Edited version of your written advice

Authorisation Number: 1013079117884

Date of advice: 5 September 2016

Ruling

Subject: Commissioner's discretion

Question

Will the Commissioner's discretion be exercised under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company B does not control Company A?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Company A was started by Individual A to conduct research and development

The current ownership structure of Company A is:

Company C - more than 40%

Company B - more than 40% but less than 50%

Individual D - less than 40%

All of the shares issued in Company A, carry the same voting rights.

Company C is 100% owned and controlled by the A Family.

Company B is 100% owned and controlled by the B family.

The Shareholders Agreement for Company A, which governs the appointment of directors, states that each shareholder has the right to appoint X directors to the board however if any party appoints less than X directors they are still entitled to X votes each.

A shareholder resolution was passed to amend the Shareholder's Agreement. This amendment made Individual A the chairman of the board with a deliberative and casting vote.

Each family therefore has X votes in any board meeting with Individual A having the casting vote.

Individual D has never had any board representation and does not intend to which is consistent with their passive shareholding in Company A.

Individual A makes all day to day and strategic decisions for the company.

Individual A's relative, as Project Director, manages research and development (R&D), contractors and experimental trials.

Individual D is not an affiliate of Company B.

Company B is not an affiliate of Company C.

At all times Company B has had no input into the running of Company A.

Relevant legislation

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 subsection 325-125(2)

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 328-130(1)

Income Tax Assessment Act 1997 subsection 328-130(2)

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

Paragraph 328-125(2)(b) 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, or have the right to acquire the beneficial ownership of, equity interest 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.

In this case, Company B holds a control percentage of X%. Accordingly, Company B will control Company A in accordance with subsection 325-125(2) of the ITAA 1997.

Commissioner may determine that an entity does not control another entity

If an entity's control percentage in a company is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by a third entity (other than an affiliate of the first entity).

For the Commissioner to be able to consider the exercise of discretion in subsection 328-125(6) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage (including the interests of any affiliates) of at least 40% of the company. It 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 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.

In this case, for the Commissioner to consider the exercise of the discretion contained in subsection 328-125(6) of the ITAA 1997 there would need to be a single, identifiable third entity that would have a control percentage (including the interests of its affiliates) of more than 40%.

Application to your circumstances

In this case, Company B owns more than 40% but less than 50% of the shares in Company A. Company B is 100% owned and controlled by the B family. Company C is controlled by the A family and owns more than 40% of the shares in Company A. In accordance with the Shareholder Agreement of Company A, Individual A holds the casting vote at board meetings. Individual A also makes all day to day and strategic decisions for Company A. Further, Individual A's relative, as Project Director, manages R&D, contractors and experimental trials.

Given the information provided we accept that Company A is controlled by Company C. Therefore, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Company B does not control, and is not connected with, Company A.