Edited version of your private ruling

Authorisation Number: 1012506878222

Ruling

Subject: Request for the Commissioner to make a determination under subsection 328-125(6) of the Income Tax Assessment Act 1997

Question 1

Will the Commissioner make a determination under subsection 328-125(6) of the Income Tax Assessment Act 1997 that Company A was not controlled by Company B during the 2012 year, but rather that it was controlled by Entity C.

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2012

Relevant facts and circumstances

1. Company A, is an Australian incorporated proprietary company.

2. Company B, holds greater than 40% non-controlling interest in Company A.

3. Entity C comprises a number of shareholders who collectively hold greater than 50% of the total number of issued shares in Company A.

4. The shareholders comprising Entity C will act in concert in their dealings amongst themselves and therefore are affiliated.

5. There is no affiliate relationship between Company B and Entity C.

6. Company A's board is responsible for overall direction and management and the formulation of policies.

7. The day-to-day management of Company A is to be managed by shareholders which make up Entity C, who is to occupy the key management positions of Company A (unless the board determines otherwise). Entity C reports, and is responsible, to the board.

8. Any material management decision of Company A must be approved by both the Chief Executive Officer (CEO) and the Chief Investment Officer (CIO) of Company A, who are part of Entity C.

9. Where the CEO and the CIO cannot agree on a material management decision a meeting of the board must be called by the directors at which the matter will be decided by a special directors' resolution.

10. Company B has the power of veto at special directors resolutions and special shareholder resolutions.

11. Matters that require special resolutions effect the strategic direction of Company A.

12. Some matters that require special directors resolution effect the day to day management of company A.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 328-125(b)

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

Income Tax Assessment Act 1997 subsection 328-130(1)

Reasons for decision

Subsection 328-125(b) of the Income Tax Assessment Act 1997 (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 40% of the voting power in the company.

An affiliate, as defined by subsection 328-130 of the ITAA 1997, is an individual or company which acts, or could reasonably be expected to act in accordance with another entity's directions or wishes, or in concert with another entity, in relation to affairs of the business of the individual or company.

Company A is an Australian incorporated proprietary company authorised to conduct business as a licensed provider of equity funds management services in the financial services sector.

Company B completed an agreement for it to subscribe to greater than 40% non-controlling interest in Company A.

The remaining interest is held by Entity C. Entity C is comprised of shareholders who act in concert in their dealings amongst themselves and are therefore affiliated. Entity C in total held greater that 50% of the total number of issued shares in Company A during the 2012 year, therefore holding majority equity ownership of the company.

The Company B and Entity C are not affiliates.

Subsection 328-125(6) of the ITAA 1997 provides that if an entity's control percentage in a company 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 other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates. That is, in this case as Company B has a control percentage in Company A of at least 40% but less than 50% the Commissioner may determine that Company B controls Company A.

There is no definition of the term control provided in Division 328 of the ITAA 1997, however, some guidance is provided in the Advanced Guide To Capital Gains Tax Concessions For Small Business 2011-12 (the Guide). The example given on page 25 of the Guide shows that having the majority shareholding is not enough to prove control. Rather, it is the shareholder that controls all the day-to-day and strategic decisions for the company, who controls the company. In this example the non controlling shareholder takes no part in the day-to-day or strategic operation of the business it is totally controlled by the majority shareholder. The Guide states that it is possible for both the entities with a control percentage of at least 40% to control the company if such responsibilities are shared.
In this case Company B is the third entity with a control percentage of 40% or more. Therefore it is necessary to consider who is responsible for the day-to-day and strategic running of the company to determine if Company B controls Company A. It is possible that both of the entities, Company B and Entity C, having a control percentage of at least 40% may control the company if such responsibilities are shared.

Day-to-day running of Company A

The board is responsible for the overall direction and management of Company A and the formulation of the policies to be applied to Company A.

Company A is managed on a day-today basis by Entity C, which occupies the key management positions of Company A. Any material management decisions regarding Company A must be approved by both the CEO and the CIO. Where they cannot agree on a material management decision the matter has to be decided by a special directors' resolution.

Company B directors' are actively involved in the decisions made by the board which effect the day-to- day running of Company A. Company B shares with Entity C the control of the day-to-day operations as evidenced by their required participation in meetings and voting on ordinary resolutions and the relevant special resolutions.

Strategic direction of Company A

Special directors' resolutions and special shareholders' resolutions go to the structure, scope and management of Company A's business and encompass matters which pertain to Company A's capital structure, shareholders' rights, corporate governance as well as business scope and strategic direction.

As stated by the applicant for matters requiring special shareholders' resolution, a resolution is only passed when the resolution is approved by shareholders who between them hold more than 50% of the total number of issued shares, provided that Company B votes in favour of the resolution. Where a matter requires a special directors' resolution, for it to be passed it requires at least one Company B director and one Entity C director to vote in favour of the resolution.

Therefore, as a Company B director has to vote in favour of a special resolution for that resolution to pass Company B has the power of veto.

Whether the power of veto is a form of control was considered in the case Re Application of News Corp Ltd (1987) 15 FCR 227. Where Bowen CJ stated:

…it was argued that a power of veto does not constitute control in the relevant sense. Control, it was said, exists only where there is a power to get one's own will.

I do not agree that the concept of control is so limited. The Oxford English Dictionary defines "control" as "to exercise restraint or direction". A power to veto is a power to restrain, and hence to control.

The ATO has previously determined, in ATO Interpretive Decisions, that the power of veto over matters that go to the structure, scope and management of an entity's business constitutes control, or the ability to control, directly or indirectly, the affairs or operations of an entity (see ATO Interpretative Decisions ATO ID 2003/162 and 2011/11).

Therefore Company B controls the strategic direction of Company A.

Therefore, Company B and Entity C, as previously discussed, share the control of the day today operations of Company A. Additionally, Company B controls the special shareholders' and directors' resolutions process.

Considering that Entity C and Company B share control in the day-to-day and strategic direction of Company A the Commissioner will not make a determination under subsection 328-125(6) that Company A was controlled by Entity C.