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Edited version of your private ruling
Authorisation Number: 1012576424761
Ruling
Subject: Schedule 2F - Interposed Entity Election
Question 1
Will subsection 272-87(3) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) deem the Interposed Entity Election (IEE) made by X. to be invalid?
Answer
Yes. As the family control test was not passed at the time the IEE was made the election is not valid and has no effect.
This ruling applies for the following periods:
1 July 2003 to 30 June 2013
Relevant facts and circumstances
The X Trust made a Family Trust Election (FTE) in 200X nominating Person A as the test individual for the X Trust.
In the 200Y year a related entity, X Pty Limited., made an Interposed Entity Election (IEE) with reference to the FTE made in 200X by the X Trust. The election commencement time of the IEE was 01/07/200Y.
X Pty Limited. is a company which at all material times had three shareholders who are siblings. These siblings, Person B, Person C and Person D, each hold equal shares in X Pty Limited. which give them fixed entitlements to the income and capital of the company. All the shares carry the same entitlements to the income and capital of X Pty Ltd.
A variation to the 200X FTE was made in 200Z to change the test individual from Person A to Person B. Person B is the parent of Person A.
Relevant legislative provisions
Income Tax Assessment Act 1936
Schedule 2F
Section 272-75
Section 272-80
Section 272-85
Section 272-87
Section 272-90
Section 272-95
Reasons for decision
Requirements for making a valid Interposed Entity Election (IEE)
Under subsection 272-85(1) of Schedule 2F to the ITAA 1936 a company, partnership or trust may lodge an interposed entity election (IEE), so that from the date specified in the election, the company, partnership or trust will be included in the family group of the individual specified in a family trust election. The making of an IEE by the interposed entity means that any distributions or conferrals by that entity must be confined to the family group of the trust to which the IEE relates.
A prerequisite for the making of an IEE is that the interposing entity must pass the family control test at the end of the specified income year - refer subsection 272-85(4) of Schedule 2F to the ITAA 1936.
Subsection 272-87(3) of Schedule 2F to the ITAA 1936 sets out how companies and partnerships pass the family control test:
272-87(3)
A company or partnership in respect of which an interposed entity election is proposed to be made passes the family control test if a group consisting of:
(a) the individual who is specified in the family trust election mentioned in subsection 272-85(1) in relation to the interposed entity election; or
(b) one or more members of the individual's family (see section 272-95); or
(c) the trustees of one or more family trusts, provided the individual is specified in the family trust election of each of those family trusts; or
(d) any persons covered by any combination of the above paragraphs;
have (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the income or a greater than 50% share of the capital of the company or partnership.
In this instance the family control test is failed as the specified individual and family members did not hold more than 50% of fixed entitlements to the income or capital of X Pty. Ltd. The only family member who held fixed entitlements to the income and capital of the company at the time the IEE was made was Person B, the parent of the specified individual. Person B only held fixed entitlements of 33.3% of the income and capital of X Pty. Ltd.
The definition of 'family' in subsection 272-95(1) of Schedule 2F to the ITAA 1936 does not include uncles of the specified individual. Therefore Person C and Person D were not members of the test individual's family for the purposes of the family control test.
Accordingly, the company did not pass the family control test in subsection-272-85(4) of Schedule 2F to the ITAA 1936 at the time the IEE was made. as X Pty. Ltd. did not meet this pre-condition, the IEE was not validly made and can have no effect.
Variation of FTE
The X Trust made a variation to the FTE on 30/06/200Z with an election commencement time of 01/07/200V (the variation). The individual specified in the FTE variation was Person B.
At this time X Pty. Ltd. became a member of the family group as all the fixed entitlements to the income and capital of the company were held by the test individual and members of their family (their two siblings) - refer subsection 272-90(5) of Schedule 2F to the ITAA 1936. Therefore any distributions made by the X Trust to X Pty. Ltd. since that time will not attract a Family Trust Distributions Tax.