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Authorisation Number: 1012142309977

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Ruling

Subject: Commissioner's discretion

Question 1

Are you a connected entity of a private company for the purpose of subsection 328-125(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Commissioner's discretion be exercised under subsection 328-125(6) of the ITAA 1997 to determine that you do not exercise control over the company and that you are not connected with the company for the purpose of the maximum net asset value test in section 152-15 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling, and

· the documents provided with the application for private ruling.

· You are an Australian resident for income tax purposes.

· The company is owned by your family.

You and your brother currently own 100% of the shares on issue in the company.

Some years ago you and your brother acquired shares in the company.

After the passing of your parents, the ownership of the company was spilt between you, your brother and your four sisters.

Your brother took on the responsibility of the company after the passing of your parents by working full time on the property.

Your brother has been solely responsible in the dealings with the financial institutions over the years including signing personal guarantees for significant sums.

As your brother has been primarily conducting the farming operations and in particular, responsible for the day to day strategic and operational decisions of the company in relation to the rural property and farming operations, he some time ago commenced a number of steps to buy out his siblings and take control of the company.

Approximately four years ago the shares held by the three sisters in the company were acquired by your brother and yourself. These negotiations were protracted, acrimonious and led to family relationships breaking down. It was at this time that you and your brother decided to separate their interest so as to avoid any similar downstream problems for their respective families.

Following further share acquisitions the current ownership interest of the company is split between you, holding more than 40% but less than 50% of the share capital and your brother, holding more than 50% of the share capital.

The ordinary shares held by you and your brother have voting rights, dividend rights and a right to capital surplus on the winding up of the company.

As part of the separation of your farming interest and your brother's farming interest you acquired the three rural properties in your own name.

These properties were previously leased to the company as part of the overall farming operations of the family. As you and your brother are splitting the farming operations the properties would no longer be provided to the company to undertake its farming operations.

Since you acquired the above rural properties you are responsible for the day to day operations and the strategic planning decisions of these properties. This has been the same scenario with the rural property held by the company whereby your brother is responsible for the strategic running of the company and in particular the day to day operations of the farm.

Your brother resides on the rural property owned by the company and you reside on your property.

After partaking in bona fide negotiations, you and your brother have resolved that you will divide the farming operations between your respective families. To facilitate this strategy and the separation of the combined ownership interest you would transfer your shareholding to your brother at market value thereby giving him 100% ownership of the company.

You and your brother have established another company which would hold the farming plant & equipment and be used by both you and your brother to undertake cropping and other farming activities on their respective rural properties.

The other company would also be used to employ staff that would undertake activities on your rural properties and your brother's rural properties.

You and your brother make decisions independent of each other in relation to the activities undertaken on the respective rural farms other than sharing equipment and staff.

You have held the shares in the company for more than 12 months. You have held the shares in the company on capital account and not as trading stock.

The annual turnover of the company fluctuates each year depending on the weather conditions for instance, the tumover would be less than $1 million in a drought year.

The net value of the company is approximately greater than $6 million.

You did not have a full time occupation prior to acquiring your own farming properties.

Your brother did not have a full time occupation away from the company prior to you acquiring your own properties.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-125 and

Income Tax Assessment Act 1997 section 328-130.

All legislative references are to the ITAA 1997, unless otherwise specified.

Question 1

Summary

Given that you own more than 40% of the shares on issue in the company, you are considered to be a connected entity of the company under section 328-125.

Detailed reasoning

The meaning of connected entity is defined under section 328-125 of the ITAA 1997 which states as follows:

328-125(1) An entity is connected with another entity if:

(a) either entity controls the other entity in the way described in this section; or

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

Direct control of entity other than a discretionary trust

328-125(2) An entity (the first entity) controls another entity if the first entity, its affiliates or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership - the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company - beneficially own, or have the right to acquire the beneficial ownership of, equity interest in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

Commissioner may determine that an entity does not control another entity

328-125(6) 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 entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates.

An entity is connected to another entity if either entity controls the other entity or both entities are controlled by the same third entity. It also means that an entity is connected to another entity, if the entity, its affiliates or both of them beneficially own, or have the right to acquire the beneficial ownership of interests in, the other entity that give them the right to receive at least 40% of the distribution of income or capital by the other entity.

Given that you own more than 40% of the shares on issue in the company, you are considered to be a connected entity of the company under section 328-125.

Question 2

Summary

As you are not an affiliate of your brother, under section 328-125(6) the Commissioner is prepared to exercise discretion that you do not exercise control over the company. This control is exercised by your brother who has a shareholding of more than 50% and is responsible for the strategic and day to day running of the company.

Detailed reasoning

Affiliate

The term affiliate is defined in section 328-130. 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.

In this situation, you and your brother treat each other equally as individuals and there is no hierarchical relationship between the parties. You and your brother are financially independent and capable of making your own independent business and financial decisions. Regardless of family relationships, the business operations of the company are conducted utilising formal legal contracts and agreements at arms length.

There is no indication that you act, or could reasonably be expected to act in accordance with you brother's directions or wishes or in concert with him in relation to the affairs for the business. Therefore, you will not be considered an affiliate of your brother.

Connected entity

If an entity's control percentage in a company is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by a third entity (other than an affiliate of the first entity).

For the Commissioner to be able to consider the exercise of discretion in subsection 328-125(6) there must be a single, identifiable third entity that has a control percentage (including the interests of any small business CGT affiliates) of at least 40% of the company. It must control the company in the way described in subsection 328-125(2). Unless the conditions of subsection 328-125(2) are met the Commissioner cannot determine that the first entity does not control the company.

If there was a third entity with a control percentage of 40% or more it would then be necessary to consider additional factors such as who is responsible for the day to day and strategic running of the company to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least 40% may control the company if such responsibilities are shared.

In this situation there are two entities each with a control percentage of 40% or more in the company. Your brother has a shareholding of more than 50% and you have a shareholding of more than 40% but less than 50%. Your brother has been responsible for the company since your parents passed away and works full time on the property with no other source of income.

Your brother has been solely responsible in dealings with banks and has signed personal guarantees to the banks for significant sums. Over the years your brother has embarked on a strategy of acquiring respective shareholding in the company from his siblings. Your brother is responsible for the day to day and strategic running of the company, in particular the rural property and farming activities.

Given the circumstances described in relation to the control and day to day running of the business, under section 328-125(6) the Commissioner is prepared to exercise discretion that you do not exercise control over the company. This control is exercised by your brother who has a shareholding of more than 50% and is responsible for the strategic and day to day running of the company.