Edited version of your private ruling

Authorisation Number: 1012555609784

Ruling

Subject: Affiliate and active asset test

Question 1

Is Company A considered to be your affiliate as defined under section 328-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes

Question 2

Will the property be considered an active asset?

Answer:

Yes

This ruling applies for the following period(s)

Year ending 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

You (along with three others) acquired a property (the property) in 20XX.

You hold a 25% interest as a joint tenant in the property.

You and A separated and divorced in the X's.

You state that a business commenced in the 1970's as a partnership between you and A. The incorporation of the business, into Company A, was effected in order to introduce your child, B, as an equity stakeholder in the business.

Company A was incorporated in the early X's. The issued capital is now as follows:

· A - 90% ordinary shares

· B - 10% ordinary shares

A and B are also the directors of Company A.

You state that you continue to actively participate in the business. In spite of the divorce, the company has continued to run as a 'family business' with significant financial input and participation by you.

Company A is currently occupying all of the property and has done so since 20YY.

Since the property was acquired at least 50% of the lettable area of the property has been occupied by Company A, with the remainder being let on an arms length basis. In Y of the years since the property was acquired the occupancy of Company A exceeded 75% of the area.

The income derived from the arms length rental of the property during the period of ownership did not exceed business income in any single year.

An option to purchase the property has now been granted on an arms length basis to an unrelated party and it is anticipated that contracts for sale will be exchanged and completed within the 20YY financial year.

You state that you have actively participated in the management of Company A since inception. You were engaged in an unpaid capacity although you did receive fees for your services in 20ZZ and 20YY financial years.

You state that your skills were of significant value to Company A.

You state that you were consulted by the directors of Company A on all significant financial matters pertaining to the business. Meetings were held with the directors/shareholders of Company A on a regular but informal basis.

You state that you have assisted in reviewing specific projects and company financial records, in particular:

· configuration of budgets - particularly in regards to stock and expenses

· examination of trade debtors and creditors

· reviewing the marketing strategies of the company

· examining the general ledgers and issuing reports to clarify inherent problems

· to put in place strategies to check 'job costs' to reflect a realistic outcome, particularly since Company A successfully tendered for a contract

· to provide feasibility studies on sales analysis, and

· to establish and monitor cash flow.

You state that you have retained a significant degree of financial control which can be evidenced by allowing your 25% interest in the property to be used as security for loans made by various banks to Company A.

You are the sole director and shareholder of Company B which operates in its capacity as the trustee of B Trust. You are the appointor of the trust and also the main beneficiary.

B Trust owns a building (Building B).

In 20XX and 20YY, Company A had contracts with an entity which required it to give performance guarantees and letters of credit to suppliers. You state that you allowed Building B to be used as primary security for both facilities. The facilities were approximately $X million on each occasion. You state that Company A's own bank would not reasonably provide these facilities.

You state that since acquisition of the property the following unsecured and interest free funds have been provided to Company A

· $xxx in 200X - by you personally

· $xxx in 20XX - via B Trust

· $xxx in 20XX - via B Trust

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 328-130

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-35

Reasons for decision

Detailed reasoning

An entity that is 'connected with' you

Subsection 328-125(1) of the Income Tax Assessment Act 1997 (ITAA 1997) explains that an entity is connected with another entity if:

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

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

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

a) beneficially owns, or have the right to acquire the beneficial ownership of, interests in the other entity that give the right to receive a least 40% (the control percentage) of any distribution of income or capital by the other entity: or

b) if the other entity is a company - beneficially owns, or has the right to acquire beneficial ownership of, equity interests in the company that give at least 40% of the voting power in the company.

Subsection 328-125(3) of the ITAA 1997 explains that 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.

In your case, you are the sole director and shareholder of Company B. Company B is the trustee of B Trust. You are also the appointor of the trust.

Therefore, it is likely that B Trust would act, or reasonably be expected to act, in accordance with your directions or wishes, or in concert with you. Accordingly, you are considered to control B Trust and, B Trust will be an entity that is connected with you.

Affiliates

An affiliate is defined by section 328-130 of the ITAA 1997 as being an individual or company who 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 individual or company.

In FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344 the full High Court, in considering the meaning of the phrase 'might reasonably be expected', held that a reasonable expectation required more than a possibility'

Relevant factors that may support a finding that a person acts in such a manner include:

· the existence of a close family relationship between the parties

· financial relationships or dependencies

· 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.

Generally, another entity would not be acting in concert with you if they:

· have different employees

· have different business premises

· have separate bank accounts

· do not consult you on business matters, and

· conduct their business affairs independently in all regards.

Importantly, even where a family relationship is present, it must be of sufficient strength to enable the entity to direct or influence the potential affiliate in relation to all, or a substantial part, of the affairs of the latter's business. You must be able to demonstrate that you are able to direct the other person in relation to (not merely where the person is involved in, connected to or participating in) the carrying on of the business.

In your case, based on the information provided;

· you have actively participated in the management of Company A since its inception and continue to attend regular (though informal) meetings with the directors

· the company values your skills and you have been consulted on all significant financial matters pertaining to the business of Company A

· you assist in reviewing projects and the company's financial records

· you have allowed your 25% interest in the property to be used as security for loans made by various banks to Company A and for overdraft and commercial bill facilities

· as controller of B Trust, you have allowed a trust asset (Building B) to be used as security for the performance guarantees and letters of credit in order for Company A to secure a contract.

· you have personally loaned funds, unsecured and interest free, to Company A

· as controller of B Trust, you have loaned trust funds, unsecured and interest free, to Company A

· that despite your divorce from A in the X's and the fact that you are not a shareholder or director of Company A, you continue to be involved in the 'family' business and have provided advice and financial support to Company A.

Therefore, it can be concluded that Company A acts, or could reasonably be expected to act, in accordance with your directions and wishes, or in concert with you. Accordingly, Company A would be considered your affiliate.

Active asset test

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

· you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

· you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

Importantly, subsection 152-40(4) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset. Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use.

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

· the comparative areas of use of the premises (between rent and business)

· the comparative times of use of the premises (between rent and business), and

· the comparative levels of income derived from the different uses of the asset.

In your case, since 200X, you have held a 25% interest in the property which is used by your affiliate (Company A) in the course of carrying on its business. In X of the years since 200X, Company A has occupied at least 75% of the area of the property. The remaining area has been let on an arm's length basis to another entity. Since 20XX, Company A has occupied 100% of the area of the property.

The income derived from the arms length rental of the property during the period of ownership did not exceed business income in any single year.

Accordingly, it is considered that the main use of the property is not to derive rent and therefore the property will be an active asset. Further, as the asset has been an active asset for over half the period of your ownership, the asset satisfies the active asset test.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).