Edited version of your written advice

Authorisation Number: 1051243626925

Date of advice: 30 June 2017

Ruling

Subject: Application of Division 328 of the Income Tax Assessment Act 1997

Question 1

Is A and B a partnership as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and for the purposes of Division 328 of the ITAA 1997, in relation to their joint ownership of XX% of the ordinary shares in Company X?

Answer

Yes

Question 2

Does A control Company X pursuant to subsection 328-125(2) or subsection 328-125(7) of the ITAA 1997?

Answer

Yes, A indirectly controls Company X pursuant to subsection 328-125(7) of the ITAA 1997.

Question 3

If the answer to question 1 is yes, will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that A and B (as a partnership) do not control Company X?

Answer

Yes

Question 4

If the answer to question 2 is yes, will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that A does not control Company X?

Answer

Yes

This ruling applies for the following period

Income tax year ended 30 June 2017

Relevant facts and circumstances

Company X is an Australian proprietary company.

Prior to April XXXX A and AA each owned YY of the XYZ ordinary shares in Company X.

In recognition of the contribution that B made in running Company X, A and AA each transferred YY% interest in XX of their shares to B (to be held as joint tenants).

In November XXXX, the directors of Company X resolved to split the shares on a 2 for 1 ratio, meaning that Company X now had ABC shares on issue.

B then acquired AA’s shares and the remaining YY% interest in the shares that B and AA owned jointly.

B financed the purchase of these shares through a loan which was secured by personal guarantee and mortgage over the assets of Company X.

Since November XXXX:

● B has owned XYZ shares (YY%) in their own right and less than 100 shares jointly with A (XX%); and

● A has owned X shares (X%) in their own right and less than 100 shares jointly with B (XX%).

As a result, B is entitled to a percentage of all capital distributions and dividends paid by Company X and A is entitled to a percentage.

Company X has not declared any dividends since the date B acquired the shares from A.

An Amended Constitution for Company X was adopted in November XXXX. Amongst other things, this constitution provides:

● subject to clause X, B will be entitled to chair all Shareholder meetings and has a casting vote at those meetings

● any person present at a meeting of members shall have one vote and on a poll every person present in person or by proxy or other duly authorised representative has one vote for each share they hold

● A will be entitled to the voting rights attached to shares jointly held by A and B unless a Disqualifying Event has occurred in respect of A

● a Disqualifying Event means any of the following events occurring in relation to a person:

● the person dies

● the person resigns as a director

● the person becomes of unsound mind or a person whose person or estate is liable to be dealt with in any way under the law relating to mental health; and

● the person is prohibited from being a director under the Corporations Act

● subject to clause X, B will be entitled to chair all meetings of Directors and has a casting vote at those meetings

● clause X, which only applies whilst A is the joint owner of any shares with B and no Disqualifying Event has occurred in respect of A, specifies:

● if A and B cannot agree whether a dividend should be paid or on the amount of a dividend, B has the casting vote on any resolution relating to a Required Dividend

● if A and B cannot agree whether a dividend should be paid or on the amount of a dividend, A has the casting vote on any resolution in relation to all other dividends; and

● some decisions (as listed) require unanimous approval of shareholders.

B has control of the day-to-day operations and is responsible for making all decisions other than those outlined in clause X and does not consult with A on operational matters.

B has authority to undertake all banking transactions for Company X.

A and B do not have a joint bank account.

A and AA sold a property in February XXXX.

A and AA operated a Farming Partnership on that property until the sale of that property.

A was a YY%’s partner in the Farming Partnership and therefore controlled it for the purposes of section 328-125 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 328

Income Tax Assessment Act 1997 paragraph 328-115(2)(b)

Income Tax Assessment Act 1997 section 328-125

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

Income Tax Assessment Act 1997 paragraph 328-125(1)(b)

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

Income Tax Assessment Act 1997 paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 subparagraph 328-125(2)(a)(ii)

Income Tax Assessment Act 1997 paragraph 328-125(2)(b)

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

Income Tax Assessment Act 1997 subsection 328-125(7)

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

Reasons for decision

All legislative references in this document are to the ITAA 1997.

Question 1

Summary

A and B are a partnership for income tax purposes in relation to their ownership of XX% of the ordinary shares in Company X as joint tenants.

Detailed reasoning

The term 'partnership' is defined in subsection 995-1(1) to mean:

(a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly; or

(b) a limited partnership.

The first limb of paragraph (a) reflects the general law definition of a partnership, which is the relation which subsists between persons carrying on a business in common with a view of profit.

A and B are not carrying on a business as partners by virtue of their co-ownership of shares in Company X, and therefore do not satisfy the first limb.

Pursuant to the second limb of paragraph (a) in the above definition, an association of persons will nevertheless be treated as a partnership for income tax purposes when in receipt of ordinary income or statutory income jointly.

Therefore, co-owners of shares (such as A and B, being an 'association of persons’) may come within the definition of partnership for income tax purposes where they are in receipt of income (in the form of dividends) jointly.

The fact that Company X has not declared any dividends since A and B jointly held their shares in Company X, such that they are yet to actually receive any income jointly, does not change this outcome - see paragraph 25 of GSTR 2004/6 Goods and services tax: tax law partnerships and co-owners of property which provides:

To be in receipt of income jointly, it is not necessary to have actually received the income. We consider that there is receipt of income jointly if there is a joint entitlement to income.

Question 2

Summary

A does not directly control Company X pursuant to subsection 325-125(2). However, A indirectly controls Company X pursuant to subsection 325-125(7).

Detailed reasoning

For the purposes of the operation of paragraph 328-115(2)(b), subsection 328-125(1) provides that 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 an entity that is a company may be established via satisfaction of either of two tests set out in subsection 328-125(2). That provision provides:

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 – own, or have the right to acquire the 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 – own, or have the right to acquire the ownership of, 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.

A does not directly control Company X pursuant to subsection 328-125(2) as he personally only owns 1% of the shares (interests) in Company X, with no right to acquire the ownership of more shares in Company X, and this shareholding does not carry a right to:

● receive a percentage that is (for the purposes of the test at paragraph 328-125(2)(a)) at least XY% of any distribution of income or capital by Company X; or

● exercise, or control the exercise of, a percentage that is (for the purposes of the test at paragraph 328-125(2)(b)) at least XY% of the voting power in Company X.

Subsection 328-125(7) contains an indirect control test and applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly or indirectly controlled by the second entity.

A directly controls the partnership between them and B pursuant to subsection 328-125(2) as they personally own YY% of the interests in the partnership and this shareholding carries a right to receive a percentage (YY%) that is (for the purposes of the test at subparagraph 328-125(2)(a)(ii)) at least XY% of the net income of the partnership.

The partnership between A and B directly controls Company X pursuant to subsection 328-125(2) as it owns XX% of the shares (interests) in Company X and this shareholding carries a right to receive a percentage (XX%) that is (for the purposes of the test at paragraph 328-125(2)(a)) at least XY% of any distribution of income or capital by Company X.

As A has a YY% direct interest in the partnership which in turn has a XX% direct interest in Company X, A is taken to indirectly control Company X pursuant to subsection 328-125(7).

Questions 3 and 4

Summary

The Commissioner will exercise his discretion under subsection 328-125(6) to determine that neither A and B in partnership or A individually control Company X.

Detailed reasoning

If an entity's control percentage (as referred to in subsection 328-125(2)) in an entity ('the other entity’) is at least 40% but less than YY%, the Commissioner may determine under subsection 328-125(6) that the first entity does not control the other entity if the Commissioner thinks that the other entity is controlled by a third entity (other than an affiliate of the first entity).

For the Commissioner to be able to consider the exercise of the discretion in subsection 328-125(6) there must be a single, identifiable third entity that has a control percentage of at least XY% of the other entity. 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 other entity in the way described in subsection 328-125(2). Unless the conditions of subsection 328-125(2) are met the Commissioner cannot determine that the first entity does not control the other entity.

If there was a third entity with a control percentage of XY% 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 other entity 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 other entity if such responsibilities are shared.

For the reasons set out in explanation to the response provided to question 2 of this ruling, the partnership between A and B controls Company X pursuant to subsection 328-125(2), and A is taken to control Company X pursuant to subsection 328-125(7). Each of these entities has a control percentage of less than YY%.

B (being the 'third entity’ referred to above) also directly controls Company X pursuant to subsection 328-125(2) as she personally owns YY% of the shares in Company X and this shareholding carries a right to:

● receive a percentage (YY%) that is (for the purposes of the test at paragraph 328-125(2)(a)) at least 40% of any distribution of income or capital by Company X; and

● exercise, or control the exercise of, a percentage that is (for the purposes of the test at paragraph 328-125(2)(b)) at least 40% of the voting power in Company X.

Of the three entities who are identified as having control of Company X pursuant to section 328-125, the Commissioner is of the view that Company X is controlled by B and will consequently exercise his discretion under subsection 328-125(6) to determine that neither A and B in partnership or A individually control Company X.

This view is reached on the cumulative basis of the following factors:

● through a combination of their individual and joint shareholding in Company X, B effectively owns a percentage of the equity interests in Company X and thus has an entitlement to a percentage of all dividends and capital distributions

● B alone controls the day-to-day operations of Company X

● B alone controls the banking operations of Company X

● subject to decisions on matters listed in clause X, B has the casting vote at shareholder meetings and, as such, has more than YY% of the voting control at these meetings; and

● subject to decisions on matters listed in clause X, B has the casting vote at director meetings and, as such, has more than YY% of the voting control at these meetings.

As A is not held to have control of Company X (pursuant to subsection 328-125(6)), Company X will not be a connected entity of the Farming Partnership pursuant to paragraph 328-125(1)(b).

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