Edited version of your written advice

Authorisation Number: 1012986971739

Date of advice: 23 March 2016

Ruling

Subject: Commissioner's discretion under subsection 103A(5) of the Income Tax Assessment Act 1936 (ITAA 1936)

Question 1

Would the Commissioner exercise his discretion under subsection 103A(5) of the ITAA 1936 to deem the Company to be a public company for the income year ended 31 December 20xx if it does not meet the test in paragraph 103A(3)(a) of the ITAA 1936 at a time in the year ended 31 December 20xx?

Answer

Yes

This ruling applies for the following periods:

Period ending 31 December 20xx

The scheme commences on:

1 January 20xx

Relevant facts and circumstances

The Company has a SAP ending 31 December.

The Commissioner exercised his discretion under subsection 103A(5) of the ITAA 1936 to deem the Company to be a public company for the prior income year.

The Company was listed on the Australian Securities Exchange (ASX) in the income year ended 31 December 20xx. These shares were not shares entitled to a fixed rate of dividend.

The purpose of the initial public offer (IPO) was to raise capital to repay the Company's existing corporate debt, strengthen the Company's balance sheet and provide access to equity markets. The offer also provided institutional and retail investors the opportunity to invest in the Company (creating a liquid market for the company's shares).

The IPO comprised an offer to issue a substantial amount of fully paid ordinary shares in the Company and the sale of a large number of fully paid ordinary shares.

The market capitalisation of the Company increased significantly since listing and is consistent with that of a public company.

The number of beneficial owners in the issued capital of the Company is substantial and consistent with that of a listed public company.

Substantial Shareholder Notices lodged following the IPO have been used to analyse the persons holding interests through various nominees. On the basis that these holdings have not changed substantially, these notices have been used in analysing the shareholder composition.

Based on these notices, the top 20 shareholders held more than 75% of the ordinary shares on issue.

A number of these top 20 shareholders were nominee companies which beneficially held shares for more than one underlying beneficial owner. After tracing through these nominee shareholders to their underlying beneficial owners, the top 20 shareholders held less than 75% of the interests in the Company. These nominal shareholders are not associates of each other.

The voting rights and dividend rights attaching to the ordinary shares in the Company are within the bounds of what could reasonably be expected in the case of a public company.

Management and operation of the Company, the conduct of general meetings, appointment and remuneration of directors, distribution of profits and winding up provisions would be comparable to other publicly listed companies.

The Company is not a co-operative company as defined by section 117 of the ITAA 1936.

The Company has been carried on for the purposes of profit or gain to its individual members.

The Company is not a mutual life insurance company.

The Company is not a friendly society dispensary.

The Company is not a body constituted by a law of the Commonwealth or of a State or Territory and established for public purposes, not being a company within the meaning of the law in force in a State or Territory relating to companies, or a company in which such body has or ever had a controlling interest in.

The Company is not a subsidiary of a public company.

A family group do not control more than 50 per cent of the voting power of the Company.

Assumption

At a time in the income year ended 31 December 20xx the Company will not satisfy the 20 person 75% test in paragraph 103A(3)(a) of the ITAA 1936. The Company remains listed on the ASX.

Relevant legislative provisions

Acts Interpretation Act 1951 subsection 22(1)

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 103A(2)

Income Tax Assessment Act 1936 paragraph 103A(2)(a)

Income Tax Assessment Act 1936 paragraph 103A(2)(b)

Income Tax Assessment Act 1936 paragraph 103A(2)(c)

Income Tax Assessment Act 1936 paragraph 103A(2)(d)

Income Tax Assessment Act 1936 subsection 103A(3)

Income Tax Assessment Act 1936 subsection 103A(5)

Income Tax Assessment Act 1936 subsection 103A(7)

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Regulations 1997, Schedule 5, regulation 995-1.05

Reasons for decision

All references refer to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise stated.

Issue 1

Question 1

Summary

The Commissioner would exercise his discretion under subsection 103A(5) to deem the Company to be a public company for the income year ended 31 December 20xx if it does not meet the test in paragraph 103A(3)(a) at a time in the year ended 31 December 20xx.

Detailed reasoning

Subject to the succeeding provisions of section 103A, a company will be a public company in relation to a year of income, if it satisfies at least one of the conditions in paragraphs (a) to (d) of subsection 103A(2). Subsection 103A(2) provides:

For the purposes of subsection (1), a company is, subject to the succeeding provisions of this section, a public company in relation to the year of income if:

(a) shares in the company, not being shares entitled to a fixed rate of dividend with or without a further right to participate in profits, were listed for quotation in the official list of a stock exchange, being a stock exchange in Australia or elsewhere, as at the last day of the year of income;

(b) at all times during the year of income, the company was a co-operative company as defined by section 117;

(c) the company has not, at any time since its formation, been carried on for the purposes of profit or gain to its individual members and was, at all times during the year of income, prohibited by the terms of its constituent document from making any distribution, whether in money, property or otherwise, to its members or to relatives of its members; or

(d) the company is

(i) a mutual life assurance company;

(ii) a friendly society dispensary;

(iii) a body constituted by a law of the Commonwealth or of a State or Territory and established for public purposes, not being a company within the meaning of the law in force in a State or Territory relating to companies;

(iv) a company in which a Government or a body referred to in subparagraph (iii) had a controlling interest on the last day of the year of income; or

(v) in relation to the year of income, a subsidiary of a public company.

The Company satisfies paragraph (a) of subsection 103A(2) because shares in the Company, not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits, were listed for quotation in the official list of the ASX as at the last day of the year of income ended 31 December 20xx.

The Company did not satisfy any of the conditions in paragraphs (b) to (d). Specifically;

• The Company did not satisfy paragraph (b) because it was not at all times during the year of income a co-operative company as defined by section 117.

• The Company did not satisfy paragraph (c) because it has been carried on for the purpose of profit or gain to its individual members.

• The Company did not satisfy paragraph (d) because it was not any of the following:

• a mutual life assurance company

• a friendly dispensary society

• a body constituted by a law of the Commonwealth or of a State or Territory and established for public purposes, not being a company within the meaning of the law in force in a State or Territory relation to companies, or a company in which such a body; or a Government had a controlling interest on the last day of the year of income, or

• a subsidiary of a public company in relation to the year of income ending 30 June 20xx.

As the Company has satisfied at least one of the conditions in subsection 103A(2), it will be a public company in relation to the year of income ended 31 December 20xx, unless a subsequent provision of section 103A applies. Relevantly, the Company will also need to satisfy subsection 103A(3).

Is subsection 103A(3) of the ITAA 1936 satisfied?

Subsection 103A(3) provides that:

Subject to subsection (5), a company is not, by virtue of paragraph (2)(a) or (b), a public company for the purposes of subsection (1) in relation to the year of income where:

(a) at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, shares representing not less than three-quarters of the value of the shares in the company, other than shares entitled to a fixed rate of dividend only;

(b) at any time during the year of income, not less than three-quarters of the voting power in the company was capable of being exercised by one person or by persons not more than 20 in number;

(c) not less than three-quarters of:

(i) the amount of any dividend paid by the company during the year of income; or

(ii) if more than one dividend was paid by the company during the year of income - the total amount of all dividends paid by the company during the year of income,

was paid to one person or to persons not more than 20 in number; or

(d) a dividend was not paid by the company during the year of income but the Commissioner is of the opinion that, if a dividend had been paid by the company at any time during the year of income, not less than three-quarters of the amount of that dividend would have been paid to one person or to persons not more than 20 in number.

Broadly, subsection 103A(3) requires that at all times during the year of income, more than 20 persons own (or have the right to acquire) 75% of the equity capital in the company and have a right to 75% of the voting power and dividends paid (the '20 person 75% test').

The test in subsection 103A(3) applies to "persons". The term "persons" is defined in subsection 6(1) to have the same meaning as in the Income Tax Assessment Act 1997 (ITAA 1997). Subsection 995-1(1) of the ITAA 1997 states that a person includes a company. Subsection 22(1) of the Acts Interpretation Act 1901 provides that unless the contrary intention appears, expressions to denote persons generally (including the word person) shall include a body politic or corporate as well as an individual. Therefore, each company or body corporate in the shareholder structure of the Company will be considered a person for the purposes of the test in subsection 103A(3).

Post listing, the top 20 shareholders held more than 75% of the ordinary shares on issue. On the surface, it appears that the Company may have failed the test prescribed by subsection 103A(3). However, by virtue of the operation of subsection 103(3) of the Act, the Commissioner is required to look beyond the nominal shareholdings of the Company.

Subsection 103(3) is concerned with the definition of an indirect interest held in a company. The section states that:

For the purposes of this Division, shares in a company shall be deemed to be held indirectly on behalf of or for the benefit of a person (not being a private company, trustee or partnership) if in the event of the payment of a dividend on those shares, that person would, otherwise than as a shareholder of the company, receive the whole or a pan of that dividend if there were successive distributions of the relative parts of that dividend to and by each of any private companies, trustees or partnerships interposed between the company paying the dividend and that person.

The section indicates that in determining the control of a company, regard should be had to the ultimate recipient of the beneficial interest in the shares held, rather than the nominal ownership of those shares.

Related to this provision is subsection 103A(7) that discusses the nomineeship of a person by another person or entity. The section determines that a person, his relatives and nominees and his relatives' nominees are deemed to be one.

Due to the operation of subsection 103(3) above, the definition of "held indirectly" not only goes behind the legal ownership of shares held in trust to the beneficiaries, but also goes behind the legal entity of an interposed company to its shareholders, in order to determine the individuals who would be the ultimate recipients in the event of distributions by a company and by any partnerships, trustees or other companies interposed between that company and those individuals.

The decision of Case El2, 73 ATC 81 discussed the operation of subsection 103A(7) in determining whether a certain company, which was listed on the ASX, satisfied the 20 person 75% test of subsection 103A(3). The Board of Review unanimously held that nomineeship is to be apportioned as between the different principals for whom a nominee is a nominee in relation to shares held by that nominee.

The effect of this decision, for present purposes, is that a nominee's holdings should only be grouped together with each of its investors separately. A nominee should not be grouped together with all of its investors and treated as one entity for the purposes of subsection 103A(3).

Thus, whilst on the surface it may appear that the Company may fail the 20 person 75% test prescribed by subsection 103A(3) of the Act, subsection 103(3) directs the Commissioner to look at the underlying ownership of the company.

Amongst the top 20 shareholders of the Company are several nominee companies that held shares in the Company for two or more underlying beneficial owners. The exact percentage shareholdings of these underlying beneficial owners cannot be determined with certainty, as this information is not published or made available publicly. However, to the extent that the applicant was provided with this information, via reports and Substantial Shareholder Notices, it has traced through a number of these nominee shareholders to their underlying beneficial owners.

Based on this analysis of the information, the top 20 shareholders held less than 75% of the interests in the Company. The applicant has submitted that it can reduce this percentage even further by tracing through to the underlying beneficial owners (by excluding shares held by public companies and tracing through the other nominee shareholders). However, the percentage shareholdings of these underlying beneficial owners are unknown.

Based on all available information at the current time, after tracing through to the underlying beneficial owners, the top 20 shareholders held less than three quarters of the shares in the Company. Therefore, by virtue of the operation of subsection 103(3) of the Act, the Company appears to be a public company for taxation purposes.

However, it is possible that the Company may inadvertently fail the 20 persons 75% test during the year ended 31 December 20xx given its shareholders are able to freely trade their shares via the ASX. Therefore it cannot be ascertained with certainty whether the Company will continually satisfy the 20 person 75% test in the year ended 31 December 20xx.

However, the 20 person 75% test contained within subsection 103A(3) is subject to the Commissioner's discretion under subsection 103A(5) of the Act, to treat a company as a "public company" if he considers it reasonable to do so.

Therefore, for the purposes of this private ruling, an assumption has been made that at a time in the income year ended 31 December 20xx the Company will not satisfy the 20 person 75% test in paragraph 103A(3)(a). This has been done so that the possible future application of the Commissioners discretion can be considered.

The Commissioners discretion

The Commissioner has a discretionary power under subsection 103A(5) to treat a company as a public company even though it does not satisfy one or more of the prescribed conditions in section 103A.

Subsection 103A(5) provides that:

Where a company would not, under the preceding provisions of this section, be a public company for the purposes of subsection (1) in relation to the year of income but the Commissioner is of the option that, having regard to:

(a) the number of persons who were, at any time during the year of income, capable of controlling the company and whether any of those persons was a public company;

(b) the market value of the shares issued by the company before the end of the year of income;

(c) the number of persons who beneficially owned shares in the company at the end of the year of income; and

(d) any other matters that the Commissioner thinks relevant,

it is reasonable that the company should be treated as a public company for the purposes of subsection (1) in relation to the year of income, the company shall be deemed to be a public company for those purposes in relation to the year of income.

The Commissioner has issued guidance as to the consideration of these factors and when the discretion will be exercised. This guidance considers the specific factors referred to above as well the other matters that the Commissioner thinks are relevant in deciding whether to exercise the discretion in subsection 103A(5). They include:

• Canberra Income Tax Circular Memorandum number 847 (CITCM no. 847).

• Public Information Bulletin number 3 (PIB no. 3).

• ATO Interpretative Decision ATO ID 2004/760 Income Tax: Private company held as an investment by a superannuation fund: discretion to treat as public company (ATO ID 2004/760).

As an overarching principle ATO ID 2004/760 states that:

The main question to be considered when exercising the discretion is whether the company reasonably falls within the concept of a public company.

This requires balancing all the relevant factors referred to in subsection 103A(5) of the ITAA 1936 to determine whether the company reasonably falls within the concept of a public company.

ATO ID 2004/760 notes that the principal features of a public company are:

• that shares in the company (other than fixed rate preference shares) be quoted on the official list of a stock exchange at the end of the income year; and

• that 20 or fewer persons shall not at any time during the year of income own (or have the right to acquire) 75% of the equity capital in the company or have a right to 75% of the voting power or dividends paid (20 person 75% test).

It is noted that the Company satisfies the first of the features as it was listed on the ASX at the end of the income year. The ASX is listed as an approved stock exchange under regulation 995-1.05 of Schedule 5 of the Income Tax Assessment Regulations 1997.

As mentioned previously, the Company initially satisfies the 20 person 75% test under subsection 103A(3). However, it is possible that the Company may inadvertently fail the 20 persons 75% test during the 31 December 20xx income year. Therefore, an assumption has been made for the purposes of this private ruling that the Company will not satisfy the test at all times under section 103A.

The Commissioner has considered the situation where a listed company temporarily fails to comply with the 20 persons 75% test at page 4 of PIB No. 3. Relevantly, PIB No. 3 provides:

There may, from time to time, be cases in which a company [listed on a stock exchange] temporarily fails to comply with the "20 persons/75 percent" test. This situation could occur without the knowledge of the company, for example, where a purchaser of shares has them registered in the name of a nominee and neither the directors nor the employees of the company are aware of the circumstances.

In the case of such accidental failures to comply with the test, sympathetic consideration will be given to the exercise of the discretion, especially where efforts are made as soon as reasonably practicable to remedy the position.

Based on the information available, the Commissioner finds that sympathetic consideration should be given to the Company regarding the exercise of the Commissioner's discretion as the Company would potentially fall within the circumstance of accidental failures to comply with the 20 person 75% test.

In addition, it will be an unnecessary burden for the Company to have to monitor its shareholdings throughout the year to ensure that the 20 person 75% test is continuously satisfied. The Commissioner recognises this potential burden on listed companies at page 3 of PIB No. 3 where he states:

At this stage, it may be made clear that listed companies will not generally be required to establish by positive information that [the 20 persons 75%' test] have been satisfied at all times during the year of income. If any other view were taken, companies that are clearly public companies could be put to a great deal of unnecessary trouble and expense.

As a result, it is necessary to undertake a detailed examination of each relevant factor referred to in subsection 103A(5) to further demonstrate that the Company reasonably falls within the concept of a public company.

(a) The number of persons capable of controlling the company and whether any of those persons was a public company

The control of a company generally resides in the voting power of its shareholders to carry out a resolution at a general meeting of the company (WP Keighery Pty Ltd v Federal Commissioner of Taxation (1957) 100 CLR 66).

To assist in applying the legislation to the Company's case, it is instructive, if not binding, to examine the policy objectives in relevant explanatory memorandums to amendments to the Division. In the Explanatory Memorandum to Income Tax Assessment Bill 1948, commentary was written about the concepts of what is a private company and a public company for the purposes of the application of the revenue law;

CLAUSE 2.-DEFINITIONS.

…

"Private company" is defined in section 103(1.) to mean a company which is under the control of not more than seven persons, and which is not a company in which the public are substantially interested or a subsidiary of a public company.

Section 103(2.)(c) provides that a company shall be deemed to be under the control of any persons where the major portion of the voting power or the majority of the shares is held by those persons or nominees of those persons or where the control is, by any other means whatever, in the hands of those persons.

This construction of the definition was successfully challenged before the Full High Court in Adelaide Motors Ltd. v. Federal Commissioner of Taxation (1942) 66 C.L.R. 436, and in Federal Commissioner of Taxation v. West Australian Tanners and Fellmongers Ltd. (1945) 70 C.L.R. 623.

These decisions of the Court have clearly established that, where the shareholders of a company are more than seven in number, that company is not a private company unless control of the company is actually exercised by seven or less persons. If this actual control is not demonstrable, the Company is not a private company as at present defined.

In accordance with the reasoning above, this attribute is more indicative of a private company rather than a public company. Therefore, the Commissioner considers that the Company's circumstances in relation to this factor do not support the exercise of the discretion in subsection 103A(5).

(b) The market value of the shares issued by the company before the end of the year of income

The market value of the shares issued by the Company before the end of the income year is substantial and is what would be expected of a public company rather than a private company. This factor supports the exercise of the Commissioner's discretion to treat the Company as a public company.

(c) The number of persons who beneficially held shares in the company at the end of the year of income

ATO ID 2004/760 indicates that a larger number of shareholders is more indicative of a public company and states that:

Whilst a company with several hundred shareholders and a paid up capital of $20 million would generally be more likely to be accepted as a public company than a company with 30 shareholders and a small amount of paid up capital, there is no specific quantum of shareholders or paid up capital that is required to have the discretion exercised.

In the Company's case, the large number of shareholders, the existence of nominee companies holding shares for multiple underlying beneficial owners and the increase in the number of shareholders post listing indicates that there would be a substantial number of persons who beneficially held shares in the Company at the end of the income year. This factor supports the exercise of the discretion in subsection 103A(5).

(d) Any other matters that the Commissioner thinks relevant

Both CITCM no. 847 and PIB no. 3 provide guidance as to how the discretion in subsection 103A(5) is to be exercised. In each instance, the guidance provides a number of factors that are to be considered. These factors are relevant to determining whether the Company falls within the general concept of a public company.

CITCM no. 847 provides that the discretion in subsection 103A(5) may usually be exercised where:

(a) the Company has sufficiently large paid-up capital and wide spread of shareholdings to enable it to obtain a listing on a stock exchange in an Australian capital city;

(b) the dividend policy of the Company is consistent with what might be expected of a listed public company in similar general circumstances to the Company;

(c) the Company is not controlled by a family group for shareholders, i.e., the family group do not control more than 50 per cent of the voting power;

(d) the voting and dividend rights attached to the shares are in all material respects, comparable with rights normally attached to shares of a listed public company; and

(e) the appointment and rotation of directors is undertaken in the same manner as is done in the case of listed public companies.

The Company has sufficiently large paid-up capital and wide spread of shareholdings to enable it to obtain a listing on a stock exchange in an Australian capital city. It was in fact listed on the ASX during the income year ending 31 December 20xx and remains listed on the ASX.

The dividend policy of the Company as shown by their IPO prospectus is consistent with what would reasonably be expected in the case of a listed public company.

The Company is not controlled by a family group for shareholders.

The voting rights and dividend rights attaching to the ordinary shares in the Company are within the bounds of what could reasonably be expected in the case of a public company.

The appointment and rotation of directors in the Company is considered to be undertaken in reasonably the same manner as is done in the case of listed public companies.

The Company satisfies all the points referred to in CITCM no. 847 that are favourable to the exercise of the discretion and this supports the exercise of the Commissioner' discretion in subsection 103A(5).

PIB no. 3 states in relation to unlisted companies that:

Expressed in very broad terms, the question will be "Does the company fall within the general concept of a public company?". The prospects of the discretion being exercised to grant public company status will thus be enhanced if;

(a) the dividend policy of the company; and

(b) the dividend and voting rights attached to particular classes of shares,

are within the bounds of what could reasonably be expected in the case of a public company.

As noted above the Company's dividend policy and the voting and dividend rights attaching to its shares are consistent with what would be expected of a listed public company in similar circumstances. They are within the bounds of what could reasonably be expected in the case of a public company and this further supports the exercise of the Commissioner's discretion under subsection 103A(5).

Conclusion

In determining whether to exercise the discretion to treat a company which does not satisfy one or more the prescribed conditions of a public company, the Commissioner must have regard to the factors in subsection 103A(5). In cases such as the present, where some of the factors support the exercise of the discretion and others do not, it is necessary to balance the factors to reach a conclusion as to whether the Company reasonably falls within the concept of a public company.

Whilst a small number of persons are capable of controlling the Company, and it cannot be concluded with certainty as to whether the Company satisfies the 20 person 75% test post listing on the ASX, other relevant factors and matters examined are consistent with those that would be expected of a public company. These supporting considerations include that:

• the shares of the Company were listed on the official list of the ASX at the end of the income year

• the appointment and rotation of directors of the Company is consistent with what would be expected of a listed public company

• the dividend policy of the Company as shown by their IPO prospectus is consistent with what would could reasonably be expected in the case of a listed public company

• the voting rights and dividend rights attaching to the ordinary shares in the Company are within the bounds of what could reasonably be expected in the case of a public company

• the number of beneficial owners in the issued capital of the Company is substantial and consistent with that of a listed public company, and

• the market value of the issued capital of the Company is substantial and consistent with that of a public company.

On the balance of considerations, the Commissioner considers that the Company reasonably falls within the concept of a public company and would exercise his discretion under subsection 103A(5) to treat the Company as a public company for the year ended 31 December 20xx.

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