Edited version of your private ruling

Authorisation Number: 1012457537394

Ruling

Subject: Capital Gains Tax - Connected entities

Question 1

For the purposes of the maximum net asset value test in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997), is X Pty Ltd as trustee for Trust X a connected entity of Y Pty Ltd under section 328-125 of the 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 X Pty Ltd as trustee for the Trust X does not control Y Pty Ltd for the purpose of section 328-125 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2011

The scheme commences on:

On or after 1 January 2011

Relevant facts and circumstances

Just prior to the a date in 20VV, Trust X held Z% of the total voting rights in Y Pty Ltd.

Trust B, a trust unrelated to Trust X, held W% of the voting rights in Y Pty Ltd.

On the a date in 20VV, X Pty Ltd as trustee for Trust X entered into a sales contract to sell shares to Company C. This is the relevant CGT event.

Individual A and Individual D own the shares and are directors of the trustee company, X Pty Ltd.

Prior to a date in 20VV, Individual A was a director of Y Pty Ltd, alongside two other unrelated individuals who will be known as Individual B and Individual C.

Individual B represented the interests of Trust B in Y Pty Ltd and Individual C represented the interests of Company C.

Although still a director, Individual A had effectively retired and no longer worked in the business after a date in late 20VV. The last time that they received payment for director services was a date in early 20VV. They spent a significant amount of time overseas and were not privy to day to day operational decisions, or strategic decisions relating to Y Pty Ltd. They were entitled to vote at board meetings, but formal meetings were not usually held and where they were, Individual A was not required to and regularly did not attend.

Individual B was the managing director and controlled the day to day operations of Y Pty Ltd. Individual B was responsible for the strategic direction of Y Pty Ltd, with input from Individual C. Little to no input as to the strategic direction of Y Pty Ltd was provided from Individual A.

The day to day and strategic responsibilities of Y Pty Ltd were not shared, but were the responsibility of Individual B who took on these responsibilities in consultation with Individual C.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-5

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Subsection 328-125(1)

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

Income Tax Assessment Act 1997 Subsection 328-125(6)

Reasons for decision

Question 1

Section 152-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that for a capital gain to be eligible for the capital gains tax (CGT) small business reliefs, it is a basic condition that the entity making the gain:

· satisfies the maximum net asset value test; or

· satisfies the small business entity test requirements for the income year.

Section 152-15 states:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(b) the net value of the CGT assets of any entities connected with you;

Trust X has asked the Commissioner to consider whether it is a connected entity of Y Pty Ltd for the purposes of section 152-15.

An entity is connected with another entity if either entity controls the other or both entities are controlled by the same third entity under subsection 328-125(1) of the ITAA 1997.

An entity will control a company if it, its affiliates or all of them together beneficially own, or have the right to acquire beneficial ownership of, equity interests in the company that give at least 40% (the control percentage) of the voting power in the company under subsection 328-125(2)(b) of the ITAA 1997.

Just before the CGT event on a date in 20TT, X Pty Ltd as trustee for Trust X held beneficial ownership of Z% of the shares in Y Pty Ltd. This gave Trust X at least 40% of the voting power in Y Pty Ltd. Therefore Trust X controls Y Pty Ltd and the entities are connected.

Question 2

If an entity's control percentage in another entity is at least 40% but less than 50%, the Commissioner may determine that the first entity does not control the other entity if he is satisfied that a third entity (not including any affiliates of the first entity) controls the other entity (subsection 328-125(6)).

The Advanced guide to capital gains tax concessions for small business 2010-11 (NAT 3359-02.2012) (the Guide) at page 25 provides that for an entity to be controlled by a third entity, the third entity must also have a control percentage of at least 40% in the entity.

The Guide provides the following example

Lachlan owns 48% of the shares in Ayoubi Art Supplies. He plays no part in the day-to-day or strategic decision making of the business. Daniel owns 42% of the shares in the company. The remaining 10% of shares are beneficially owned by a third shareholder who does not take part in the management of the business. All shares carry the same voting rights and Daniel makes all day-to-day and strategic decisions for the company. Even though Lachlan owns 48% of the shares in Ayoubi Art Supplies, he would not be taken to control the company if the Commissioner was satisfied that the company is controlled by Daniel.

This indicates that if there were a third entity with a control percentage of at least 40%, it would be necessary to consider additional factors to determine whether the third entity controlled the company. Such additional factors could include who is responsible for the day to day and strategic running of the company.

In this case there is a third unrelated entity, Trust B which held a control percentage of W% in Y Pty Ltd before the CGT event.

The interests of Trust B were represented by Individual B, who was a director of Y Pty Ltd alongside Individual A and Individual C.

Individual A had effectively retired and no longer performed work for Y Pty Ltd after a date in late 20VV. The last time that they received payment for director services was a date in early 20VV. Although they were still a director, they spent a significant amount of time overseas and were not privy to day to day operational decisions, or strategic decisions relating to Y Pty Ltd. They were entitled to vote at board meetings, but formal meetings were not usually held and where they were, Individual A was not required to and regularly did not attend.

Individual B was the managing director and controlled the day to day operations of Y Pty Ltd. Individual B was responsible for the strategic direction of Y Pty Ltd. Little to no input as to the strategic direction of Y Pty Ltd was provided from Individual A.

The facts provided indicate that the day to day and strategic responsibilities of Y Pty Ltd were not shared, but were the responsibility of Individual B who took on these responsibilities in consultation with Individual C.

This would lead to the conclusion that Y Pty Ltd was controlled by another entity, Trust B, and not by Trust X. The Commissioner will exercise his discretion to determine that Trust X did not control Y Pty Ltd for the purposes of section 328-125 of the ITAA 1997.