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Authorisation Number: 1011810755702

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Ruling

Subject: Small Business Capital Gains Relief - Affiliate

Question 1

Is Company B your 'affiliate' as defined in section 328-130 of the Income Tax Assessment Act 1997 for the purpose of determining whether the commercial property owned by you was an active asset?

Answer

Yes.

This ruling applies for the following period<s>:

Year ended 30 June 2010

The scheme commences on:

October 19XX

Relevant facts and circumstances

Company A was incorporated. Shortly after incorporation it was equally owned by Person A, Person B and Person C. The shareholders were also the directors of Company A.

Person C sold their interest in the company to Persons A and B resulting in Persons A and B owning 50% each in the Company. Person C also ceased to be a director of Company A upon transfer of their shares. There has been no further change in the shareholding of Company A.

Company B was incorporated. Persons A,B and C are equal shareholders who are also directors of the company. There has been no change in the shareholding since incorporation. The Directors are unrelated to each other.

The primary activity of Company A has been the provision of premises to Company B, under commercial terms, and the further provision of financial support to Company B to allow it to undertake its construction activities. Three isolated property transactions were completed by the company some years ago.

The Company purchased a property. The property consisted of land with an office and workshop on it. The property was leased to company B for it to use in carrying on its construction business. A market rent was paid by Company B.

Company B has rented and carried on its business from the commercial property from the time Company A acquired the property. Company B has been the only tenant for the entire period that the property was owned by Company A.

The premises were rebuilt. It was purpose built for Company B. The new building contained an office and warehouse. The warehouse was specifically designed to meet the needs of Company B to house heavy duty machines and equipment used by Company B for its construction business.

Company A has provided security for bank guarantees over the years to assist Company B to obtain security funding to meet contractual obligations on construction jobs undertaken by Company B. Without this financial and security support Company B would not have been able to take on some of the work that it secured.

Company B was placed in administration in 0XX. Company A stopped charging rents to Company B due to financial stress endured by Company B. Company A has met some costs for Company B since Company B was placed in administration.

Company A sold the commercial premises to a third party. Settlement occurred post 30 June. A capital gain was realised.

Reasons for decision

Summary

Company B is your 'affiliate' as defined in section 328-130 of the Income Tax Assessment Act 1997 (ITAA 1997) for the purpose of determining whether the commercial property owned by you was an active asset.

Detailed reasoning

Subsection 328-130(1) of the ITAA 1997 states that 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.

Subsection 328-130(2) of the ITAA 1997 clarifies that 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 first part of the 'affiliate' definition looks at the actual acts of the potential affiliate to see if it acts, or has acted, in accordance with the entity's directions or wishes or in concert with the entity in relation to the potential affiliate's business affairs (that is, 'acts in the relevant way').

Where the potential affiliate has not actually acted in the relevant way, the second part of the definition considers whether the potential affiliate 'could reasonably be expected' to have acted in the relevant way at that time despite not actually having done so.

The three categories of behaviour caught by the definition (that is, acting according to the directions, wishes or in concert with an entity) represent alternatives in terms of control, influence or cooperation. Only one of these alternatives needs to be present for the definition to apply (paragraph 41 of Taxation Ruling TR 2002/6).

Meaning of 'could reasonably be expected'

'A reasonable expectation requires more than a possibility' (FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344). In the High Court's view the phrase involves a prediction that must be sufficiently reliable for it to be regarded as reasonable.

Where the taxpayer stands in a relationship of control or influence over the potential affiliate, it can reasonably be expected that the potential affiliate will act, or would have acted, in the relevant way (paragraph 51 of Taxation Ruling 2002/6)

The conclusion that such a relationship exists or existed in the relevant year may be based on:

(a) inferences drawn from events, transactions or patterns of behaviour which show that the entity has been, is, or will be able to direct or influence the potential affiliate's behaviour; and

(b) the presence of a relationship between the two entities which enables or has enabled the entity to influence or direct the potential affiliate.

The types of relationships that may constitute a relationship of control or influence include:

(a) family or other close personal relationships;

(b) financial relationships and dependencies; and

(c) relationships created through links such as common directors, partners or shareholders.

However even where such a relationship is present, it must be of sufficient strength to enable the entity to direct or influence the potential affiliate's actions in relation to:

· all or

· a substantial part

of the affairs of the latter's business. After having regard to the full facts and circumstances of the particular case, if it is evident that, despite that relationship, the potential affiliate cannot reasonably be expected to act in the relevant way, then it will not come within the definition.

Taxation Determination TD 2006/79 discusses the meaning of CGT affiliate, and at paragraphs 41 and 42 states:

41. Whether a person acts in such a manner, is a question of fact dependent on all the circumstances of the particular case. The key consideration is the actions of the parties. If the parties act together in pursuit of a common goal or purpose or the taxpayer is able to direct the other person in relation to (not merely where the person [entity] is involved in, connected to or participating in) the carrying on of the business, these are factors that may support a conclusion that the parties act in concert or the other person acts in accordance with the taxpayer's directions or wishes.

42. 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. Relevant factors may include the existence of a close family relationship or friendship between the parties and any agreement or common understanding between the parties about how the parties are to act in relation to each other.

Meaning of 'in concert'

The term 'in concert' is not defined in the ITAA 1997. It therefore needs to be interpreted according to its ordinary meaning and legislative context. Paragraphs 59 and 60 of TR 2002/6 explain that a potential affiliate will only be regarded as acting 'in concert' with another entity where:

(a) it is acting together with the other entity in pursuit of a common goal or objective; and

(b) that common goal or objective is the carrying on of a business by the potential affiliate with a substantial degree of connection with or dependence on the business carried on by the other entity.

The overall degree of that connection must be such that the potential affiliate cannot be viewed as operating independently of the other entity.

Under the definition it is sufficient if the potential affiliate's business has the required degree of connection with or dependence on the taxpayers business. It is not necessary for the taxpayer's business to also have a substantial degree of connection with, or dependence on, the potential affiliate's business.

No factor is decisive, nor does each one necessarily have to be given the same weight. Rather, determining whether the potential affiliate is acting in concert with the entity in relation to the business affairs of the former will be a matter of overall impression.

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.

TR 2002/6 discusses in detail some of the factors that can determine whether two entities are affiliated:

Financial relationships

104. Any financial relationships or dealings between the two entities should also be taken into account, particularly where these render the potential *STS affiliate financially dependent on the entity on an on-going basis. A finding that the potential *STS affiliate is financially dependant on the entity is a factor that would support a conclusion that the potential *STS affiliate might reasonably be expected to act as the entity wishes or directs. This is because it can reasonably be expected to comply with these directions or wishes to avoid jeopardising the financial support it needs to maintain its profitability or simply to continue in business. Typically, arm's length loans from unassociated third party lenders do not involve this sort of control.

Relationships based on other common links

105. The entity should also consider any other relevant relationships or links between it and the potential *STS affiliate that may support a conclusion that the potential *STS affiliate will act as the entity directs or wishes. Examples of such links include common directors, shareholders or partners. This type of relationship is relevant because it may reveal that each entity is ultimately controlled or owned by the same group of individuals. Depending on the circumstances of the case, this may provide a mechanism by which one entity can seek to direct or influence the activities of the other entity in the relevant way.

Application to the current case

For both Company A and Company B there is a common majority ownership with Persons A and B each owning 50% of Company A and a one third ownership in Company B. Where it could be determined that two entities are controlled by the same group of people it is reasonable to conclude that there would be strong links in the behaviours and actions of the two entities.

Company B was reliant upon Company A's continued support and willingness to assist in Company B securing funding to meet contractual obligations. This indicates a requirement for Company B to consult regularly with Company A in order to ensure the continued support of the funding and their programs. Without working together to secure the funding, Company B would not have been able to secure some of the projects undertaken.

Additionally, Company B has been the sole tenant of the property from the time that it was purchased. During this period the primary activity of Company A was the provision of the premises to Company B for their construction company. Therefore, it can be reasonably surmised that Company A was reliant upon the continued occupancy by Company B and the market value rent that was paid by them. Therefore a strong mutual dependency exists between the two companies due to the financial relationships built between the companies.

The building that was constructed on the land was custom built for the purposes of Company B by Company A therefore indicating consultation between Company A and Company B to ensure that the building constructed met the needs of Company B. This indicates that the companies worked in concert in the furtherance of Company B's business activities by providing the infrastructure needed.

Therefore, looking at the factors and the relationship between Company A and Company B it can be determined that Company B is an affiliate of Company A for the purposes of section 328-130 of the ITAA 1997.