Edited version of private advice

Authorisation Number: 1052404883981

Date of advice: 4 June 2025

Ruling

Subject: Commissioner's discretion

Question 1

Will the Commissioner exercise the discretion under subsection 328-125(6) to determine that Trust A doesn't control Company C?

Answer

Yes.

Question 2

Is Company C connected with Trust A for the purpose of the maximum net asset value test in section 152-15?

Answer

No.

This ruling applies for the following period:

20YY income year

Relevant facts and circumstances

1.  Company C is a company that provides medical services.

2.  Person E is a practitioner at Company C.

3.  Company C currently has two shareholders.

•                     Trust A holds 40% of the total shares on issue, and the other shareholder, Company D, holds 60%.

•                     Corporate Trustee B is the trustee for Trust A.

•                     Person E and Person F are the shareholders and directors of Corporate Trustee B.

•                     Company D has two directors: Person G and Person H.

4.  All issued shares in Company C carry the same rights to dividends, capital, and voting power.

5.  Company C has three directors: Person E, Person G, and Person H.

6.  Person G and Person H represent Company D on the Company C board, and have a habitual practice of voting as a consensus block.

7.  Trust A entered a contract in the 20YY income year to sell all its shares in Company C, and made a capital gain.

8.  Trust A is a discretionary trust.

9.  The applicant has given us copies of Company C's constitution and shareholder agreement. For convenience, we've paraphrased the effect of what we see as being the relevant clauses in Tables 1 and 2, and paragraphs 10, 11, and 12. But the full documents are incorporated in the facts and circumstances of this ruling, and prevail over Tables 1 and 2 if there's any inconsistency.

10.  Clause XXX of the shareholder agreement says, to the extent there's any inconsistency or conflict between the agreement and constitution, the shareholder agreement prevails.

Table 1: Clauses in the constitution and shareholder agreement addressing shares, general meetings, directors, and dividends

11.  Clause XXX of the shareholder agreement says the following decisions require ordinary resolutions of directors:

•                     approval of business plans and annual budgets

•                     acquisition or leasing of any property (with a price or value exceeding $XK)

•                     appointing or terminating staff or reviewing remuneration packages (exceeding $XK each year)

•                     borrowing other than under established credit facilities in the ordinary course of business

•                     acquiring or disposing of any assets of the company other than in the ordinary course of business

•                     entering, ratifying, varying, terminating, waiving, enforcing, or approving any agreement between the company and a shareholder

•                     starting or acquiring a new business.

12.  Clause XXX of the shareholder agreement says the following decisions require a special resolution of shareholders:

•                     making loans or providing other financial accommodation to shareholders or directors

•                     issuing or repurchasing any shares

•                     selling the business or any material part of it

•                     decisions on amending the constitution or this agreement.

13.  The shareholder agreement also has clauses addressing other topics, paraphrased in Table 2.

Table 2: miscellaneous topics in the shareholder agreement

14.  Company D isn't an affiliate of Trust A.

15.  None of Person E, Trust A, Trust A's affiliates, or Person F have any shares in Company D.

16.  There's no agreement, arrangement, or understanding (written or unwritten, binding or otherwise) between the shareholders or directors that has the effect of varying any rights or powers under Company C's constitution or its shareholder agreement.

17.  Person E and Person F exercise independent judgment (as directors) when determining how Corporate Trustee B makes trustee decisions (as trustee of Trust A).

18.  Trust A's trustee hasn't nominated Company D, any of Company D's affiliates, or any of Company D's directors or controlling minds to be controllers of Trust A under section 152-78.

19.  Trust A only distributed income and capital to Person F, and didn't distribute income or capital to any of the following entities, in the 2021, 2022, 2023, or 2024 income years.

•                     Company C

•                     Company C's affiliates

•                     Company D

•                     Company D's shareholders

•                     Company D's affiliates.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-78

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 328-130

Reasons for decision

In these reasons all legislative references are to provisions in the Income Tax Assessment Act 1997.

Question 1

Will the Commissioner exercise the discretion under subsection 328-125(6) to determine that Trust A doesn't control Company C?

Answer

Yes.

Summary

20.  The Commissioner may exercise a discretion to determine that an entity doesn't control another entity where two conditions are met. One condition is that the first entity's section 328-125 control percentage (of a target entity) must be at least 40% but less than 50%. The second condition is that the Commissioner must be satisfied that another entity or entities (excluding the first entity) controls the target entity.

21.  The Commissioner looks to the types of control generally associated with ownership (such as rights to income or capital and to vote on significant matters) in determining whether a third entity or entities controls a target entity for the purpose of this second condition.

22.  The Commissioner will exercise the discretion here because the two conditions are met. First, Trust A's section 328-125 control percentage is 40%. Second, the Commissioner thinks that Company C is controlled by Company D because Company D is a majority shareholder and nothing in the constituent documents or any associated agreements has the effect of limiting its majority rights.

Detailed explanation (Question 1)

An entity is connected with another entity if either entity (together with any of its affiliates) controls the other for section 328-125 purposes, or if both entities are controlled by the same third entity (together with the third entity's affiliates).

23.  Section 328-125 is about when an entity is connected with another entity.

•                     Subsection 328-125(1) says an entity is connected with another entity if a) either entity controls the other in a way described in the section, or b) both entities are controlled in a way described in this section by the same third entity.

•                     The effect of subsection 328-125(2) is that one entity controls a target entity (that isn't a discretionary trust) if the first entity (together with its affiliates) owns, or has rights to acquire, interests in the target entity that carry the right to receive at least 40% of any distribution of income or capital, or (in the case of a company) at least 40% of voting power.

•                     Subsections 328-125(3) and (4) are about controlling discretionary trusts. An entity controls a discretionary trust under subsection (3) where the trustee acts, or could reasonably be expected to act, in accordance with the entity's directions or wishes (including the directions or wishes of its affiliates). An entity controls a discretionary trust under subsection (4) where the trustee paid at least 40% of the trust's income or capital to the entity (or its affiliates) in any of the previous 4 income years.

•                     The Commissioner has a discretion under subsection 328-125(6) to determine that an entity doesn't control another entity in certain circumstances, as we explain in paragraph 25.

•                     Subsections 328-125(7) and (8) are about indirect control through interposed entities.

24.  Section 328-130 is about affiliates. An individual or 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 individual or company's business. However, an individual or company isn't your affiliate merely because of the nature of the business relationship you and the individual share.

There are two conditions for the Commissioner's discretion: the control percentage is at least 40% but less than 50%, and the Commissioner thinks that another entity (or other entities) controls the target entity.

25.  Subsection 328-125(6) gives the Commissioner a discretion to determine that an entity doesn't control another entity if two conditions are met.

•                     First, the control percentage in subsection (2) or (4) (broadly about distributions of income or capital, or, in the case of a company, voting power) is at least 40%, but less than 50%.

•                     Second, the Commissioner thinks that the other entity is controlled by an entity apart from, or by entities that don't include, the first entity or any of its affiliates.

26.  The explanatory memorandum to the bill that introduced subsection 328-125(6)[1] made some relevant points about the second condition.

•                     The Commissioner may think another entity controls based on fact or on a reasonable assumption or inference. [2.60]

•                     Whether or not the third entity has a 40% interest may assist in determining whether the third entity controls, but it isn't decisive. [2.60]

•                     Example 2.10 describes a company with two shareholders. One has 42% of the interests and no involvement with the manager, who has the remaining 58%. The example says the 42% interest holder won't include the company's turnover if the Commissioner thinks the company is actually controlled by the party with 58%.

The Commissioner's approach in determining whether a third entity or entities controls the target entity is to look to the types of control generally associated with ownership: rights to distributions and to vote on key matters (such as constituent documents, funding, structure, and management).

27.  TD 2023/5[2] gives guidance on a few specific issues arising out of the concept of 'control' in administering the discretion in subsection 328-125(6).

28.  TD 2023/5 stresses that responsibility for day-to-day management doesn't in itself amount to control: see paragraphs 11, 14, and 15.

29.  The TD makes some general points about determining whether a third entity 'controls' a target entity for the purposes of the discretion at paragraph 13. It says the nature of control relevant to the Commissioner's discretion is control over those matters typically associated with ownership of a business entity, meaning entitlements to income and capital, and participation in decision-making on key matters affecting the entity's constitution, funding, structure, and management. It says that these matters (typically associated with ownership of a business entity) ordinarily include matters such as:

•                     decision-making on the composition and oversight of the management team

•                     amending the entity's constituent documents

•                     deciding on capital and entity restructuring proposals, the issue of new ownership interests, or winding up

•                     authorising significant changes in the direction of the entity's business operations.

30.  At paragraphs 16-18, TD 2023/5 discusses example 2.10 from the explanatory memorandum, saying it shows:

•                     the manager's power stems from its 58% ownership interests rather than its identity as a manager

•                     the Commissioner is likely to conclude a third entity holding more than 50% of the ordinary shares in a company would control that company, assuming that this majority interest is enough to determine most fundamental matters, and majority voting rights aren't qualified or compromised by other arrangements.

31.  We'll discuss two relevant examples from the TD.

•                     Example 2 from the TD describes a company with two shareholders. Person W holds 56%. person Q is a passive investor holding 44%. person W manages the business, and his majority shareholding enables him to unilaterally approve ordinary resolutions on all matters except where a special resolution is required. The Commissioner would conclude that person W controls the company, and would exercise the discretion. person W's day-to-day management is relevant to the extent it reflects his actual control through his majority shareholding.

•                     Example 3 from the TD is a variation on Example 2. person W still holds 56%. However, the 44% shareholder is a finance company that has entered into a shareholder agreement with person W. The agreement requires that many matters about the company's business affairs require a special resolution, including business funding, significant new transactions, and changes in the nature of the existing business. Depending on the nature and extent of matters to be dealt with by special resolution under the shareholder agreement, the Commissioner might not think that person W actually controls the company, if person W's rights have been substantially compromised.

The first condition in subsection 328-125(6): does Trust A have a control interest in Company C of at least 40 but less than 50%? Yes. It owns 40% of the shares and no indirect interests or affiliate relationships give it a greater percentage here.

32.  The first condition for the discretion in subsection 328-125(6) is that the entity has a subsection 328-125(2) or (4) control interest in Company C of at least 40% but less than 50%.

33.  This condition appears to be met, looking just at Trust A's direct interest. Trust A owns 40% of the shares in Company C, with the remaining 60% owned by another entity. All Company C's shares are ordinary shares, and ordinary shares carry voting and dividend rights. It follows that Trust A has interests carrying rights to 40% of Company C's votes and distributions of income or capital. This gives it a control interest in Company C of 40% under subsection 328-125(2). However, the control interest could be greater if Trust A had indirect control interests through Company D, or Company D was its affiliate.

34.  Trust A's control interests won't be increased in this case. Trust A and its affiliates don't own shares in Company D, and Company D isn't Trust A's affiliate. This means we can exclude indirect control through Company D. It also means Trust A's associate inclusive control won't be greater than 40%, as it has no relevant affiliates holding control interests (directly or indirectly) in Company C.

35.  This means the first condition in subsection 328-125(6) is met: Trust A has a subsection 328-125(2) control interest in Company C of 40%, so it fits within the range of at least 40 but less than 50%.

The second condition in subsection 328-125(6): is the Commissioner satisfied that Company C is controlled by a third entity or entities? Yes. We're satisfied that Company D controls Company C because it has 60% of the shares, and the relevant constituent documents give a majority shareholder rights that we think, in this case, amount to the type of control associated with ownership.

36.  Company D has control over many of the matters identified in TD 2023/5 paragraph 13 as being typically associated with ownership of a business entity.

•                     Company D has 60% of the shares, giving it rights to a majority of distributions of income and capital, rights to a majority of votes in shareholder meetings, and currently 2 out of the 3 directors are its nominees.

•                     Company C may appoint or replace directors by a simple resolution in the general meeting, and also block Trust A attempts to appoint or replace directors.

•                     Further, Company D may appoint the chair for both director and shareholder meetings and in both cases the chair has a casting vote.

•                     In combination, these facts mean Company D can determine any board decisions that require only a simple majority, and the board is responsible for administering and managing the company.

37.  Another question is whether the matters requiring a special resolution of the shareholder meeting (in clause 5 of the shareholder agreement) 'substantially compromise' Company D's majority rights: see Example 3 in TD 2023/5.

38.  Our answer is no. We don't think the matters requiring a special resolution substantially compromise the rights listed in TD 2023/5.

•                     The only matters that require a special resolution (and Trust A's agreement) are a) making loans to shareholders or directors, b) issuing/repurchasing shares, c) selling the business or a substantial part of it, and d) decisions on amending the constitution or Company C's shareholder agreement.

•                     Requiring special resolutions for loans to shareholders or directors seems like a reasonable corporate governance safeguard, rather than something that would undermine control.

•                     Other limitations stop Company D unilaterally amending the constituent documents, or imposing restructuring or share capital proposals, or winding-up.

•                     We don't think these limitations on Company D's control are significant here, because a) Company D already has 60% of the capital, income, and voting rights, and b) Company D can block any Trust A resolution seeking to amend the constitution or capital structure to vary the rights it already enjoys.

•                     In any case, varying the constitution or share structure for most companies would require a special resolution of shareholders, and Examples 2 and 3 from TD 2023/5 don't suggest usual special resolution requirements would substantially compromise majority voting rights. The concerns in Example 3 (where the shareholder agreement had the effect that a majority shareholder couldn't determine resolutions on business funding, significant new transactions, and changes in the nature of the existing business) don't apply to Company C.

•                     Company D can still determine most remaining decisions unilaterally, including composition and oversight of the management team, and authorise significant changes in the direction of the entity's business operations.

39.  Therefore, we're satisfied that Company D controls the company in the sense of subsection 328-125(6).

40.  Both elements of subsection 328-125(6) are met. First, Trust A has at least 40% but less than 50% of subsection 328-125(2) control interests. Second, the Commissioner is satisfied that Company D controls the company.

41.  It follows that the Commissioner will determine that subsection 328-125(6) applies so that Trust A doesn't control Company C.

Question 2

Is Company C connected with Trust A for the purpose of the maximum net asset value test in section 152-15?

Answer

No.

Summary

42.  Company C and Trust A aren't connected for the purpose of the maximum net asset value test, because:

•                     neither entity controls the other, and

•                     the two entities aren't controlled by a common third entity.

Detailed explanation (Question 2)

The maximum net asset value test includes the net value of CGT assets of entities that are 'connected with you' in the sense of section 328-125.

43.  Subdivision 152-A is about the basic conditions for accessing the CGT small business concessions. They're listed in subsection 152-10(1).

44.  One way to pass paragraph 152-10(1)(c) is to satisfy the maximum net asset value test in section 152-15.

45.  Section 152-15 says you satisfy the maximum net asset value test if, just before the CGT event, the sum of the net value of the CGT assets of yours, any entities connected with you, and the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (excluding double counting) doesn't exceed $6 million.

46.  Section 995-1 says an entity is 'connected with' you in the circumstances described in section 328-125, as affected by section 152-78.

Trust A would be connected with Company C if either controlled the other or both were controlled by a third entity.

47.  We explained the concept of 'connected with' for section 328-125 in Question 1. To quickly summarise, entities are connected if either controls the other for section 328-125 purposes, or both are controlled by the same third entity. One entity will control:

•                     a company if it has a control percentage of 40% (rights to income, capital, or votes)

•                     a discretionary trust if it received 40% of distributions of income or capital in any of the previous 4 income years

•                     a discretionary trust if the trustee acts (or could be reasonably expected to act) in accordance with the first entity's directions or wishes.

48.  Section 328-125 includes affiliates when testing control: see paragraph 23.

49.  Section 152-78 allows a trustee of a discretionary trust to nominate controllers in years where the trustee had a tax loss or no net income to distribute.

50.  Applied to this situation, Company C would be connected with Trust A if:

•                     Trust A controlled Company C, or

•                     Company C controlled Trust A, or

•                     Company C and Trust A were both controlled by a third entity.

There's no control relationship that could make Trust A connected with Company C. First, the Commissioner will determine that subsection 328-125(6) applies so that Trust A doesn't control Company C. Second, Company C doesn't control Trust A. Third, the two entities can't be controlled by a third entity, because the only likely controller is Company D, and Company D doesn't control Trust A.

51.  We can dismiss the first possibility: in Question 1, we concluded that the Commissioner would exercise the discretion in subsection 328-125(6) to determine that Trust A didn't control Company C.

52.  However, Trust A and Company C could still be connected if Company C controls Trust A, or if both are controlled by a third entity (taking control in an affiliate-inclusive sense in both cases).

53.  As Trust A is a discretionary trust, to determine whether Company C controls the trust, the possibilities for control are:

•                     subsection 328-125(3), which is a directions or wishes test

•                     subsection 328-125(4), which is a distribution test

•                     section 152-78, which allows a trustee of a discretionary trust to nominate beneficiaries to be its controllers.

54.  Subsection (3) control applies where the trustee acts, or it's reasonable to expect that the trustee acts, in accordance with another entity's directions or wishes.

55.  This test isn't met because the directors of Trust A's corporate trustee exercise independent judgment when making decisions. Since the directors exercise independent judgment, the trustee can't act according to another entity's directions or wishes, and it wouldn't be reasonable to expect that they could act that way. Therefore, neither Company C nor a third-party controller of Company C could control Trust A under this test.

56.  Subsection (4) control applies where the trustee has distributed at least 40% of the trust's income or capital to the entity, or any of its affiliates, in any of the previous 4 income years.

57.  Company C didn't control Trust A under subsection (4). Trust A didn't distribute income or capital to Company C or any of its affiliates in any of the income years from 20YY through 20YY.

58.  Company C doesn't control Trust A under section 152-78 because the trustee hasn't nominated controllers under that section.

59.  We also need to address whether Trust A could be controlled under subsection 328-125(4) by a third-party who also controls Company C.

60.  We can discount Company D as a common controller of Trust A and Company C. Company D controls Company C under subsection 328-125(2), because it has 60% of the shares in Company C (and therefore rights to 60% of the votes and distributions of income or capital). But Company D doesn't control Trust A under subsection 328-125(4), because neither Company D nor its affiliates received distributions of income or capital during any of the income years from 20YY through 20YY. There's no control under other provisions either: we established at paragraph 55 that no entity can control Trust A under subsection 328-125(3), and the trustee hasn't nominated controllers under section 152-78.

61.  Another possibility is whether any of Company D's shareholders could control both entities. Company D's shareholders may also control Company C indirectly through Company D under subsection 328-125(7). Trust A and Company D could be connected if any Company D shareholder with a control percentage in Company D could also control Trust A.

62.  We can also discount this possibility. Trust A can only be controlled under subsection 328-125(3), subsection 328-125(4), and section 152-78. The trustee hasn't nominated controllers under section 152-78. Trust A has no controllers under subsection 328-125(3) for the reasons given at paragraph 55. Trust A only distributed income or capital to Person F in the income years for 20YY to 20YY, so Person F is the only controller under subsection 328-125(4). Since Person F doesn't own shares in Company D, Trust A and Company C can't have a common controller.

63.  This means that Trust A and Company C aren't connected. We've established that neither entity controls the other for section 328-125 purposes, and the two entities aren't both controlled by a common third entity. Subsection 328-125(1) doesn't apply to treat them as connected entities.

64.  It follows that Trust A and Company C aren't connected for the purposes of applying the maximum net asset value test in section 152-20.

[1] Explanatory Memorandum (House of Representatives) to the Tax Laws Amendment (Small Business) Bill 2007.

[2] Taxation Determination TD 2023/5 Income tax: aggregated turnover and connected entities - Commissioner's discretion that an entity does not 'control' another entity.

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