Edited version of private ruling

Authorisation Number: 1011773281176

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Ruling

Subject: Small business entity - affiliates

Question 1

Is the company considered to be your affiliate under section 328-130 of the Income Tax Assessment Act 1997 (ITAA 1997) in the 2008-09 income year?

Answer

No

Question 2

Would you be considered to be a small business entity under section 328-110 of the ITAA 1997 in the 2008-09 income year?

Answer

Yes

This ruling applies for the following period:

1 July 2008 - 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You are an individual.

You are in business. You state the business commenced in the 2008-09 income year.

You were granted a personal services business determination for the 2008-09 income year in respect of the business activity.

In the 2008-09 income year you were a director or trustee of a number of entities. One of these entities, the company, had an annual turnover of $X in the 2008-09 income year.

You are one of a number of directors of the company. There is not a close family relationship between you and the other directors.

You each hold a proportion of the issued share capital in the company. You hold less than 40% of the voting rights in the company.

Since incorporation the company has conducted activity in the industry which you consult in.

You did not provide advice to the company in the 2008-09 income year as part of your personal services business activity.

There were no loan or lease arrangements between you and the company.

Your turnover from business activity was less than $2 million in the 2008-09 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Subsection 328-110(4)

Income Tax Assessment Act 1997 Section 328-115

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 Section 328-130

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Affiliates

The term affiliate is defined in section 328-130 of the ITAA 1997. An individual or company can be your affiliate if the individual or company acts, or could reasonably be expected to act, in accordance with your wishes or directions, or in concert with you, in relation to the affairs of their business.

However an individual or company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No one factor will necessarily be determinative.

Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:

· the existence of a close family relationship between the parties

· the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

· the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and

· the actions of the parties.

Stephens's case

The Administrative Appeals Tribunal (AAT) decision in the case Stephens v. F.C. of T (2008) AATA 176 (Stephens Case) discusses the concept of affiliates and acting in concert. In Stephens case, the taxpayer, Mrs Stephens, was a beneficiary of a discretionary trust which together with five other interest-holders sold a commercial property. Mr and Mrs Stephens were directors of the corporate trustee of the discretionary trust. Mr Stephens was also a director of NF Legal Pty Ltd which carried on a legal practice. At the time of sale, he was a partner/equity holder and director in the practice with six others.

The commercial property was rented to the legal practice but two of the shops on the practice were leased to other tenants.

The taxpayer returned a capital gain on the basis of being able to obtain the 50% CGT reduction under former section 152-205 of the ITAA 1997 because of the commercial property being an active asset. She contended that NF Legal was a small business CGT affiliate of the discretionary trust because NF Legal acted, or could reasonably be expected to act, in accordance with the directions or wishes, or in concert with the discretionary trust.

The Commissioner disagreed because the corporate trustee / discretionary trust was merely one of six owners of the property and Mr Stephens was merely one of seven directors of NF Legal. Of those seven directors, only four had any connection with the trust. The AAT agreed with the Commissioner and held that there was insufficient evidence of the connection submitted.

In Stephens case, the taxpayer attempted to argue that seven people collectively being the partners of NF Legal, would act in accordance with the direction and wishes of one person, Mr Stephens.

Application to your situation

In the present case, you are one of a number of directors and a minority shareholder in the company. You can be out voted by the other shareholders. As in Stephens Case, if you were out voted it could not be said that there is reason for the other directors to act in accordance with your wishes or directions. The company is not your affiliate for the purpose of section 328-130 of the ITAA 1997.

Question 2

Small business entity

To qualify as a small business entity for an income year a taxpayer must carry on a business in that year and satisfy a $2 million aggregated turnover requirement (section 328-110 of the ITAA 1997). Aggregated turnover for an income year is the sum of the relevant annual turnovers for the year of the taxpayer and of any connected entities and affiliates (section 328-115 of the ITAA 1997).

One way a taxpayer may satisfy the $2 million aggregated turnover requirement is if the taxpayer's aggregated turnover for the year, worked out as at the end of that year, is less than $2 million (subsection 328-110(4) of the ITAA 1997).

For the purpose of calculating aggregated turnover an entity is 'connected with' another entity if either entity controls the other entity in the way described in section 328-125 of the ITAA 1997 or both entities are controlled in that way by the same third entity.

An entity controls another entity if it, its affiliates, or it together with its affiliates beneficially owns, or has the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive at least 40% of any distribution of income or capital by the other entity (paragraph 328-125(2)(a) of the ITAA 1997).

Directors of a company are not considered affiliates of each other merely because of the nature of the business relationship between them.

Application of law to your circumstances

You state you commenced carrying on a business in the 2008-09 income year. Your turnover from carrying on the business in the 2008-09 income year was less than $2 million.

In addressing the aggregated turnover of entities connected to you it is noted you are not connected to the company as your total shareholding is less than 40% of total issued capital. The other directors are not your affiliates because of the business relationship shared. In addressing the aggregated turnover of your affiliates it is noted that in answer to question 1 (above) it was concluded that the company was not your affiliate.

As a result your total aggregated turnover will be less than $2 million in the 2008-09. You will be a small business entity for the 2008-09 income year.