere in this ruling, and it is apparent that the third entity as director of H Co may not have sufficient influence so that the first entity would act in accordance with, or in concert with, his directions in relation to the operation of the business such that the first entity would be considered to be an affiliate within the meaning set out under subsection 328-130(1) of the ITAA 1997. Therefore it is reasonable to conclude that DFT does not control HDT.

Therefore, DFT is not 'connected with' HDT within the meaning set out under subsection 328-125(1) of the ITAA 1997.

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