Edited version of your private ruling

Authorisation Number: 1012443255258

Ruling

Subject: Commissioner's discretion

Questions:

1. Will the Commissioner's discretion be exercised under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company A is not controlled by another entity either directly or indirectly?

Answer:

Yes.

2. Does your aggravated turnover for the purposes of section 328-115 of the ITAA 1997 include the turnover of Company B?

Answer:

No.

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2010

Relevant facts

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:

· your application for private ruling which we received in early February 20XX

Company A is an Australian registered company.

Until recently, the directors of Company A held a percentage of the company, in equal shares.

In the 20YY-ZZ financial year, Company B acquired between V% and W% ownership of the company.

Company B is also an Australian registered company based in a different state to Company A.

Company B is owned by its founder.

The shareholding of Company B in Company A is described as 'passive'. Company B has no active involvement in or responsibility for the day to day management of the Company A, nor in the strategic running of the company.

The directors of Company A continue to hold the remaining W%+ ownership in the company, in equal shares.

One of the directors has control of the overall business and all key commercial and financial decisions are made by him/her.

Another director acts in accordance with key financial, commercial and business decisions made by him/her. For example, hiring staff without consultation and initiating the arrangement with Company B.

Company A intends to apply for the research and development (R&D) tax offset under Division 355 of the Income Tax Assessment Act 1997 (ITAA 1997) for R&D expenditure incurred in the 2011-12 financial year.

The company's aggregated turnover for the relevant financial year is less than $20 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 328-115

Income Tax Assessment Act 1997 - Section 328-125

Income Tax Assessment Act 1997 - Section 328-130

Reasons for decision

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

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 a company

Paragraph 328-125(2)(b) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own equity interests 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 V% of the voting power in the company.

In this case, Company B currently holds between V and W% of the shares in Company A. In accordance with subsection 325-125(2) of the ITAA 1997, Company B controls the company.

Commissioner may determine that an entity does not control another entity

If an entity's control percentage in a company is at least V% but less than W%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 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) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage of at least V% of the company. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account. The third entity must control the company in the way described in subsection 328-125(2) of the ITAA 1997. Unless the conditions of subsection 328-125(2) of the ITAA 1997 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 V% 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 V% may control the company if such responsibilities are shared.

In this case, for the Commissioner to consider the exercise of the discretion contained in subsection 328-125(6) of the ITAA 1997 there would need be a single, identifiable third entity that would have a control percentage (including the interests of its affiliates) in the company of more than V%. Neither of the two remaining shareholders in Company A holds a control percentage of V% or more in their own right. Accordingly, we must consider if an affiliate relationship exists between the remaining shareholders.

Affiliates

An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you (subsection 328-130(1) of the ITAA 1997). The Advanced guide to capital gains tax concessions for small business 2011-12 (NAT 3359), provides a number of relevant factors that may support a finding that a person is an affiliate of a taxpayer in accordance with subsection 328-130(1) of the ITAA 1997:

· 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.

However, subsection 328-130(2) of the ITAA 1997 points out that an individual or company is not your affiliate merely because of the nature of the business relationship. For example, companies and trusts are not affiliates of their directors and trustees respectively and vice versa, merely because of the positions held.

In this case, the directors of Company A hold the remaining W%+ ownership in the company, in equal shares. There is no close family relationship between them and, as directors of the company; there is some formality to their relationship.

However, while their business relationship is based on common financial interests in the company, there is evidence to show that one of the director/shareholder has control of the overall day to day running of the business andanother director/shareholder acts or could be reasonably expected to act in accordance with his/her directions.

Commissioner is satisfied that Company A is not controlled by Company B but is instead controlled by a one of the directors/shareholders of Company A with a control percentage of W%+, including the interests of his/her affiliate, the other director/shareholder. Accordingly, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997.

Aggregate turnover

Under subsection 328-115(2) of the ITAA 1997, your aggregated turnover includes your annual turnover, the annual turnover of any entity connected with you at any time during the year, and the annual turnover of any entity that is an affiliate of yours during the income year.

Connected entity

As discussed above, an entity is connected with you if the entity controls the company (section 328-125 of the ITAA 1997). An entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own equity interests 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 V% of the voting power in the company.

As concluded in the discussion above, the Commissioner is satisfied that the company is not controlled by Company B but is instead controlled by one of the directors/shareholders with a control percentage of W%+, including the interests of his/her affiliate, the other director/shareholder.

Affiliate

Under subsection 328-130(1) of the ITAA 1997, an affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you.

However, a person is not your affiliate merely because of the nature of a business relationship you and the person share. Companies are not affiliates of their directors, and vice versa, merely because of the positions held.

There is nothing to suggest that Company B acts or could be reasonably expected to act in accordance with Company A's directions or in concert with Company A in relation to their business affairs.

Therefore, Company B is not considered to be connected with Company A or an affiliate of Company A for the purposes of calculating Company A's aggregated turnover.