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Edited version of your written advice
Authorisation Number: 1013028211137
Date of advice: 3 June 2016
Ruling
Subject: Connected entities
Question 1
Will the Commissioner exercise the discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Trust A does not control Trust C and is therefore not a connected entity of Trust C?
Answer
Yes.
Question 2
Is Trust C controlled by person X?
Answer
Yes.
This ruling applies for the following periods:
Year ending 30 June 2016
Year ending 30 June 2017
The scheme commences on:
1 July 2015
Relevant facts and circumstances
Trust C was established to set up a business.
Trust A and Trust B both hold over 40% of the issued units in Trust C.
Trust A is controlled by Person Y.
Trust B is controlled by Person X.
Person X has no other business interests apart from their involvement in Trust C's business.
Person Y has other business interests.
Person X makes all of the decisions in relation to the day to day running of the business.
Person Y has never been part of any business direction. Since Trust C's conception, Person Y has always been agreeable for Person X to fully control the operations of the trust.
Relevant legislative provisions
Income Tax Assessment Act 1997 - Section 328-125
Income Tax Assessment Act 1997 - Section 328-130
Reasons for decision
The meaning of a connected entity is defined under section 328-125 of the ITAA 1997 which states as follows:
An entity is connected with another entity if:
(a) either entity controls the other entity in the 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 a company
Subsection 328-125(2) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own:
• interests in the company that give them the right to receive at least 40% (the control percentage) of any distribution of income or capital; or
• equity interests in the company that carry between them the right to exercise at least 40% (the control percentage) of the voting power in the company.
An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you (section 328-130 of the ITAA 1997). A trust, partnership or superannuation fund cannot be an affiliate.
Commissioner may determine that an entity does not control another entity
The Commissioner's discretion, as set out in subsection 328-125(6) of the ITAA 1997 states the following:
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 Advanced Guide to Capital Gains Tax Concessions for Small Business 2012-2013 NAT 3359 (Advanced Guide) discusses the application of the discretion contained in subsection 328-125(6) of the ITAA 1997.
The Advanced Guide provides that for the Commissioner to be able to consider the discretion in subsection 328-125(6) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage of at least 40% of the company. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account. The third entity must control the company in the way described in subsection 328-125(2) of the ITAA 1997. Unless the conditions of subsection 328-125(2) of the ITAA 1997 are met by a third entity, the Commissioner cannot determine that the first entity does not control the company.
If there was a third entity with a control percentage of 40% or more it would then be necessary to consider additional factors such as who is responsible for the day to day and strategic running of the company to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least 40% may control the company if such responsibilities are shared.
Application to your circumstances
Trust C was established to set up a business. In this case, Person X and Person Y both hold over 40% of the issued units of Trust C through their control of Trusts B and A respectively. Because both entities hold more than 40% of the issues units in the trust, they will both be deemed to control the trust unless the Commissioner exercises the discretion under subsection 328-125(6) of the ITAA 1997.
In this case, Person X makes all decisions in relation to the business and is responsible for its day to day operations. Person Y has never had any direct involvement in the running of the business. Accordingly, the Commissioner will exercise the discretion contained in subsection 328-125(6) of the ITAA 1997 to determine that Trust A does not control Trust C.
The control tests for the 'connected with' rules are designed to look through business structures that include interposed entities. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity. As a result, Person X is deemed to control Trust C through their control of the Trust B.