Edited version of private advice

Authorisation Number: 1051847535247

Date of advice: 3 June 2021

Ruling

Subject: Commissioner's determination - control over an entity

Question

Will the Commissioner exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 to determine that C does not control the company?

Answer

No.

This ruling applies for the following period periods:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Relevant entities

The Company operates a business.

A and B formed the Company in year xxxx. A and B were the founding managers, original shareholders, and sole employees.

C Pty Ltd ('C') acquired a 49% interest in the Company through a Share Sale Agreement entered in 2018, and appointed a delegate to be a director of the Company. C is a member of the XYZ Group.

The Company's annual turnover is less than $XX million. C's annual turnover is more than $XX million. The Company seeks the Commissioner's discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 to treat C as not controlling the Company for the purposes of determining the Company's aggregated turnover.

The Company has 3 current shareholders:

•         A, in his capacity as trustee for A's Trust: 25.5%

•         B1 Pty Ltd in its capacity as trustee for B's Trust: 25.5%

•         C: 49%.

All shares carry equal rights to votes, income, and capital distributions.

The Company's board consists of A, B and a director nominated by C.

C seeks to acquire minority interests in high-growth and well-run financial planning businesses. C generally seeks to acquire between 20-40% of the shares when investing, and does not generally seek to acquire more than 50%. C's strategy is to act as a passive investor, generating dividend income, and does not seek operational or legal control of the businesses in which it invests.

The applicant has submitted that C's role is to provide strategic value via a long-term partnership, and assist with a succession solution for A and B. B wishes to exit the business within the next 5 years, and A desires to leave the business in 10 to 15 years from now. The applicant submits that C is not seeking any management role as new principals step into management as B and A exit.

C has no relationship with either the Company, A or B, other than its status as a shareholder in the Company.

C' initial proposal was that it would acquire no more than 40% of the shares in the Company. However, A and B wished C to take a greater share in the Company for personal reasons, including paying down personal debts.

A and B control the decision-making and management of the Company's day-to-day operations. The applicant submits that they collectively act as the controlling minds. They have been partners for 10 years. Neither C nor its nominees have any involvement in decisions. A and B have always acted together, and have never voted against each other in shareholder or director meetings.

Before becoming 50/50 partners and directors of the Company in year xxxx, B and A had met and formally worked together some years earlier.

In year xxxx, B started to look for a business partner to acquire 50% of his business and sought out A. At that time, both B and A agreed that they would each own 50% of the business and, in doing so, would both continue to work together to ensure the Company thrived.

The applicant submits that, from that time, A and B run the practice as a united team (e.g., formal internal weekly meetings to staff to present a unified front), with any business decisions always being agreed by both parties before presenting to the team. This could be described as conducting the business on a 'consensus basis'. For example:

•      when hiring staff, both B and A attended the interviews and made the hiring decisions

•      B and A have always drawn equal pay, equal dividends and always discussed if and when any of these needed to change to ensure they were both happy before proceeding

•      if there was a need to spend some funds for ad-hoc business purposes, they always agreed to discuss this first and to collectively agree to it

•      when one was away on leave, the other would always ensure client phone calls and meetings were attended by that person still working. This ensured clients and the market saw B and A as a joint offering where, if one was not available, the other would be there to assist.

B and A are close friends beyond their business relationship and have spent time holidaying together and socialising together. Their respective spouses are personal friends and they socialise outside of the work environment. For instance, both B and A are members of the same social club and continue to interact personally outside of our business on a personal basis.

The applicant has submitted that, in terms of the negotiations with C, both C and B/A agreed it was very important that B/A were seen as the (singular) majority shareholder with one voice and not two disparate minority shareholders. All discussions with C and advisors by B and A were undertaken collectively and with a single voice and the same is true for all board and management meetings (e.g., decisions are made by B and A and then presented to C out of courtesy at quarterly board meetings).

Neither A nor B act in accordance with the other's wishes or directions when making decisions despite them seeking to run the business on a consensus basis.

The Constitution

The current version of the Company's Constitution was adopted in 2018 after C acquired 49% of the shares. On or around the same date, C, A, B, A's Trust, B's Trust and the Company entered a Shareholders Deed. The Shareholders Deed was amended during 20XX ('the 20XX amendments').

Clause Z.Z of the Constitution says that the Constitution is 'subject to the Shareholders Deed in all respects'. Clause Z.Z says 'to the extent of any inconsistency between this Constitution and the Shareholders Deed, the Shareholders Deed prevails and the Shareholders must amend this Constitution to remove any inconsistency.'[1]

To summarise the effect of some of the provisions governing voting and meetings:

•         quorums at general (shareholder) meetings and board/director meetings must include an C nominee: clauses Z.Z and Z.Z

•         shareholder resolutions are carried by majority, and the chairperson does not have a casting vote: clauses Z.Z and Z.Z

•         shareholders have one vote for each ordinary share they hold: clause Z.Z

•         decisions at directors meetings are determined by majority,[2] and the chairperson does not have a casting vote: clauses Z.Z and Z.Z.

Original form of the Shareholders Deed

We summarise what we see as relevant clauses in the Shareholders Deed, before the 20XX amendments took effect, at paragraphs 23 through 34.

Shareholders must exercise their rights to ensure that the Board is composed, and that Board meetings are carried out, in accordance with Schedule Y to the Shareholders Deed: clause 6.

Schedule Y to the Shareholders Deed sets out procedures for the board's composition and conduct of board meetings:

•         Management Shareholders (defined as all shareholders other than C) may appoint one director for each 20% of share capital they hold: clause Z.Z

•         Management Shareholders must not appoint directors from XYZ Group competitors without C's consent: clause Z.Z

•         C may appoint up to 2 directors if it holds up to 40% of the capital, and an additional director for each 20% of share capital it holds above 40%: clause Z.Z

•         each director has one vote for each share held by his or her nominating shareholder: paragraph Z(z)

•         where more than one director nominated by the same shareholder is present at a meeting, each of those directors shall have the number of votes equal to the number of shares held by the nominating shareholder, divided by the number of their nominee directors present: paragraph Z(z)

•         all decisions are by simple majority, but the majority must include all directors appointed by the C shareholder: paragraph Z(z)

•         the chairperson does not have a casting vote: paragraph Z(z).

Management powers (such as day-to-day management, general administration, implementing the business plan) are vested in the Board and Managing Director: Clause Z.

The Company must not do, or commit to do, any of the things listed in Schedule Z ('Schedule Z Matters')[3] without the consent of C: Clause Z.Z.

The Schedule Z Matters are broad, and cover topics including:

•      appointing directors

•      acquiring securities

•      borrowing, entering mortgages, giving guarantees

•      undertaking activities not covered by the business plan

•      adopting or varying a business plan, or other operating, capital, cash budget or business financial plan

•      acquiring or disposing of any company or business

•      stopping a business plan, or altering the scale of operations, or starting any business or operational activities

•      selling a substantial part of the business or substantially all of the assets

•      acquiring or disposing of assets with a value exceeding $50,000

•      incurring capital expenditure of more than $10,000

•      entering into, materially varying, or terminating agreements with directors/shareholders

•      making loans

•      adopting or altering an employee share plan

•      paying remuneration to directors

•      paying bonuses to directors

•      proposing a special resolution of shareholders

•      setting or changing the dividend policy

•      altering insurance

•      undertaking a reorganisation event

•      entering a lease costing more than $10,000, except in accordance with the business plan

•      listing the Company, winding up, or altering the Constitution.

The Board was required to:

•      submit draft Business Plans to C for approval: subparagraph Z(z)(z)

•      recommend changes to the Business Plan to C for consideration: paragraph ZZ.Z(z)

•      recommend the outcomes of strategic planning sessions requiring amendments to the Business Plan to C for consideration: clause Z.Z.

If C did not approve a Business Plan, the previous Business Plan would remain in force: clause Z.Z.

The Company was required to distribute at least 90% of its profits to shareholders each financial year: paragraph Z(z).

Shares could not be issued or sold to competitors of XYZ Group: paragraph ZZ.Z(z) and clause Z.Z.

Shares could not be sold to third parties without the approval of shareholders holding at least 75% of the shares, which must include C, unless C is the seller: clause Z.Z.

Shareholders were prevented from selling shares to other shareholders without C's consent: clause Z.Z.

Broadly, shareholders seeking to exercise a 'drag along' power had to include C (that is, other shareholders could not approve a takeover and 'drag along' C by compelling it to sell its shares to the acquirer): paragraph Z.Z(z).

The amendments to the Shareholders Deed

The 20XX amendments purport to take effect from 1 July 20XX. We summarise what we see as the most relevant amendments at paragraphs 36 through 40.

Clause Z was amended to remove references to Clause Z, and add a new paragraph Z(z) which said the Board was responsible for the Schedule Z Matters.

Clause Z was deleted - so that the Schedule Z Matters no longer required C's consent.

The requirement for the Board to submit the draft Business Plan to C for approval in subparagraph Z(z)(z) was removed.

Clause Z.Z was changed to replace references to C with 'the Board'.

Paragraph Z(z) of Schedule Y was amended to remove the requirement that for Board decisions, the majority must include all directors appointed by the XYZ Group Shareholder.

However, the amendments do not affect:

•         clause Z.Z, which requires the outcomes of strategy sessions requiring amendments to the Business Plan to C for consideration

•         paragraph Z(z) which requires the Company to distribute at least 90% of profits to shareholders each financial year

•         paragraphs Z(z) and Z, which prevent shares being issued or sold to competitors of XYZ Group

•         clause Z.Z, which prevents shares being sold to third parties without the approval of shareholders holding at least 75% of the shares, which must include C

•         clause Z.Z, which prevents shareholders from selling shares to other shareholders without C' consent

•         clause Z, that shareholders cannot exercise a 'drag along' power unless the 'dragging' shareholders include C.

The applicant has submitted that:

•      the inclusion of the items in the Shareholder Deed relating to C providing approval in respect of, for example, the Business Plan are legacy powers, and all that is intended by these items is to ensure that certain decisions which go to the protection of C's investment in the company (as opposed to control of the company) are made unanimously

•      these powers are not unusual from a commercial perspective and would be found in a number of agreements involving significant (e.g., 20%), but not major or controlling shareholders

•      the existence of these powers does not provide support for the basis that such powers result in control either from a practical or legal perspective.

Other points about the Shareholders Deed

C's involvement in the Company is generally limited to being provided with monthly financial reports (as prepared by Management) for dividend purposes.

To the extent that any Schedule Z Matters arise, C has always provided its consent and has never once rejected a consent matter.

C's purpose in requiring consent for Schedule Z Matters was to ensure that business critical decisions, such as whether to sell the business to third parties, are decided by unanimous consent of all major shareholders.

C does not envisage ever relying on its power to withhold consent to a Schedule Z Matter, unless A and B sought to undertake a radical new strategy, such as selling the business to a third party.

C views its power to withhold consent as a power of last resort designed for critical decisions, as a means of ensuring that Management cannot destroy shareholder value, and that decisions on Schedule Z Matters are made unanimously rather than by majority.

Relevant legislative provisions

Section 328-115 of the Income Tax Assessment Act 1997

Section 328-125 of the Income Tax Assessment Act 1997

Section 328-130 of the Income Tax Assessment Act 1997

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997

Question

Will the Commissioner exercise his discretion under subsection 328-125(6) to determine that C does not control the company?

Summary

No. The Commissioner will not exercise his discretion under subsection 328-125(6). While C has more than 40% and less than 50% of the shares in the Company, the Commissioner does not think that another entity or other entities control the company in a sense which enlivens the discretion.

Detailed reasoning

Relevant concepts

Taxpayers need to determine their aggregated turnover for many reasons under taxation laws, including access to concessions.

An entity's aggregated turnover includes the annual turnover of entities connected with it: subparagraph 328-115(2)(b).

Subsection 328-125(1) says that an entity is connected with another entity if:

•         either entity controls the other entity in a way described in this section, or

•         both entities are controlled in a way described in this section by the same third entity.

The relevant effect of subsection 328-125(2) (for entities other than discretionary trusts) is that an entity controls a company if, together with its affiliates, it has rights to, or rights to acquire interests to, at least 40% of either income, capital, or votes.

Subsections 328-125(3) and 328-125(4) are control tests for discretionary trusts. Broadly, an entity will control a discretionary trust if the trustee either:

•         acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity or its affiliates, or

•         pays or applies at least 40% of any distributions of income or capital to the entity or its affiliates.

The general effect of subsection 328-125(7) is that entities may control other entities 'indirectly' through 'directly' controlled entities.

Subsection 328-125(6) says:

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.

Subsection 328-125(6) was discussed in the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007, under the subheading 'the Commissioner's discretion,' at paragraphs 2.59 and 2.60:

2.59 Where an entity's interest in another entity is at least 40 per cent but less than 50 per cent the Commissioner may choose to ignore the interest of that entity in the other entity if the Commissioner determines that a third entity actually controls the other entity. [Schedule 1, item 1, subsection 328-125(6) of the ITAA 1997]

2.60 The Commissioner may think that another entity controls the entity either based on fact or on a reasonable assumption or inference. Whether or not the third entity has a 40 per cent interest may assist in determining whether the third entity controls the other entity, but it is not decisive.

The Explanatory Memorandum provides only one illustration of how the Commissioner's discretion in subsection 328-125(6) may operate. Example 2.10 suggests that it may be appropriate for the Commissioner to determine that a 42% shareholder does not control a company, where that shareholder has no dealings with the company's manager, who holds the remaining 58% of the shares.

The meaning of 'affiliate' is set by section 328-130:

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.

The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 also contained the following relevant paragraphs, under the subheading 'when is an entity an affiliate of another entity?'

2.36 The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert:

•         family or close personal relationships;

•         financial relationships or dependencies;

•         relationships created through links such as common directors, partners, or shareholders;

•         the degree to which the entities consult with each other on business matters; or

•         whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

2.37 None of these factors are determinative in their own right.

....

2.39 Similarly, an individual or company is not automatically an affiliate merely because of a business relationship [Schedule 1, item 1, subsection 328-130(2) of the ITAA 1997]. For example, co-directors, co-trustees or partners are not necessarily affiliates. Also, directors are not automatically affiliates of the company of which they are a director, nor would the company automatically be an affiliate of the directors.

...

2.40 Only an individual or company can be an affiliate of another entity. Entities (for tax purposes) such as trusts, partnerships, and superannuation funds are not capable of being affiliates of entities.

Subsection 328-125(6) allows the Commissioner to determine that one entity ('the first entity') does not control another entity ('the target entity') if:

•         the first entity has a control percentage in the target entity of at least 40% but less than 50%, and

•         the Commissioner thinks that the target entity is controlled by:

-        an entity controlled by an entity other than, or

-        entities that do not include

the first entity or any of its affiliates.

Therefore, there are two requirements which must be met before the Commissioner's discretion in subsection 328-125(6) may be exercised. The first entity's control percentage in the target entity must be at least 40% but less than 50%, and the Commissioner must think that another entity, or entities, control the target entity.

C has more 49% of the shares in the Company. Since this is more than 40% but less than 50%, the first requirement is met. Therefore, the discretion will be available if the Commissioner thinks that another entity, or entities, controls the Company.

It is therefore necessary to determine if either A, A's Trust, B, B's Trust (or a combination of these entities treated as a group) controls the Company in the sense required by subsection 328-125(6).

Does another entity, or entities, control the Company?

We consider that the discretion in subsection 328-125(6) is a strict test of legal control. Control over day-to-day management, or effective 'practical' control, may be a factor that points towards legal control, but on its own is not enough to establish legal control. Merely pointing towards another entity that has a control percentage of greater than 40% under subsection 328-125(2) is not enough. It needs to be another entity that could control, or does control, the company. As discussed at paragraphs 76 and 77, we do not consider that two or more unrelated entities habitually acting together, or conducting the business on a 'consensus basis' necessarily would have legal control of an entity, for the purposes of determining whether the discretion in subsection 328-125(6) is available.

The Macquarie dictionary says that meanings of 'control' (when used as a verb) include 'to exercise restraint or direction over; dominate; command'.[4]

We consider that 'legal control' means the powers which relevant powers can exercise under the relevant law, including applicable governing documents. For the Company, this means the Company's Constitution, the Shareholders Deed, as affected by Australian company law.

Considered together, the general effect of the Company's Constitution and the Shareholders Deed (as amended) is that:

•         directors manage the company: clause Z

•         director resolutions are determined by majority, the chair does not have a casting vote, and C need not be part of the majority: paragraphs Z(z) and Z(z) of Schedule Y

•         each director has votes equal to the number of shares held by their appointing shareholder: paragraphs Z(z) and Z(z) of Schedule Y

•         shares can't be sold or transferred without C's consent: clauses Z.Z, Z and Z

•         directors must distribute at least 90% of company profits as dividends to ordinary shareholders: paragraph Z(z).

The effect of the revised Schedule Z to the Shareholder Deed is that the Board will determine a broad list of topics mentioned at paragraph 27. This list of Schedule Z Matters would cover many operational or management decisions relevant to running the Company. Therefore, the Board is the company organ with the legal authority to operate or manage the Company.

We consider that for the Commissioner to think that an entity or entities control the Company, that entity or entities would need to be able to determine Board decisions, either directly, or indirectly through its right to appoint or remove directors. An entity will not be able to demonstrate legal control of the Company if it cannot determine Schedule Z Matters in its favour without the support of other parties. In other words, if entity Y cannot determine a decision or resolution on a Schedule Z Matter if entity Z disagrees with it, entity Z does not control the Company.

Do either A, or B, considered independently, control the Company?

A and B are current board members, alongside a third board member nominated by C. A's Trust and B's Trust each hold 25.5% of the company's shares.

Shareholders have the power to appoint directors, subject to Schedule Y to the Shareholders Deed. Clause Z.Z of Schedule Y says that a Management Shareholder with at least 20% of the shares may appoint one director, and remove or replace them from time to time. Therefore, under current shareholdings, A's Trust and B's Trust can only appoint one director each. Clause Z.Z of Schedule Y to the Shareholders Deed says C can appoint up to two directors if it holds up to 40% of the Share Capital, and an additional director for each additional 20% above 40%. While C only currently has one director, since it has 49% shares, it has the power to appoint two directors. However, this does not entitle C to extra votes when determining board decisions. The effect of clause Z of Schedule Y is that directors have votes equal to the number of shares held by their controlling shareholder, divided by the number of directors appointed by them.

Therefore, at Board meetings, A, B and the C nominee will have votes equal to the number of shares respectively held by A's Trust, B's Trust, and C. The former requirement that the C nominees must be part of the majority was removed by the 20XX amendment.

From the current shareholding and Board composition, neither A nor B (or their trusts) considered independently, would be able to carry a motion without the support of another shareholder or director. For example, for A to carry a motion in a Board meeting, he or she would need either the support of B or C. Similarly, for A's Trust to carry a shareholder resolution, it would need the support of B's Trust or C. Therefore, it cannot be said that any of A, A's Trust, B, or B's Trust, taken independently, can demonstrate the legal power to control the company.

The applicant contends that A and B should be treated as a 'collective' entity which controls the Company. This raises two subsidiary questions:

•         can A and B be considered as a collective?

•         if A and B can be considered as a collective, do they control the company in the sense required by subsection 328-125(6)?

Can A and B be considered as a collective?

Subsection 328-125(6) will only apply if the Commissioner thinks that the Company is controlled by 'an entity other than, or by entities that do not include, the first entity or any of its *affiliates'. The use of 'entities' suggests that multiple entities could, in some circumstances, exercise collective control. It is not clear on the face of subsection 328-125(6) in what circumstances or situations it would be appropriate for the Commissioner to think that multiple entities have collective control. We discuss this topic at paragraphs 75 to 96.

The Explanatory Memorandum does not address the meaning of 'entities' in this subsection, or provide any guidance on the circumstances in which the Commissioner might think two or more entities would exercise collective control for the purposes of subsection 328-125(6).

As mentioned at paragraph 63, we take the view that control, in the context of subsection 328-125(6), requires strict legal control. Given this view, we consider that it would not be appropriate for the Commissioner to treat multiple entities as a collective unless they have a relationship which clearly demonstrates a common identity or collective interests, that would mean they do together have actual legal control of the business (for example, they are affiliates). Although shareholders might have some common identity or collective interests (for example, a common desire for the entity to generate profits), something more than this would be needed to show that the entities could be considered collectively as a group having legal control of the entity. We do not consider it appropriate to regard multiple unrelated entities as a collective simply where their combined votes, if they agreed, would carry a shareholder or board resolution.

Further, a habit or established practice of acting together, or conducting the business on a 'consensus basis', would not necessarily demonstrate that multiple unrelated entities can be considered as a group, or collective controllers for the purpose of establishing whether they have legal control of the business, for the purposes of determining whether the discretion in subsection 328-125(6) is available. This is because unrelated parties would normally only agree where they determined that collective action was in their individual interests. The relationship would not offer any guarantee or reasonable certainty that they would continue to act collectively, or make consensus decisions where their interests ceased to coincide. Once two independent, unrelated entities had conflicting interests about a company matter, they would be unlikely to vote together. Given that possibility, we do not see how we could be satisfied that unrelated entities could be a group which exercises legal control.

We consider that subsection 328-125(6) should be interpreted in the context of the entire section. Therefore, when addressing what sort of relationship would be appropriate to recognise entities as holding collective control, we find it helpful to consider subsection 328-125(2), which sets out the primary test for determining control of a company. This subsection operates on a single entity basis: it determines whether an entity, including its affiliates, controls the target entity.

We consider that this context suggests that the use of 'entities' in subsection 328-125(6) may be intended to cover multiple entities who are affiliates. Another example may be where the entities are connected under the control tests under subsections 328-125(2), 328-125(3) and 328-125(4), that is, one controls the other, or both are controlled by the same third entity.

There is no explicit requirement in subsection 328-125(6) that multiple entities must be 'affiliates' or 'connected entities' to exercise collective control. However, we consider that these are examples of circumstances in which it may be appropriate for the Commissioner to think that they exercise collective control. If entities are connected, they would most likely have common ownership and/or a common controlling mind. If entities are affiliated, one would either act in accordance with the directions or wishes of the other, or they both act in concert, in relation to any business they separately carry on. When considering control of a company, it would usually be reasonable to expect that two connected or affiliated shareholders or directors would always vote together in any shareholder or director resolution. They would be unlikely to have conflicting interests, and even if their personal interests sometimes diverged, their close relationship might override those interests to ensure agreement.

We consider it unlikely that a relationship between entities, where they were not affiliated or connected, and each exercises independent judgment, would provide the Commissioner with assurance that they would continue to act collectively in the future. Therefore, the Commissioner would be unlikely to think that those multiple entities held legal control.

A and B cannot be connected entities because they are both individuals. We have no information suggesting that A's Trust and B's Trust have common beneficiaries, that any common beneficiary received, or was entitled to receive at least 40% of distributions of income or capital in a relevant year, or that either trustee acts in accordance with the wishes or directions of the trustee of the other trust, or entities associated with the other trust. Therefore, we have no reason to think that A's Trust and B's Trust are connected under the control tests in subsections 328-125(2), 328-125(3), 328-125(4) or 328-125(7). We also have no reason to think that A's Trust is connected with B, or that B's Trust is connected with A.

Therefore, we will consider whether A and B are affiliates.

Subsection 328-130(1) establishes two alternative tests for establishing whether entities are affiliates. An individual or a company ('the first entity') is an affiliate of another entity ('the second entity') if the first entity acts, or could reasonably be expected to act:

•         in accordance with the second entity's directions or wishes, ('the directions or wishes test')or

•         in concert with the second entity ('the in concert test').

in relation to the affairs of the business of the first entity: subsection 328-130(1).

The applicant has submitted that A and B are affiliates because they have a business relationship, a personal relationship, and act as a united front in relation to Capital Private Wealth's business. However, neither A nor B act in accordance with the other's directions or wishes. Further, we do not consider that these circumstances are enough to make it reasonable to expect that either A or B would act in accordance with the other's directions or wishes, in relation to any individual business which either A or B might carry on. Therefore, neither A nor B are affiliates of the other under the 'directions or wishes' test.

It could be suggested that A and B are affiliates under the 'in concert' test. From the facts presented, A and B have always acted together, and have never voted against each other in shareholder or director meetings.

However, both the 'directions or wishes' and 'in concert' tests apply in relation to the affairs of the business of the individual or company. The relevant 'individual or company' here is A or B (that is, the entities being tested to see if they are affiliates), rather than the Company (that is, Capital Private Wealth).

A and B's have an established business relationship: they have been business partners for 10 years through their involvement in the Company's business. They also have a personal relationship, in that A, B and their spouses meet socially outside of work. However, this is not necessarily enough to establish an affiliate relationship. While A and B arguably 'act in concert' when making Company decisions, their relationship is limited to the Company's business: there is no suggestion that they act in concert for any separate private business which they might have, or carry on, as individuals. Therefore, they are not affiliates under the 'in concert' test. For that matter, there is nothing to suggest that either A or B act in accordance with the other's directions or wishes about any other private individual business which they might have, outside the Company. Further, subsection 128-130(2) says that individuals or companies are not affiliates of another entity simply because of the business relationship that they share.[5]

Since neither the 'directions or wishes' or 'in concert' tests have been met, it follows that neither A nor B is an affiliate of the other.

We consider that the same outcome under the 'directions or wishes' or the 'in concert' tests would apply among any related entities, in much the same way as it would between A and B as individuals. However, under section 328-130, only individuals or companies can be an affiliates of another entity.[6] Therefore, neither A's Trust nor B's Trust could be an affiliate of the other trust, or an affiliate of A or B.

The applicant has submitted that there is no requirement for the 'other' entities to be affiliates for the Commissioner to think that the other entities exercise collective control for the purposes of subsection 328-125(6).

Even though there may be no formal requirement in subsection 328-125(6) for entities to be affiliates or connected to establish collective control, we consider that the multiple entities must be linked or related in some significant way which affects their decision making, to meet the threshold of legal control for the purpose of determining whether the discretion in subsection 328-125(6) is available.

Here, A and B do not act in accordance with the other's directions or wishes, and we don't think it reasonable to expect that either would do so. While they have never voted against each other in practice, this is presumably because each, exercising their own independent judgment, have concluded that the resolution or decision supported their interests as a shareholder. We do not think that a mere history of voting together justifies treating multiple unrelated entities as exercising collective control. Rather, we consider this simply evidences that A and B have a style or preference for running the business on a consensus basis, as they both consider this achieves the best results for the business. If this was enough to treat multiple entities as having collective control, it would mean that a diverse group of unrelated parties with small shareholdings could be treated as 'controlling' another entity for the purposes of subsection 328-125(6). This seems an unlikely result.

If their interests did not align, or ceased to align, we expect that A or B could exercise their vote as a director to vote against a resolution advanced by the other. We do not see that their history of having run the business on a consensus basis up until now would ensure that they would continue to do so if their interests ceased to align. Nor do we see how we could be satisfied that their personal interests and independent business judgments will always align in the future, so that disagreement over a significant business decision could not arise.[7] Therefore, we do not see any compelling reason why they should be treated as a collective or group when determining whether they have legal control of the Company for the purposes of determining the subsection 328-125(6) discretion.

Further, C has never voted against any management decisions. If a history of voting together is enough for multiple entities to establish collective control for the purposes of the Commissioner's discretion under subsection 328-125(6), there would seem no reason to include A and B, but exclude C from the relevant group of entities.

We conclude that A and B (or their trusts) should not be treated collectively when determining whether they control the Company. Since neither A nor B can demonstrate individual control, and we do not consider it appropriate to treat them as a group exercising collective control, it follows that no other entity or entities controls the Company in the sense required by subsection 328-125(6). It follows that the Commissioner's discretion is not available.

Would A and B (or their trusts), if they were considered together, have legal control of the Company?

For completeness, we will consider whether the outcome would be different if A and B (or their trusts) can be considered to exercise collective control for the purposes of subsection 328-125(6).

As mentioned at paragraph 36, the Board is responsible for determining the Schedule Z Matters. These powers are extensive and cover many significant operational or management decisions.

A's and B's Trusts together hold 51% of the ordinary shares, and therefore 51% of the votes in Shareholder and Board meetings. A and B, voting together, could determine Board votes on any of the Schedule Z Matters, even if C voted against them. Clause Z.Z of Schedule Y of the Shareholders Deed allows C to appoint a second director. However, this does not entitle C to more votes in Board meetings. Since the 20XX amendments, there is no requirement for the majority to include C nominees. It could be suggested this means that A and B (or their trusts), if considered as a collective, do control the Company.

However, we consider that the Shareholders Deed, even as amended, still provides C with significant powers which, if exercised, could significantly limit the ability of A and B, and their trusts, to make significant decisions. For example:

•         if outcomes from strategy sessions require amendments to the Business Plan to be submitted to C for their consideration: Clause Z.Z

•         the company must distribute at least 90% of profits to shareholders each financial year: paragraph Z(z)

•         clauses Z.Z, Z.Z, Z.Z and Z.Z limit the Company's ability to transfer or issue shares to other parties without C' consent.

We have noted the applicant's submissions to the effect that the powers referenced in paragraph 100, are merely 'legacy' powers, are not unusual and may be held by minority shareholders, and do not provide control from either a practical or legal perspective. We disagree. Broadly, we consider that a shareholder with legal control would be able to change the Business Plan, direct the Board to retain profits rather than pay a dividend, or sell or issue shares without seeking the consent of another party. Therefore, A and B (or their trusts), even acting together, would not be able to demonstrate the level of legal control required by subsection 328-125(6).

Conclusion

The discretion in subsection 328-125(6) will only be available if the Commissioner thinks that another entity or entities controls the Company.

The Commissioner does not think that A and B (or their trusts) control the Company for the following reasons:

•         considered independently, they cannot determine significant matters without the support of each other, or C

•         they cannot be treated as a collective entity for the purposes of establishing control under subsection 328-125(6)

•         even if they are treated as a collective entity, they have restricted rights to change strategy, change dividend policy, issue or sell shares without C' agreement.

Since the Commissioner does not think that another entity or entities controls the Company, the discretion in subsection 328-125(6) cannot be exercised.

[1] Clause Z of the Shareholders Deed says "This deed prevails over any inconsistent clause in the Company's constitution and the Shareholders must amend the Company's constitution to remove any inconsistency as soon as they become aware of it."

[2] Clause Z.Z of the Constitution says 'each Director has one vote subject to the Shareholders Deed.' This would therefore be overridden by Clause Z of Schedule Y to the Shareholders Deed. The broad effect of Clause Z is that each Director has one vote for each share held by his or her nominating shareholder, however, if multiple directors appointed by the same shareholder are present, each director has the number of votes held by the nominating shareholder, divided by the number of directors appointed by that shareholder.

[3] In the original form of the Shareholders Deed, Schedule Z was titled 'XYZ Group Consent Matters.' After the 20XX amendments, the title was changed to 'General Group Company Matters.' We refer to the contents of Schedule Z as 'Schedule Z Matters' for convenience.

[4] Macmillan Publishers Australia, The Macquarie Dictionary online, www.macquariedictionary.com.au, accessed 1 June 2021.

[5] The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 says, at paragraph 2.39, that co-directors are not necessarily affiliates.

[6] The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 says, under the subheading 'entities that cannot be an affiliate', at paragraph 2.40: "only an individual or company can be an affiliate of another entity. Entities (for tax purposes) such as trusts, partnerships, and superannuation funds are not capable of being affiliates of entities."

[7] For example, we note that B and A have different plans to exit the business: B intends to leave within the next 5 years, while A desires to leave in 10 to 15 years. This illustrates one potential source of conflicting interests. As a general rule, one might expect that a shareholder who plans to leave the business in the next few years would favour decisions which maximised profits and dividends over the short term, while shareholders who expected to hold their shares for a longer period may be more willing to sacrifice short term profits and dividends by reinvesting profits, or applying resources to long term projects. This is just an illustrative example. We do not assume this would necessarily be the case for B and A, or their respective trusts.

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