Edited version of your private ruling

Authorisation Number: 1012554805995

Ruling

Subject: Connected entities / affiliates status - R&D tax offset

Question 1

For the purposes of calculating the aggregated turnover of the Rulee under section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997) to determine its entitlement to a research and development tax offset (R&D) at the rate under item 1 of the table under subsection 355-100(1) of the ITAA 1997, is a foreign entity (the Foreign Entity) connected with the Rulee for the purposes of subsection 328-125(2) of the ITAA 1997?

Answer

Yes.

Question 2

Following on from Question 1, where the Foreign Entity is connected with the Rulee for the purposes of subsection 328-125(2) of the ITAA 1997, will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that the Foreign Entity does not control the Rulee for the purposes of section 328-125 of the ITAA 1997?

Answer

Yes.

Question 3

For the purposes of calculating the aggregated turnover of the Rulee under section 328-115 of the ITAA 1997 to determine its entitlement to an R&D tax offset at the rate under item 1 of the table under subsection 355-100(1) of the ITAA 1997, is the Foreign Entity an affiliate of the Rulee for the purposes of section 328-125 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2013

Relevant facts and circumstances

Structure of the Rulee

The Rulee is a company which was incorporated with more than 50% of its total ordinary shares held by a group of Australian Entities (the Australian Entities), and 40-50% held by the Foreign Entity. All the ordinary shares in the Rulee carry equally proportionate rights to distribution of income and capital and voting rights.

The Australian Entities together own shares carrying a right to receive more than 50% of income and capital distributions of the Rulee. The shares also entitle the Australian Entities to exercise more than 50% of the voting rights in the Rulee

The Foreign Entity is incorporated overseas.

The Foreign Entity shareholdings carry a right to receive 40-50% of income and capital distributions of the Rulee. The shares also entitle the Foreign Entity to exercise 40-50% of the voting rights in the Rulee. the Foreign Entity also owns redeemable convertible preference shares (RCPS) units which do not carry any right to income or capital distribution, or any voting rights.

Commercial objective of the Rulee

The Rulee was established to provide media services. The Rulee is undertaking research and development of new services and associated technologies for the purpose of bringing them to market.

Governance of the Rulee

The board of directors of the Rulee is made up of a total of five directors, comprising two directors appointed by the Foreign Entity and three directors appointed by the Australian Entities.

The only two executive directors in the Rulee are appointed by the Australian Entities.

Control of voting rights in the Rulee

The Articles of Association and the Subscriptions and Shareholder Agreement (SSA) give a single director, Director A, control of all the voting power of the Australian Entities. The Australian Entities hold a combined voting power of more than 50% in the Rulee.

The Foreign Entity controls the remaining 45.95% of the voting power in the Rulee.

Board Meetings of the Rulee

To date all board meetings have been held in Australia at the offices of the Rulee. The overseas based directors from the Foreign Entity have either attended personally, via proxy or via phone hook up.

Intellectual property

The Rulee owns all intellectual property it develops as part of its operations and/or research and development program. This includes any intellectual property developed by its employees.

Conduct of the Rulee R&D activities

All R&D activities are independently directed and conducted by the staff of the Rulee. They do not rely on the staff of the Foreign Entity. The staff of the Foreign Entity has no involvement in the R&D activities conducted by the Rulee.

Day to day operations

The decision making and management of day to day operations, administration, legal and finance functions of the Rulee are undertaken by an executive group of the Rulee that reports to Director A - a director of the Rulee appointed by the Australian Entities. Any Board reserved matters are dealt with proactively on a daily basis by the executive group and then presented at Board meetings. The executive group does not report to any directors appointed by the Foreign Entity.

All director level sign offs are undertaken by the directors appointed by the Australian Entities. No the Foreign Entity directors are involved in the signoff processes adopted by the Rulee.

The Rulee is required to conduct its business affair and operations in accordance with business plans and budgets, which are prepared each year by the executive group reporting to Director A.

The executive management of the Rulee includes three key staff, from the Australian Entities shareholder group - the two executive directors, the technical director and the chief financial officer. These staff are the sole signatories on the domestic bank accounts of the Rulee. They hold key roles and exercise material influence in the executive management of the Rulee.

The Foreign Entity has no communications or negotiations with suppliers, clients or other key external stakeholders of the Rulee. These functions are undertaken by the executive group of the Rulee reporting to Director A.

Relationship between the Foreign Entity and the Australian Entities

Other than the formal business and contractual arrangements through their shareholdings in the Rulee, governed by the SSA and Articles of Association, there are no personal relationships, financial dependencies, commons links such as directors, or shared strategic decision making that exist between the two groups.

Structure of the Foreign Entity

The Rulee does not own any rights to votes or distributions of income or capital in the Foreign Entity.

The Rulee has stated that the Rulee does not have any affiliates that have an interest in the Foreign Entity - it does not have any relationships with or interests in entities that have a connection with the Foreign Entity that meet the requirements of section 328-130 of the ITAA 1997.

Relationship between the Foreign Entity and Director A

The Rulee has stated that Director A is not an affiliate of the Foreign Entity, within the meaning of section 328-130 of the ITAA 1997, (or vice versa).

Relationship between the Foreign Entity and the Rulee

The Foreign Entity holds 40-50% of the ordinary shares in the Rulee. Director A exercises the combined voting power of more than 50% held in the Rulee by the Australian Entities.

There are no family or close personal relationship between the Foreign Entity and the Rulee. However, two of the directors of the Rulee have been appointed by the Foreign Entity.

The two the Foreign Entity appointed directors do not have the combined controlling vote on the board of the Rulee.

Outside of the shareholding the Foreign Entity has in the Rulee, which is governed by the SSA and the Articles of Association, there are no financial interrelationships or dependencies between the two.

Business matters of the Rulee are generally handled independently by Director A and his executive group. Strategic direction, decision making and action is determined prior to the meetings of the Executive group reporting to Director A. The Board meetings, which include the two the Foreign Entity appointed directors, generally consist of updates of prior activities, ratification of some reserved matters and broader discussions of performance, relationships and opportunities.

The Rulee has no role in the activities undertaken by the Foreign Entity.

There are no agreements in place that place an obligation on either party to purchase goods from the other or conduct their business with the other entity.

There are no arrangements that give either entity the right to dictate the actions of the other party.

The Foreign Entity and the Rulee are physically located in separate countries and do not share any infrastructure or employees.

The Rulee and the Foreign Entity operate with separately functioning boards.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 328-115

Income Tax Assessment Act 1997, paragraph 328-115(2)(c)

Income Tax Assessment Act 1997, section 328-125

Income Tax Assessment Act 1997, subsection 328-125(1)

Income Tax Assessment Act 1997, paragraph 328-125(2)(a)

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

Income Tax Assessment Act 1997, subsection 328-125(2)

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

Income Tax Assessment Act 1997, subsection 328-125(7)

Income Tax Assessment Act 1997, subsection 328-125(8)

Income Tax Assessment Act 1997, section 328-130

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

Income Tax Assessment Act 1997, Division 355

Income Tax Assessment Act 1997, section 355-100

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Introduction

The Rulee intends to apply for an R&D tax offset under the R&D tax incentive in Division 355 for the year ended 30 June 2013.

The rate of the tax offset and whether it is refundable depends primarily on the R&D entity's aggregated turnover (section 355-100). Only eligible entities with an aggregated turnover of less than $20 million (and one or more exempt entities do not control more than 50 per cent of the entity), are entitled to a refundable tax offset equal to 45 per cent of its notional R&D deductions.

Section 995-1 provides that the phrase 'aggregated turnover' has the meaning given 328-115.

Aggregated turnover is calculated on a 'group' basis (section 328-115). In broad terms, it is the sum of the annual turnovers of all of the following:

· the R&D entity

· any entity connected with the R&D entity

· any entity that is an affiliate of the R&D entity.

excluding any dealings between those entities.

For the purposes of determining an entitlement to the R&D tax offset, the Rulee has sought a ruling on whether the Foreign Entity is connected with or an affiliate of the Rulee for the purposes of section 328-125, to establish whether the annual turnover of the Foreign Entity is included in the aggregated turnover of the Rulee. This ruling only addresses that question.

However, it is important to note that in determining its entitlement to an R&D tax offset at the rate under item 1 of the table under subsection 355-100(1) of the ITAA 1997, the Rulee will still need to consider all the requirements of Division 355 - including whether the aggregated turnover of the Rulee includes the annual turnovers of entities other than the Foreign Entity.

Question 1

For the purposes of calculating the aggregated turnover of the Rulee under section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997) to determine its entitlement to a research and development tax offset (R&D) at the rate under item 1 of the table under subsection 355-100(1) of the ITAA 1997, is a foreign entity (the Foreign Entity) connected with the Rulee for the purposes of subsection 328-125(2) of the ITAA 1997?

The relevant provisions

Relevantly, subsections 328-125(1), (2), (7) and (8) provide that:

328-125(1)

An entity is connected with another entity if:

(a) either entity controls the other entity in a 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 an 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 - own, or have the right to acquire the 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 - own, or have the right to acquire the ownership of, *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.

Indirect control of an entity

328-125(7)

This section applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity.

328-125(8)

However, subsection (7) does not apply if the second entity is an entity of any of the following kinds:

(a) a company *shares in which (except shares that carry the right to a fixed rate of *dividend) are listed for quotation in the official list of an *approved stock exchange;

(b) a *publicly traded unit trust;

(c) a *mutual insurance company;

(d) a *mutual affiliate company;

(e) a company (other than one covered by paragraph (a)) all the shares in which are owned by one or more of the following:

(i) a company covered by paragraph (a);

(ii) a publicly traded unit trust;

(iii) a mutual insurance company;

(iv) a mutual affiliate company.

The concept of control is fundamental to the meaning of 'connected with' for the purposes of section 328-125. The control test depends on the type of entity in question.

In accordance with subsection 328-125(1), an entity is connected with another entity if one of the entities controls the other entity, or if the two entities are controlled by the same third entity.

Direct control

For entities other than discretionary trusts - in accordance with paragraph 328-125(2)(a), an entity controls another entity where that entity alone and/or its affiliates own, or have the right to acquire the ownership of, interests in the other entity that between them give the right to receive at least 40 per cent of any distribution of either income or capital by the other entity.

For companies, an alternative test applies - in accordance with paragraph 328-125(2)(b), an entity controls another entity where an entity alone and/or its affiliates own, or have the right to acquire the ownership of equity interests in the company that carry between them the right to exercise or control the exercise of at least 40%of the voting power in the company.

Meaning of affiliates

Section 328-130 states the meaning of affiliate as follows:

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.

However, 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.

An individual or company is an affiliate of an entity where that individual or company acts, or could reasonably be expected to act in accordance with the entity's directions or wishes in relation to the affairs of that individual or company's business, or in concert with the entity in relation to the affairs of the individual or company's business. However, an individual or a company is not an affiliate of an entity merely because of the nature of the business relationship the entity and the individual or company shares.

Taxation Ruling 2002/6 Income tax: Simplified Tax System: eligibility - grouping rules (*STS affiliate, control of non fixed trusts) (TR 2002/6) sets out the Commissioner's views on the meaning of ' STS affiliate' for the purposes of determining whether an entity satisfies the eligibility rules in Subdivision 328-F (the provision has been repealed).

Although the STS no longer operates for the 2007-08 and later income years, the definition of 'STS affiliate' under the former subdivision 328-F is closely aligned with the requirements set out in section 328-125. As such, the Commissioner's guidelines in TR 2002/6 are relevant to the meaning of affiliates for the purposes of section 328-130.

The scope of the affiliate definition is described in TR2002/6 as follows:

31. The *STS affiliate definition in subsection 328-380(8) does not apply where the potential *STS affiliate acts or could reasonably be expected to act as another directs or wishes, or in concert with it, only in relation to isolated transactions or on an irregular, ad hoc basis. For the definition to apply, the potential *STS affiliate must act in accordance with the entity's directions or wishes or in concert with it, or could reasonably be expected to so act, in relation to all or a substantial part of the affairs of the potential *STS affiliate's business.

Meaning of 'could reasonably be expected'

The Full High Court, in FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344, held that the phrase 'might reasonably be expected' requires more than a possibility.

An entity, the first entity, 'could reasonably be expected' to act in accordance with another entity's, the second entity's, wishes where the second entity has a relationship of control or influence over the first entity. Such a relationship can be evidenced by the entities behaviours and the presence of any influential relationships, such as:

(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.

Conversely, the entities' behaviours, obligations to each other and external parties, and their own interests may evidence the lack of such a relationship.

For a company, this relationship depends on whether the majority shareholders and/or directors of the company can reasonably be expected to act in accordance with another entity's directions.

Meaning of in 'concert'

TR 2002/6 explains, at paragraph 59, that entities will only be regarded as acting 'in concert' with each other 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 *STS affiliate with a substantial degree of connection with or dependence on the business carried on by the other entity.

TR 2002/6 details a number of factors to take into account when determining whether two entities are acting in concert with each other. These include:

· the nature and extent of commercial dealings between the two entities;

· common resources, facilities or services;

· involvement in managerial decisions and day to day management;

· financial interdependencies;

· common flow of profits;

· common ownership/capital;

· shared purchasing of goods or services;

· common customers; and

· similar kind of business

Whether an entity is an affiliate will be a question of fact and degree in relation to which an exercise in judgement is necessary, which involves a process of evaluating and weighing a range of factors for the particular circumstances.

Indirect control

An indirect control test also applies to all entities - in accordance with subsection 328-125(7), if an entity (the first entity) directly controls another entity (the second entity), and that second entity controls (directly or indirectly) another entity (the third entity), the first entity is deemed to control the third entity.

The meaning of control in this context should be construed with reference to the meaning given in subsection 328-125(1).

Subsection 328-125(8) provides exceptions for certain entities to limit the operation of subsection 328-125(7). .

Application to the Rulee's circumstances

Based on the information provided, the relevant consideration to establish if the entities are connected is whether a relationship of control exists.

This means that the Foreign Entity and the Rulee will be connected for the purposes of section 328-125 if either the Foreign Entity controls the Rulee or the Rulee controls the Foreign Entity. In this case, they will be connected if:

· the Rulee, the Rulee's affiliates or the Rulee together with its affiliates have, or have the right to acquire, a control percentage of at least 40% in the Foreign Entity, or

· the Foreign Entity, the Foreign Entity's affiliates or the Foreign Entity together with its affiliates have, or have the right to acquire, a control percentage of at least 40% in the Rulee.

Control of the Foreign Entity by the Rulee

As the Rulee does not own or have the right to acquire the ownership of interests carrying rights to exercise voting power or distributions of income or capital in the Foreign Entity, it does not itself control the Foreign Entity.

However, the Commissioner must also consider whether the Rulee has affiliates and if those affiliates have a controlling percentage of at least 40% in the Foreign Entity.

The Rulee has stated that it does not have any affiliates, within the meaning of section 328-130, that have an interest in the Foreign Entity. As such, the only relevant consideration in this context is whether the Rulee itself has the requisite controlling percentage.

Thus, the Rulee does not control the Foreign Entity for the purposes of section 328-125 of the ITAA 1997.

Control of the Rulee by the Foreign Entity

The relevant entities which have an interest in the Rulee are the Foreign Entity, the Australian Entities.

The Foreign Entity directly holds 40-50% of the voting rights and entitlement to income and capital distributions in the Rulee. The remaining voting rights and entitlement to income and capital distributions are held between the Australian Entities.

The Commissioner must also consider whether any of the other entities that hold these rights in the Rulee are affiliates of the Foreign Entity to determine the Foreign Entity's control percentage.

The facts demonstrate that Director A effectively has the right to exercise all voting rights of the Australian Entities for the relevant income years. He exercises the voting power of all these entities. This gives Director A the majority voting power in the Rulee and allows them to influence the operation of the Rulee outright.

To this end the affiliate provisions in section 328-130 require that the Commissioner determines whether any of them are reasonably expected to act in accordance with the Foreign Entity's directions or wishes, or in concert with the Foreign Entity in relation to their own business affairs.

With reference to the above mentioned affiliate factors, the Rulee has stated that:

· there are no family or close personal relationships between the Foreign Entity and the Australian Entities;

· there are no financial relationships or dependencies outside of the Rulee business relationship;

· there are no common directors or shareholders;

· apart from the business relationship, there are no other consultations between the Foreign Entity and the Australian Entities group;

· there are no arrangements for the Australian Entities group to conduct business with or purchase goods from the Foreign Entity and vice versa;

· the Subscription and Shareholders Agreement and Articles of Association do not allow one party to dictate the actions of the other party and no other agreements to that effect exist between them;

· the Australian Entities and the Foreign Entity are independent and do not share any infrastructure or employees. The two groups are located in separate countries - Australia and country X, and

· apart from both holding shares in the Rulee, they are independent entities that do not act together.

The Foreign Entity has no influence or involvement in the business affairs of the entities in the Australian Entities group. They are independent companies located in different countries with autonomous administrative structures and sets of employees.

The Foreign Entity and the Australian Entities act independently and could not be reasonably expected to act in accordance with the directions or wishes of the other, or in concert with each other.

In view of this the Commissioner finds that the entities in the Australian Entities group are not affiliates of the Foreign Entity.

The Rulee has stated that Director A is not an affiliate of the Foreign Entity. This means that he does not and could not reasonably be expected to act in accordance with the directions and wishes of the Foreign Entity, or act in concert with the Foreign Entity.

Thus, the Foreign Entity's control percentage is limited to the rights it directly holds. The Foreign Entity, having a control percentage of 40-50% in the Rulee, meets the criteria of subsection 328-125(2)(a) and (b) and therefore controls the Rulee for the purposes of section 328-125.

Conclusion

In the first instance, the Foreign Entity controls and is therefore connected with the Rulee.

Question 2

Following on from Question 1, where the Foreign Entity is connected with the Rulee for the purposes of subsection 328-125(2) of the ITAA 1997, will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that the Foreign Entity does not control the Rulee for the purposes of section 328-125 of the ITAA 1997?

The relevant provisions

Relevantly, subsection 328-125(6) provides that:

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 other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates.

The Commissioner has the discretion under subsection 328- 125(6) to determine that an entity does not control another entity where:

· the control percentage is at least 40%, but less than 50%; and

· the Commissioner considers that the other entity is in fact controlled by others - ie a third entity, being an entity other than the first entity and/or its affiliates.

Application to the Rulee's circumstances

For the Commissioner to exercise his discretion under subsection 328-125(6), there must be another entity, together with its affiliates, that has a control percentage of at least 40%.

The key consideration here is whether an entity (or entities) other than the Foreign Entity and/or its affiliates control the Rulee.

In this case, the entities other than the Foreign Entity that have an interest in the Rulee are the Australian Entities.

Individually, none of the Australian Entities meet the criteria set out in paragraphs 328-125(2)(a) and (b) of having a control percentage of at least 40%. However the subsection provides that the control percentage includes interests held by an entity's affiliates.

The Australian Entities have delegated their voting rights in the Rulee to Director A and so act in concert with Director A and also each other in relation to the business affairs of the Rulee. Given that Director A solely exercises the rights and voting power of each entity under the Subscription and Shareholders' Agreement, it is reasonable to conclude these entities act in accordance with Director A's directions or wishes, or in concert with them in relation to the affairs of the company's business. It follows that the companies are affiliates of Director A and of each other under subsection 328-130(1). The companies act in concert with each other (via the companies' delegation to Director A).

Having regard to the relationship between Director A and the Australian Entities, the Commissioner considers that Director A effectively controls the Rulee, through his relationship with the Australian Entities. They have a combined control percentage of more than 50%, which is greater than 40%.

Consequently, there are two groups (ie. the Foreign Entity and Director A with the Australian Entities) that directly control the Rulee pursuant to section 328-125(2). As the Foreign Entity holds a control percentage of more than 40% but less than 50%, pursuant to section 328-125(6) the Commissioner may determine that the Foreign Entity does not control the Rulee if he thinks that the Rulee is controlled by an entity other than, or by entities that do not include, the Foreign Entity.

Control of the Rulee

In determining the controlling entity/entities in relation to the Rulee the Commissioner must consider who is responsible for and controls both the strategic decision making on behalf of the company and also the day to day running of the company.

Strategic decision making in relation to the Rulee

The Australian Entities contribute three representatives to the board of directors, while the Foreign Entity contributes two. However, given that the voting power of the directors rests in equal proportion to their overall ordinary shareholdings, it remains that the Australian Entities enjoy a combined more than 50% majority.

It follows that the Australian Entities (which are all controlled by Director A) retain ultimate control over the strategic operations and decision making aspects of the company at board level.

Day to day management and running of the Rulee

The Rulee advised that the decision making and management of day to day operations, administration, legal and finance functions of the Rulee are conducted by an executive group of the Rulee that reports to Director A. Any Board reserved matters are dealt with on a daily basis by the management team and then presented at Board meetings. However, the executive group does not report to any directors appointed by the Foreign Entity. Further, director level sign offs are undertaken by the directors appointed by the Australian Entities and not those appointed by the Foreign Entity.

Three key staff from the Australian Entities shareholder group are in key roles and exercise material influence in the executive management of the Rulee.

Additionally, these staff are the sole signatories on the Rulee's domestic bank accounts. No Foreign Entity employees have been made signatories on these accounts.

All R&D activities are independently directed and conducted by the staff of the Rulee, without any reliance on the staff of the Foreign Entity.

In relation to the day to day running of the Rulee, the Rulee executive and staff are appointed to all relevant administrative positions and fulfil these roles outright. The management of the Foreign Entity have no involvement in this aspect of the business.

Conclusion

In relation to the discretion afforded the Commissioner under subsection 328-125(6), the Commissioner finds that the strategic decision making and day to day running of the Rulee are controlled by personnel from the Australian Entities group, in particular Director A, who holds an irrevocable right to vote on behalf of all shareholders of the entities in the group.

Therefore, given that Director A controls the Australian Entities and they (and not the Foreign Entity) directly control the Rulee and that they are neither controlled by nor affiliates of the Foreign Entity, the Commissioner will exercise his discretion under subsection 328-125(6) and determine that the Foreign Entity is not connected with the Rulee under section 328-125 for the purposes of subsection 328-115(2). That is, the Foreign Entity's annual turnover should not be included in the Rulee's aggregated turnover by way of it being connected with the Rulee.

Question 3

For the purposes of calculating the aggregated turnover of the Rulee under section 328-115 of the ITAA 1997 to determine its entitlement to an R&D tax offset at the rate under item 1 of the table under subsection 355-100(1) of the ITAA 1997, is the Foreign Entity an affiliate of the Rulee for the purposes of section 328-125 of the ITAA 1997?

Relevant legislation

The general affiliate provisions have already been explained at Question 1.

Application to the Rulee's circumstances

For the purpose of the aggregated turnover test under paragraph 328-115(2)(c) the affiliate provisions in section 328-130 require that the Commissioner determines whether the Foreign Entity is reasonably expected to act in accordance with the Rulee's directions or wishes, or in concert with the Rulee in relation to the business affairs of the Foreign Entity.

With reference to the above mentioned affiliate factors the Rulee has stated that:

There are no family or close personal relationships between the Foreign Entity and the Rulee.

There are no financial relationships or dependencies outside of the formal business relationship of the investor (the Foreign Entity) and investee (the Rulee) that is governed by the SSA and Articles of Association.

Business matters are generally handled independently by Director A and his executive group, with minimal consultation with the Foreign Entity. Any Board reserved matters are dealt with on a daily basis by the management team and then presented at Board meetings. There are no other consultations between the Foreign Entity and the Rulee.

The affairs of the Foreign Entity are undertaken by the executive officers and support staff of the Foreign Entity and the Rulee has no role in these activities.

There are no arrangements for the Rulee to conduct business with or purchase goods from the Foreign Entity and vice versa.

The SSA and Articles of Association do not allow one party to dictate the actions of the other party and no other agreements to that effect exist between them.

The Rulee and the Foreign Entity are independent and do not share any infrastructure or employees. The two groups are located in separate countries.

The Rulee and the Foreign Entity have separately functioning boards.

With reference to the affiliate factors and the facts provided in the application the Commissioner finds that apart from the two Foreign Entity appointed directors there are no family or close personal relationships between the Foreign Entity and the Rulee. The Rulee board does not influence or work in concert with the Foreign Entity board in relation to the business affairs of the Foreign Entity.

The nature of the relationship that exists between the Foreign Entity and the Rulee is that any form of consultation that takes place is directed only towards the business affairs of the Rulee.

The Rulee has no influence or involvement in the business affairs the Foreign Entity. They are independent companies located in different countries with autonomous administrative structures and sets of employees.

The Foreign Entity could not be reasonably expected to act in accordance with the directions or wishes of the Rulee, or in concert with the Rulee.

The example in section 328-130 makes it clear that there must be more than a business relationship. With this in mind it is considered that there is minimal involvement of the Rulee in the business affairs of the Foreign Entity. Any involvement between the two parties is limited to the shareholding the Foreign Entity has in the Rulee and the Foreign Entity appointed directors in the Rulee, who do not hold the controlling interest.

Conclusion

In view of this the Commissioner finds that the Foreign Entity is not an affiliate of the Rulee under section 328-130 for the purposes of determining the aggregated turnover of the Rulee in terms of paragraph 328-115(2)(c).

Overall Conclusion

Based on the facts of this ruling, for the purposes of the R&D tax offset provisions in section 355-100, the annual turnover of the Foreign Entity should not be added to the aggregated turnover of the Rulee as a result of being connected with the Rulee or an affiliate of the Rulee.