Edited version of your private ruling

Authorisation Number: 1012600827087

Ruling

Subject: Connected entity test

Question 1

During the relevant period, did you directly control Company X pursuant to subsection 328-125(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

During the relevant period, did you indirectly control Company X pursuant to subsection 328-125(7) of the ITAA 1997?

Answers

Yes.

Question 3

Will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that the partnership did not control Company X?

Answer

The Commissioner is unable to exercise the discretion.

This ruling applies for the following period:

1 July 2011 to 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances:

Company X is an Australian resident taxpayer.

During the relevant period, the shares in Company X were held as follows:

The only shares on issue in Company X were ordinary shares, which carried rights to receive income, capital distributions and exercise voting power.

Unrelated Co and Unrelated Sub Co are wholly unrelated (both directly and indirectly) to you and your spouse. Neither yourself, your spouse, nor any entity controlled by yourself or your spouse, owned shares in Unrelated Co.

You, along with your spouse and your affiliates did not have any rights to acquire further shares in Company X.

Your spouse, and yourself are partners in a partnership. During the relevant income year:

• The partnership did not carry on a business;

• The partnership holds X% of the shares in Company X;

• The partnership also has an investment property, which was leased to a related company; and

• The net income of the partnership was split 50/50 between your spouse and yourself.

Your spouse did not carry on business at any time during the relevant income year.

You were a director of Company X during the relevant income year.

Company X did not declare or pay any dividends or distributions in the relevant income year.

Assumption

None of the following entities were your affiliates as defined by section 328-130 of the ITAA 1997:

• Company X

• Unrelated Co; or

• Unrelated Sub Co.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-125

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

Income Tax Assessment Act 1997 subparagraph 328-125(2)(a)(ii)

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

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

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

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

Income Tax Assessment Act 1997 section 960-100

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

You did not directly control Company X pursuant to subsection 328-125(2) of the ITAA 1997.

Detailed reasoning

Section 328-125 of the ITAA 1997 sets out the meaning of connected with an entity.

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.

A key word from the above provision is the notion of control. In determining whether an entity directly controls another, subsection 328-125(2) of the ITAA 1997 provides:

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.

You own interests in Company X that give you a right to receive Y% of the distribution of income of Company X. This is made up of Z% that you own in your personal name, and V% you own by virtue of the joint tenancy with your spouse. Since you individually hold less than 40% of the equity interests in Company X, you do not directly control Company X on your own.

However, it must be considered whether you have an affiliate, and whether the affiliate or you together with your affiliates, control Company X by holding interests that carry between them the rights to a distribution of at least 40% of the income or capital of Company X, or the right to voting power.

An affiliate is defined in subsection 328-130(1) of the ITAA 1997 as:

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.

It is clear from the definition of affiliate in subsection 328-130(1) of the ITAA 1997 that the affiliate must be carrying on a business.

It has been stated as a fact that your spouse did not carry on a business at any time during the relevant income year. As subsection 328-130(1) of the ITAA 1997 requires the affiliate to be carrying on a business, it is concluded that your spouse is not your affiliate. Therefore their shareholding in Company X is not taken into account in determining whether you control Company X under subsection 328-125(2) of the ITAA 1997.

The other shareholders of Company X include Unrelated Co and their wholly owned subsidiary Unrelated Sub Co. As you have stated that Unrelated Co and its subsidiary are wholly unrelated to you they will also not be your affiliates as defined by subsection 328-130(1) of the ITAA 1997.

As you only hold Y% of the shareholding in Company X, you do not directly control Company X pursuant to subsection 328-125(2) of the ITAA 1997.

Question 2

Summary

You indirectly control Company X pursuant to subsection 328-125(7) of the ITAA 1997.

Detailed reasoning

In determining whether an entity is connected with another entity, paragraph 328-125(2)(b) of the ITAA 1997 provides that the entities will be connected if both entities are controlled by the same third entity.

For the purposes of paragraph 328-125(2)(b) of the ITAA 1997, subsection 328-125(7) provides:

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.

When determining whether an entity directly controls another for the purposes of subsection 328-125(7) of the ITAA 1997, control must be established pursuant to subsection 328-125(2).

In other words, you will indirectly control Company X pursuant to subsection 328-125(7) of the ITAA 1997 if you control an entity pursuant to subsection 328-125(2), and that entity controls Company X, also pursuant to that subsection.

Tax law partnership

You are a partner in a partnership with your spouse. In respect of controlling a partnership, subparagraph 328-125(2)(a)(ii) of the ITAA 1997 relevantly provides that:

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 (a control percentage) that is at least 40% of:

(i)…; or

(ii) if the other entity is a partnership - the net income of the partnership; or

(iii) …; or

(b) …

A partnership is defined in section 995-1 of the ITAA 1997 as:

An association of persons (other than a company or a ^*limited partnership) carrying on business as partners or in receipt of ^*ordinary income or ^*statutory income jointly;

It has been taken as fact that the partnership was not carrying on a business in the relevant income year, so it is not an association of persons carrying business as partners (a 'general law partnership').

During the relevant income year, the partnership leased out an investment property to a related entity, and therefore received rental income. As you received the rental income jointly with your spouse, the partnership is considered to be a partnership as outlined by the second limb of the definition of a partnership in section 995-1 of the ITAA 1997, (a 'tax law partnership').

Subsection 328-125(2) of the ITAA 1997 applies to 'an entity'. The term 'entity' is defined in subsection 960-100(1) of the ITAA 1997, which includes a partnership at paragraph 960-100(1)(d). The fact that the partnership is a tax law partnership and not a general law partnership does not alter the conclusion that the partnership is a partnership as defined by section 995-1 of the ITAA 1997 and consequently for the purposes of section 328-125.

Indirect control of Company X

The net income of the partnership during the relevant income year, consisting mainly of rental income, was split 50/50 between your spouse and yourself. As you were in receipt of more than 40% of the net income of the partnership, you controlled the partnership under subparagraph 328-125(2)(a)(ii) of the ITAA 1997 during the relevant income year.

As provided above, an entity will control a company under subsection 328-125(2) of the ITAA 1997 if the entity owns or has the right to acquire the ownership of interests in the company that carry between them the right to receive a distribution of at least 40% of the income or capital of the company; or exercise, or control the exercise of, a percentage that is at least 40% of the voting power in the company.

The partnership holds X% of the shares in Company X. These shares are ordinary shares which carry with them rights to receive a distribution of the income and capital of Company X. As the partnership holds at least 40% of the equity interests that carry with them a right to receive a distribution of at least 40% of the income and capital of Company X, the partnership controls Company X under subsection 328-125(2) of the ITAA 1997.

As you control the partnership pursuant to subparagraph 328-125(2)(a)(ii) of the ITAA 1997, and partnership controls Company X pursuant to paragraph 328-125(2)(b), you indirectly control Company X pursuant to subsection 328-125(7).

Question 3

The Commissioner is unable to exercise the discretion under subsection 328-125(6) of the ITAA 1997 as the eligibility requirements to exercise the discretion have not been met.