1051466365358 | Legal database

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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your written advice

Authorisation Number: 1051466365358

Date of advice: 16 January 2019

Ruling

Subject: Direct control of an entity other than a discretionary trust – s 368-125(2) ITAA 1997

Question 1

Will the Commissioner exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) determine that Company B does not control Company A for the purposes of section 328-125 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June YYYY

Date on which the scheme commences:

1 July XXXX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1. Company A (‘the company’) is an Australian resident proprietary company.

2. The company has X ordinary shares on issue, held as follows:

● Individual X, ABC shares X%

● Individual Y, D share X%

● Individual Z, EF shares X%

● Company B, 412 shares X%

3. All ordinary shares on issue have equal voting rights and rights in relation to distributions of income and capital attached to them.

4. Individual X is Managing Director of and holds greater than 50% of the voting power of the company, and determines any distributions of capital and income of the company.

5. Individual X holds greater than 50% of the shares in Company A and has control of, and makes all decisions in relation to, and undertakes all management of the company.

6. Individual X’s position of Managing Director, and recognised position of ‘owner’ and ‘boss’ of Company A has never been brought into question.

7. Company B holds X% of the shares in Company A, and does not have any affiliates in relation to Company A.

8. No action on the part of Company B indicates that Company B does not recognise Individual X’s control of and capacity within Company A.

9. The annual turnover of Company A for the relevant period was less than the ‘aggregated turnover threshold’ (under section 328-115 of the ITAA 1997) for a ‘base rate entity’. However, if the annual turnover amounts for the annual period in question of Company A and Company B were combined, the aggregated turnover for Company A for the annual period would exceed the aggregated turnover threshold for it to qualify as a ‘base rate entity’ for the period.

10. Company A and Company B are unrelated companies – ie are not affiliates.

11. Individual X does not control Company B.

12. No agreements or options exist between Individual X, Company A or Company B in relation to the ownership of Company A, other than Company A’s company constitution.

13. There are no alternate debt or equity instruments on issue which convey rights to shareholders outside of the rights held by shareholders in accordance with Company A’s company constitution.

14. All rights applying to shareholders are solely in accordance with Company A’s company constitution.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-125

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

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

Income Tax Assessment Act 1997 Section 328-115

Income Tax Assessment Act 1997 Section 328-130

Question 1

Summary

The Commissioner will exercise the discretion contained in subsection 328-125(6) of the ITAA 1997 to determine that Company B does not control Company A for the purposes section 328-125 of the ITAA 1997

Detailed reasoning

1. The meaning of a connected entity is defined under section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997) which states as follows:

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

2. 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.

3. 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

4. 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.

5. The Advanced Guide to Capital Gains Tax Concessions for Small Business 2013-2014 NAT 3359 (Advanced Guide) discusses the application of the discretion contained in subsection 328-125(6) of the ITAA 1997.

6. The Advanced Guide provides that 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.

7. 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.

8. 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(2) of the ITAA 1997.

Application to your circumstances

9. In this case there are two entities that ‘control’ Company A under subsection 328-125(2) of the ITAA 1997, on the basis that they own interests in Company A that carry with them the right to receive at least 40% of any distribution of income by Company A – based on their ownership of shares in the company:

● Individual X, ABC shares X%

● Company B, GHI shares X%

10. Individual X and Company B and are not affiliated with each other.

11. Individual X holds the majority shareholding in the company – owning X% of Company A’s shares.

12. In this case, for the purposes of subsection 328-125(6) we are considering Company B to be the first entity in relation to Company A and Individual X to be an ‘entity other than the first entity’, or ‘third entity’ in relation to Company A.

13. As there are two entities that could be taken to control Company A in accordance with subsection 328-125(2) of the ITAA 1997, it is necessary to consider additional factors such as which entity is responsible for the day to day and strategic running of the company to determine which entity/s control the company.

14. As previously stated, based on the interests owned by Company B in Company A, Company B controls Company A under subsection 328-125(2) of the ITAA.

15. However, based on the information provided by the applicant, Individual X (who based on the interests he owns in Company A also controls Company A under subsection 328-125(2) of the ITAA):

● owns X% of the shares in the company

● is Managing Director and holds greater than 50% of the voting power of the company

● determines any distributions of capital and income of the company (within the constraints of the company constitution)

● has control of, and makes all decisions in relation to the company

● undertakes all management of the company

● is recognised as the ‘owner’ and ‘boss’ of the company.

16. Based on the information provided by the applicant, Company B:

● owns X% of the shares in Company A

● is unrelated to Company A

● does not have any affiliates in relation to Company A

● recognises Individual X’s capacities/roles within Company A (as set out above)

● does not participate in the management of Company A.

17. The Commissioner is satisfied that Individual X controls Company A as he manages the business and makes all of the day-to-day and strategic decisions for the company.

18. Even though Company B has a control percentage under subsection 328-125(2) of the ITAA of between 40% and 50% in Company A, the Commissioner is satisfied that Company B does not control Company A as Company A is controlled by Individual X.

Conclusion

19. Accordingly, the Commissioner will exercise the discretion contained in subsection 328-125(6) of the ITAA 1997 to determine that Company B does not control Company A for the purposes section 328-125 of the ITAA 1997.

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