1012534031548 | Legal database

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Edited version of your private ruling

Authorisation Number: 1012534031548

Ruling

Subject: Small Business Entities - 'connected with' an entity

Issue

Whether an entity has control over another entity

Question 1

For the purposes of subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997), will the Commissioner determine that Company A and Company B are not controlled by Company C?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

1. Company A and Company B both have identical ownership. The shareholders of Company A and Company B are:

(a) Individual (ordinary shares - less than 10%)

(b) Trust ('A' class shares - 50%)

2. The trustee of Trust is Company D, of which Individual is the sole shareholder and sole director.

3. Individual has, and exercises 100% control over the shares in Company A and Company B that are owned by Trust.

4. Each class of share issued by Company A and Company B do not carry identical share rights.

5. The Ordinary and 'A' Class shares are identical but they differ to the 'B' Class shares offered with regard to the winding up of the company and the right to participate in the division of surplus assets or company profits.

6. The number of voting rights attached to the shares of Company A and Company B vary depending on whether the vote is by show of hands or by poll. In regard to a show of hands, each member has one vote, and in regard to a poll, each member has one vote for each share that they hold.

7. Individual is stated as exercising control over every aspect of Company A and Company B of the business.

8. Individual and Company C are not related, connected, affiliated or associated with each other in any way besides being joint owners in Company A and Company B.

9. The director of Company A is Individual and the directors of Company B are Individual and a director of Company C.

10. No shareholders agreement has been entered into due to the parties not being agreeable over the terms.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-125, and

Income Tax Assessment Act 1997 section 328-130.

Reasons for decision

Summary

The Commissioner is satisfied that Company A and Company B are not controlled by Company C but instead are controlled by Individual who effectively has a control percentage of greater than 50% through their personal shareholdings and the shareholdings in the Trust.

Accordingly, the Commissioner will determine under subsection 328-125(6) of the ITAA 1997 that Company C does not control Company A and Company B.

There is nothing to suggest that Company A and Company B acts or could be reasonably be expected to act in accordance with the directions of Company C or in concert with Company C in relation to their business affairs.

Detailed reasoning

The meaning of 'connected with an entity' is defined under section 328-125 of the ITAA 1997. Subsection 328-125(1) of the ITAA 1997 states:

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.

Paragraph 328-125(2)(b) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own equity interests 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.

As Company C holds at least 40% of shares in Companies A and Company B, paragraph 328-125(2) of the ITAA 1997 is satisfied.

If an entity's control percentage in a company is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by a third entity (other than an affiliate of the first entity).

For the Commissioner to be able to consider the determination in subsection 328-125(6) of the ITAA 1997, there must be a single, identifiable third entity that has a control percentage of at least 40% of the company. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account. The third entity must control the company in the way described in subsection 328-125(2) of the ITAA 1997. Unless the conditions of subsection 328-125(2) of the ITAA 1997 are met the Commissioner cannot determine whether or not the first entity controls the company.

If there was a third entity with a control percentage of 40% or more it would then be necessary to consider additional factors such as who is responsible for the day to day and strategic running of the company to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least 40% may control the company if such responsibilities are shared.

Subsection 328-125(6) of the ITAA 1997 provides that if an entity's control percentage in a company 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 other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates. That is, as Company C has a control percentage in Company A and Company B, of at least 40% but less than 50%, the Commissioner may determine that Company C does not control Company A and Company B.

There is no definition of the term control provided in Division 328 of the ITAA 1997. However, some guidance is provided in the Advanced Guide To Capital Gains Tax Concessions For Small Business 2012-13 (the Guide). The example given on page 25 of the Guide shows that having the majority shareholding is not enough to prove control. Rather, it is the shareholder that controls all the day-to-day and strategic decisions for the company, who controls the company. In this example the non-controlling shareholder takes no part in the day-to-day or strategic operation of the business, it is totally controlled by the majority shareholder. The Guide states that it is possible for both entities with a control percentage of at least 40% to control the company if such responsibilities are shared.

Company C and Individual (with control over the shareholdings in Trust) are both entities with a control percentage of 40% or more. Therefore, it is necessary to consider who is responsible for the day-to-day and strategic running of the Company A and Company B to determine if Company C controls them. As previously stated, it is possible that both of the entities may control the company if such responsibilities are shared.

The day-to-day running of Company A and Company B and their associated strategic decisions are said to be made by Individual and Individual alone. Therefore, Individual as director and majority shareholder is said to have full control over the direction of Company A and Company B.

Subsection 328-130(1) of the ITAA 1997 describes an affiliate as an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you. The Guide provides a number of relevant factors that may support a finding that a person is an affiliate of a taxpayer in accordance with subsection 328-130(1) of the ITAA 1997:

· the existence of a close family relationship between the parties

· the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

· the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and

· the actions of the parties.

However, subsection 328-130(2) of the ITAA 1997 points out that an individual or company is not an affiliate merely because of the nature of the business relationship. For example, companies and trusts are not affiliates of their directors and trustees respectively and vice versa, merely because of the positions held.

There is nothing to suggest that Company A and Company B act, or could be reasonably be expected to act, in accordance with directions of Company C or in concert with it in relation to the business affairs of Company A and Company B.

Therefore, the Commissioner is satisfied that the company is not controlled by Company C but is instead controlled by Individual who effectively has a control percentage of greater than 50% through their personal shareholdings and the shareholdings in the Trust. Accordingly, the Commissioner will determine under subsection 328-125(6) of the ITAA 1997 that Company C does not control Company A and Company B.

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