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Edited version of your written advice
Authorisation Number: 1051306171063
Date of advice: 13 November 2017
Ruling
Subject: The Commissioner's determination under subsection 328-125(6) of the Income Tax Assessment Act 1997
Will the Commissioner make a determination, under subsection 328-125(6) of the Income Tax Assessment Act 1997, that the company is not controlled by Individual X, in any year during the ruling period that Individual X owns between 40% and 50% of the equity interests in the company?
Answer
Yes
This ruling applies for the following period:
1 July 2014 to 30 June 2020
Relevant facts and circumstances
Individual X and Individual Y started a company, each owning half of the shares in it. Individual Y was appointed Chief Executive Officer (CEO) of the company.
Sometime later, Individual X and Individual Y entered into an agreement that provided Individual X was to adhere to the decisions and directions of Individual Y, as CEO, and that the CEO may have an irrevocable proxy in casting any vote. This agreement was contingent on the admission of the company to the Australian Securities Exchange (ASX), which occurred a short time later. Relevant clauses of this agreement which detail the obligations of the parties were provided.
After this, Individual X’s shareholding generally amounted to between 40%–45% of the company, and at times it has dropped below 40%.
Individual X is a non-executive director of the board of the company. Although issues are discussed at the board meetings, which Individual X attends, the ultimate decision making lies with Individual Y. There are executive directors on the board. Individual X is not involved in the day-to-day running of the business.
Individual X does not have any personal assets that are used in the business.
Individual X and Individual Y are not spouses and they reside in different locations.
Relevant legislative provisions
Income Tax Assessment Act 1997 subsection 328-110(1)
Income Tax Assessment Act 1997 subsection 328-115
Income Tax Assessment Act 1997 subsection 328-125(1)
Income Tax Assessment Act 1997 subsection 328-125(2)
Income Tax Assessment Act 1997 subsection 328-125(6)
Income Tax Assessment Act 1997 subsection 328-130
Reasons for decision
Issue 1
Question 1
Summary
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 Income Tax Assessment Act (ITAA 1997) that the first entity does not control the company if the Commissioner thinks that it is controlled by another entity, other than an affiliate of the first entity.
The Commissioner makes the determination that Individual X does not control the company.
All references are to the ITAA 1997.
Detailed reasoning
Under subsection 328-110(1), an entity may be a small business entity for an income year if it carries on a business in the current year and its aggregated turnover for the current or previous year was less than $10 million.
Section 328-115 provides that an entity’s aggregated turnover includes the entity’s turnover for the income year, and also the annual turnover of any connected entities and affiliates of the entity.
The meaning of ‘connected entity’ is detailed in section 328-125, which provides:
328-125(1) 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.
Direct control of an entity other than a discretionary trust
328-125(2) 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;
(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.
(Items marked with an asterisk (*) are defined in the dictionary at section 995-1 of the ITAA 1997).
At a number of times since the company’s inception, Individual X has owned at least 40% of the equity interests in the company that carry the right to exercise voting power in relation to those equity interests.
Therefore, under section 328-125, during periods that Individual X holds at least 40% of the company, Individual X controls, and is connected with, the company for the relevant income years.
However, section 328-125 also provides the Commissioner with discretion to determine that Individual X does not control the company. Subsection 328-125(6) states:
If the control percentage referred to in subsection (2) or (4) 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.
It is therefore necessary to determine whether the company is controlled by other parties than Individual X or Individual X’s affiliates. In determining this, factors such as day-to-day involvement in the company, strategic decision making, and the roles of other shareholders are considered.
The other large shareholder of the company is Individual Y, CEO and chairperson of the board of directors of the company. The agreement Individual X and Individual Y entered into provides that Individual X will vote in accordance with Individual Y’s directions and provide an irrevocable proxy, if required, to Individual Y in relation to Individual X’s voting rights.
In practice, Individual X votes in accordance with the agreement and the ultimate decision making lies with Individual Y. The day-to-day management of the business is handled by the executive directors, who also hold senior management positions within the company. Issues with the business are discussed at board meetings, but the strategic decision making responsibility lies with Individual Y and the executive directors.
It is also necessary to consider whether Individual X’s affiliates control the company. The term ‘affiliate’ is defined in section 328-130, which states:
328-130(1) An individual or a company is an affiliate of yours if the individual or company 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 *business of the individual or company.
328-130(2) However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.
A spouse may also be an affiliate for small business relief purposes, under section 152-47.
Individual Y is not an affiliate of Individual X as they are not spouses and, based on the facts presented above, Individual Y could not reasonably be expected to act in accordance with Individual X’s directions, or in concert with Individual X, in relation to the business affairs of the company.
Accordingly, based on the facts and circumstances, the Commissioner determines that Individual X does not control the company in any year during the ruling period that Individual X owns between 40% and 50% of the equity interests in the company.
This ruling does not consider any other factors in determining whether Individual X is a small business entity under section 328-110, nor has it considered Individual X’s eligibility for any specific small business entity concessions.
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