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Edited version of your written advice
Authorisation Number: 1051334771799
Date of advice: 6 February 2018
Ruling
Subject: Maximum net value asset test
Question 1
Will the Commissioner exercise his discretion under subsection 328-125(6) of the Income tax Assessment Act 1997 (ITAA 1997) to determine that you do not control entity A?
Answer
Yes.
Question 2
Is entity A connected with you for the purpose of the maximum net value asset test in section 152-15 of the ITAA 1997?
Answer
No.
This ruling applies for the following period
Year ending 30 June 2017
The scheme commenced on
1 July 2016
Relevant facts
You are an Australian resident for tax purposes and were a shareholder of entity A.
Entity A is an Australian incorporated proprietary company.
You held 45% of the total shares on issue in entity A.
The remaining two shareholders in entity A were entity B and the entity C, holding 45% and 10% respectively of the total shares issued.
All issued shares carried the same rights to dividends, capital and voting power.
Entity D is the trustee of the entity B.
Entity E and Entity F are the trustees of the entity C with entity E being the Principal.
Entity A had two directors, entity D and entity G. Entity E was an associate director. Entity G is your spouse.
The shareholder’s agreement provided that entity D and entity G were joint managing directors and secretaries of entity A. They were both responsible for the management, strategic decision-making and the day-to-day operation of the company.
A director’s meeting was held on a weekly basis and was attended by entity D and entity G and entity E.
You had no participation or responsibility for the day-to-day and strategic running of the company. Your only involvement was with shareholder resolutions in the years when the company paid a dividend.
Shares in entity A were sold.
A capital gain arose to you from the sale of your shares in entity A.
Relevant legislative provisions
Income Tax Assessment Act 1997 – Division 152
Income Tax Assessment Act 1997 – Division 328
Detailed reasoning
Small business relief
In order to access the small business concessions contained in Division 152 of the ITAA 1997, the basic conditions contained in section 152-10 of the ITAA 1997, in addition to any conditions relevant to each specific concession must be satisfied.
Division 328 of the ITAA 1997 also provides relevant rules and definitions for small business entities.
Connected with an entity
The meaning of connected with an entity is defined under subsection 328-125(1) of the ITAA 1997 which states:
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 a company
Subsection 328-125(2) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own:
● interests in the company that give them the right to receive at least 40% (the control percentage) of any distribution of income or capital; or
● equity interests in the company that carry between them the right to exercise at least 40% (the control percentage) of the voting power in the company.
An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you (section 328-130 of the ITAA 1997). A trust, partnership or superannuation fund cannot be an affiliate.
Commissioner may determine that an entity does not control another entity
The Commissioner’s discretion, as set out in subsection 328-125(6) of the ITAA 1997 states the following:
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.
For the Commissioner to be able to consider the discretion in subsection 328-125(6) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage of at least 40% of the company. 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 company in the way described in subsection 328-125(2) of the ITAA 1997. Unless the conditions of subsection 328-125(2) of the ITAA 1997 are met by a third entity, the Commissioner cannot determine that the first entity does not control the company.
If there was a third entity with a control percentage of 40% 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 company 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 company if such responsibilities are shared.
It is necessary to consider the interpretation of section 328-125(6) of the ITAA 1997 with regard to the meaning of the term ‘connected with you’ as set out in section 328-125(1) of the ITAA 1997, and the concept of control as set out in section 328-125 of the ITAA 1997.
Application to your circumstances
As you held a 45% shareholding and entitlement to distributions of income and capital from entity A, you automatically satisfy the control test under subsection 328-125(2) of the ITAA 1997.
This control percentage falls within the range allowed for under subsection 328-125(6) of the ITAA 1997. Therefore, you may request that the Commissioner determine that you do not control entity A.
Entity D also held a 45% interest in entity A.
As there was a third entity that could be taken to control entity A in accordance with subsection 328-125(2) of the ITAA 1997, it is necessary to consider additional factors such as who was responsible for the day to day and strategic running of the company. In this case entity D and entity G were responsible for the management and day to day strategic running of the company. You had no participation or responsibility for the day-to-day and strategic running of entity A.
Considering the facts provided, the Commissioner is satisfied that you did not control entity A as the company was controlled by another entity. The other entity was not regarded as your affiliate under Division 328 of the ITAA 1997. Accordingly, the Commissioner will exercise the discretion contained in subsection 328-125(6) of the ITAA 1997.
Maximum net asset value test
Section 152-15 of the ITAA 1997 contains the maximum net asset value test. This is one of the options that an entity could satisfy to take advantage of the concessions in Division 152 of the ITAA 1997.
As outlined in section 152-15, an entity satisfies the maximum net asset value test if, just before the relevant CGT event, the sum of the net value of their CGT assets and those of their connected entities and affiliates is $6 million or less.
In your case, as determined above you do not control entity A so entity A is not your connected entity. You are not connected with entity A for the purpose of the maximum net value asset test.
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