Edited version of your written advice

Authorisation Number: 1013140170217

Date of advice: 19 December 2016

Ruling

Subject: Division 6C of the Income Tax Assessment Act 1936

Question 1

For the purposes of paragraph 102N(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936), will the Trust control or be able to control, directly or indirectly, the affairs or operations of New Co, or an entity that New Co controls or is able to control, directly or indirectly, because of Trust's minority shareholding in New Co?

Answer

No.

This ruling applies for the following periods:

Year ending 31 December 20UU

Year ending 31 December 20VV

Year ending 31 December 20WW

Year ending 31 December 20XX

Year ending 31 December 20YY

Year ending 31 December 20ZZ

The scheme commences on:

During the year ending 31 December 20UU

Relevant facts and circumstances

The scheme that is the subject of this ruling is as follows:

1. The Trust is an Australian resident for income tax purposes.

The Proposed Restructure (Restructure) and Facts

2. It is proposed that New Co will be interposed between Original Co and its shareholders - Shareholder 1 and the Trust (the Shareholders).

3. The Trust will hold a minority shareholding in New Co.

4. New Co will be a resident for tax purposes in the foreign country.

5. New Co, and its various subsidiaries, may have or control a trading business.

6. The restructure will be implemented in 20VV.

7. No investor or similar agreement will be entered into between the Shareholders of New Co to govern their rights in New Co, in addition to the New Co's proposed constitution and relevant law.

8. There will be no amendments to New Co's proposed constitution during the period to which this Ruling applies that would have a material impact on this Ruling.

Assumption

9. There will be no amendments to the relevant law that would have a material impact on this Ruling.

Relevant legislative provisions

Income Tax Assessment Act 1936 paragraph 102N(1)(b)

Reasons for decision

Question 1

For the purposes of paragraph 102N(1)(b) of the ITAA 1936, will the Trust control or be able to control, directly or indirectly, the affairs or operations of New Co, or an entity that New Co controls or is able to control, directly or indirectly, because of Trust's minority shareholding in New Co?

Detailed reasoning

Division 6C of Part III of the ITAA 1936 broadly provides that a 'public unit trust' which is carrying on a 'trading business', or controlling another person's 'trading business' - that is, anything which is not wholly 'eligible investment business' - will be a public trading trust. The combined effect of section 102S of the ITAA 1936 and section 25 of the Income Tax Rates Act 1986 is that the net income of a 'public trading trust' is taxed at the company rate.

The rules that determine when a unit trust will be treated as a trading trust are in subsection 102N(1) of the ITAA 1936. It states:

For the purposes of this Division, a unit trust is a trading trust in relation to a year of income if, at any time during the year of income, the trustee:

(a) carried on a trading business; or

(b) controlled, or was able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a trading business.

Trading business

The term 'trading business' is defined in section 102M of the ITAA 1936 to mean a business that does not consist wholly of eligible investment business.

Paragraph 102N(1)(a) of the ITAA 1936

For completeness, the Trust's ownership of shares in New Co is considered to be investing in shares in a company, and therefore meets paragraph (b) of the definition of 'eligible investment business' in section 102M of the ITAA 1936. Therefore, the ownership of shares in New Co will not, of itself, constitute carrying on a trading business for the purposes of paragraph 102N(1)(a) of the ITAA 1936.

Paragraph 102N(1)(b) of the ITAA 1936

The terms 'control' or 'controlled' are not defined for the purposes of Division 6C of the ITAA 1936. Therefore, the terms are to be construed according to their ordinary meaning, having regard to the context and purpose of section 102N of the ITAA 1936.

According to the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 4) 1985, what is now paragraph 102N(1)(b) of the ITAA 1936:

… is a safeguarding provision against arrangements to circumvent the operation of Division 6C by having activities that would constitute a trading business of a public unit trust carried on by an associated entity. By taking income from the associate in the form of eligible investment income, the trustee could otherwise ensure that the relevant trust did not qualify as a trading business and so avoid the operation of Division 6C.

The ordinary meaning of 'control' is defined in the Australian Oxford Dictionary (2004, Oxford University Press, Melbourne) as:

● the power of directing, command;

● the power of restraining, especially self-restraint; and

● a means of restraint; a check.

Therefore, the concept of 'control' encompasses both the positive aspect of directing or commanding, and the negative aspect of restraining. The control of a company may operate at both the shareholder and director level. Shareholders exercise control by means of majority voting rights, as well as by blocking actions or decisions.

The terms 'affairs' and 'operations' are not defined in the income tax legislation. The 'affairs' of a company, on ordinary concepts, include its business and its internal affairs: Re National Foods Ltd (No 1 and 2) (2005) 54 ACSR 80 at [55]. In the context of a company, Winn J in R v. Board of Trade; Ex parte St Martin Preserving Co Ltd [1964] 2 All ER 561 at 568 stated:

... the phrase "affairs of the company" comprises all its business affairs, interests or transactions, all its investment or other property interests, all its profits and losses, and its goodwill.

The term 'operations', on the other hand, is explained in the singular in the Australian Oxford Dictionary (1999, Oxford University Press, Melbourne) as:

● an action, or process or method of working or operating;

● an active process, a discharge of a function; and

● a piece of work, especially one in series.

Thus, the word 'operations' has a narrower meaning than 'affairs' and would sit more comfortably as a reference to the day-to-day business of the company rather than its business structure. However, the concept of 'affairs' may include 'operations'.

Legal corporate control

The Trust currently has a minority of the shareholder voting rights in Original Co. It is expected that the Trust will continue to hold a minority of the shares in New Co.

The Trust will not have the ability to positively control New Co notwithstanding that the Trust will become the largest direct shareholder in New Co.

Therefore, the Trust will not have legal corporate control of New Co.

Negative control

The ATO's draft paper of 2 September 2015 titled 'Guidance paper: Negative Control and the application of Division 6C' (Negative Control Paper) provides further guidance around negative control in the context of section 102N of the ITAA 1936.

The Negative Control Paper acknowledges that for the purposes of Division 6C of Part III of the ITAA 1936, the relevant affairs or operations of the person to which the provision is directed are only those that go to the trading business activities actually being carried on. Veto rights relating to the affairs or operations of an entity other those relating specifically to the carrying on of the trading business should not impact upon control under Division 6C.

Negative control clauses either require that certain decisions are approved by a super majority of the board of directors, or require a special resolution by a super majority of shareholders. Whether a specific clause requires board or shareholder approval varies from case to case.

Investor agreements can have multiple approval requirements for the same activity depending on its materiality. Investor agreements can also be structured such that minority investors will have different veto rights depending on their ownership level.

In the present case, there will be no investor agreement between the Shareholders in New Co. Shareholder rights will be dealt with exclusively by the proposed constitution and the relevant law.

Applying the Negative Control Paper and having regard to the proposed constitution and relevant law, and as there will be no investor agreement that has a bearing on the control of the affairs or operations of New Co, the Trust will not control New Co for the purposes of paragraph 102N(1)(b) of the ITAA 1936.

Conclusion

Therefore, for the purposes of paragraph 102N(1)(b) of the ITAA 1936, the Trust will not control or be able to control, directly or indirectly, the affairs or operations of New Co, or an entity that New Co controls or is able to control, directly or indirectly, because of the Trust's minority shareholding in New Co.

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