Edited version of your written advice

Authorisation Number: 1013111717579

Date of advice: 17 November 2016

Subject: Income tax and the control test

Question 1

Does the Family member 1 control the Trust within the meaning of subsection 328-125(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 201X

Year ending 30 June 201X

Year ending 30 June 201X

The scheme commences on:

1 July 201X

Relevant facts and circumstances

The AAA Family Trust (the Trust) is a discretionary trust.

The trustee of the Trust is Coy A Pty Ltd (Coy A). Coy A was incorporated for the specific purpose of acting as the trustee of the Trust. Since incorporation, Coy A has not conducted any activities other than acting as the trustee of the Trust.

The directors of Coy A are the Family member 1, and their two other family members.

The shareholders of Coy A are the Family member 1, and their two other family members. Each shareholder holds 1 ordinary share, representing XX per cent of voting and dividend and capital rights in the company.

At the time of settlement of the Trust, it was the intention that the Family member 1 and their two other family members would all jointly and equally manage and operate the trust, as it was set up to conduct business activities for the benefit of the family as a whole.

The Appointor of the trust is the Family member 1 and their two other family members acting jointly and severally. It was not intended that they be provided with several appointorship powers. Accordingly, the Trust deed is in the process of being amended to remove the several appointorship powers.

The Trust has previously been involved in the conduct of a business. At all times since the settlement of the Trust, the Family member 1, and their two other family members have all been involved in the management and operation of the Trust through their equal shareholding and directorships in the trustee company.

The Family member 1 and their two other family members meet regularly in respect of business affairs. At these meetings any matters relevant to the Trust are discussed and any actions to be taken in respect of the Trust are decided upon by mutual agreement of all three family members.

It would not be possible for the Family member 1 to exercise the several Appointors' powers, as provided under the Trust deed, without agreement from their two other family members as:

● Each family member has a specific skill-set that they bring to the operation of the Trust:

The Trust could not properly operate without the active involvement of all three family members.

● The severability of the appointment powers of the Trust has the effect that each of the three Appointors can countermand or override the appointments made by the other Appointors.

If the Family member 1 made a decision under the Appointors' powers, which was not agreed upon by their two other family members, this would likely lead to a falling out within the entire family. The family is close, and would not intend for this to happen.

The Family member 1 does not have any “affiliates” as defined in subsection 328-130(1) of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 328-125(1)

Income Tax Assessment Act 1997 Subsection 328-125(3)

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

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

Reasons for decision

Subdivision 328C of the ITAA 1997

Subdivision 328C of the ITAA 1997 explains amongst other things, the meaning of the terms 'connected with' and 'affiliate'.

Rules that apply to discretionary trusts

Direct control of a discretionary trust may be established via either of two paths. Subsection 328-125(3) of the ITAA 1997, or subsection 328-125(4) of the ITAA 1997.

Subsection 328-125(3) of the ITAA 1997

Subsection 328-125(3) provides:

'An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its *affiliates, or the first entity together with its affiliates'.

The term 'affiliate' as used in subsection 328-125(3) of the ITAA 1997, is defined in section 328-130 of the ITAA 1997.

Affiliate

Subsection 328-130(1) provides:

'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. '

Subsection 328-130(2) provides:

'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.

Example:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

Directors of the same company, or the company and a director of that company, would be in a similar position.'

Whether a person acts, or could reasonably be expected to act, in accordance with another person's directions or wishes, or in concert with them is a question of fact, dependent on all the circumstances of the particular case.

ATO Interpretive Decision ATO ID 2008/139 (Withdrawn)

ATO Interpretive Decision ATO ID 2008/139 (Withdrawn) (ATOID 2008/139) considers whether an appointor controls a discretionary trust in accordance with subsection 328-125(3) of the ITAA 1997.

The view contained in ATOID 2008/139, was that if the trust deed of a discretionary trust specified that the Appointor of the trust had the power to remove a trustee and appoint a new trustee, it was considered that the trustee could reasonably be expected to act in accordance with the directions or wishes of the Appointor. In this situation, the Appointor was considered to control the discretionary trust under subsection 328-125(3) of the ITAA 1997.

ATOID 2008/139 was subsequently withdrawn because the Commissioner's view that the ability of an Appointor of a discretionary trust to remove the trustee and appoint a new one does not, of itself, mean the Appointor controls a trust for the purposes of subsection 328-125(3) of the ITAA 1997. Whether an entity controls a discretionary trust as set out in that provision (that is, whether the trustee of a discretionary trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity and/or its affiliates) depends on the particular facts and circumstances.

The Gutteridge case

The Gutteridge case also considered the control test in subsection 328-125(3) of the ITAA 1997.

The principal dispute in the Gutteridge case was whether, for the purposes of section 328-125 of the ITAA 1997, the Trust was controlled, either alone or with others, by Mr Gutteridge's daughter. Mr Gutteridge's daughter was the sole director and shareholder of the trustee company. The consistent theme of evidence was that Mr Gutteridge controlled the Trust from behind the scenes and that his daughter would not act contrary to his wishes. In effect, he was the controller of the Trust as he made the decisions.

It was held that the statutory test calls for an examination of all of the circumstances of a case. Formal occupation of offices, such as a director of a company that is a trustee, and documented terms of instruments, such as limitations on trustees' ability to have regard to an entity's wishes or directions, do not prevent an examination of the actual circumstances when addressing the question posed by subsection 328-125(3) of the ITAA 1997.

If the actual circumstances are that a formal office holder does not control a trust, or that the terms of an instrument are not observed, the conclusion that the controller is found in the person occupying the office or the person identified by the terms of the instrument does not necessarily follow. As noted by Gordon J in a parallel context, it is necessary to undertake a critical assessment of the way in which the Trust is managed.¹ This is an enquiry into activities and decision making, and the circumstances in which they occur, not an enquiry into occupation of offices or terms of instruments per se.

Decision Impact Statement: Gutteridge and Commissioner of Taxation

A Decision Impact Statement (DIS) was issued on 19 March 2014 following the decision in the Gutteridge case.

The DIS outlined the ATO's response to the Gutteridge case which concerned whether a sole director and shareholder of a trustee company controlled the trust, so that another entity was a connected entity of the trust for the purposes of the maximum net asset value test.

The DIS made reference to the fact that the AAT considered that the control test has parallels with the definition of 'director' in the Corporations Act 2001. More specifically, there was a reasonable expectation that a person will act in a certain way if the person is 'accustomed to act' in that way.

Further, the AAT held that the test was not simply who held the formal office of director of the trustee company, nor what the trust deed stated, but rather called for an examination of the actual circumstances of a case. Based on the evidence before it, the AAT then held that although the daughter was the director and public face of the business carried on by the trust, the trustee was not accustomed to act in accordance with her wishes. The AAT considered that Mr Gutteridge alone controlled the trustee and was, in effect, a shadow or de facto director of the trustee company.

The ATO view of the decision was that:

'while the circumstances in this case allowed for a finding that a person could reasonably be expected to act in a certain way because they were 'accustomed to act' in that way, the Commissioner does not accept that the 'reasonable expectation' test in subsection 328-125(3) of the ITAA 1997 can be substituted with an 'accustomed to act' test in all cases. It depends, as the AAT said at paragraph 21, on an examination of all the circumstances of a case. For example, if there is no history at all of a trustee having acted on the directions of another, there may nonetheless be an expectation (reasonably founded) that they would act on the directions of a particular person, were such directions to be given.'

Applying the law to the facts in your case

To satisfy the control test in subsection 328-125(3) of the ITAA 1997, it is necessary to demonstrate that the Family member 1 controls the Trust on the basis that Coy A acts, or could reasonably be expected to act, in accordance with the directions or wishes of the Family member 1, its affiliates, or the Family member 1 together with its affiliates.

The facts state that the Family member 1 does not have any affiliates, accordingly, the test is limited to whether Coy A acts, or could reasonably be expected to act, in accordance with the directions or wishes of the Family member 1.

The Family member 1 acts jointly and severally with their two other family members as Appointor. Theoretically, the Family member 1 could exercise his several powers of appointment, to remove or replace the trustee of the Trust. However, it would not be practical for the Family member 1 to do so, without agreement of the other two Appointors. In the event that this occurred, the other two Appointors could exercise their own several powers, and in that way override the appointments made by the other Appointors. This would lead to conflict and an unworkable situation.

The withdrawal of ATOID 2008/139 indicated the Commissioner's view that the ability of an Appointor of a discretionary trust to remove the trustee and appoint a new one does not, of itself, mean the Appointor controls a trust for the purposes of subsection 328-125(3) of the ITAA 1997.

A critical assessment of the way in which the Trust is managed is required, with a focus on the circumstances in which activities and decision-making actually occur rather than on formal titles or the instruments under which roles within an entity are defined (Gutteridge case and DIS on Gutteridge).

It is provided on the facts that all matters relevant to the Trust, including any major decisions, are decided by mutual agreement between the Family member 1, and their two other family members for the benefit of the family as a whole. There is a reasonable expectation that the Trust will continue to be run in this way in order for the Trust to operate effectively, and not through autonomous decision making on behalf of the Family member 1.

The actual circumstances demonstrate that the Family member 1's several powers of appointment would not be used to undertake autonomous actions. The activities and decision-making and the circumstances in which they occur demonstrate that the trustee of the Trust could not reasonably be expected to act in accordance with the Family member 1s wishes independently of the wishes of each of the other family members. The business of the Trust would be unable to continue if any of the three family members withdrew their skills.

The argument is strengthened by the fact the Trust Deed is currently being amended to remove the several Appointorship power.

The Trustee would therefore take into account the directions or wishes of all three Appointors. Accordingly, the Family member 1 is not a controller of the Trust.

Conclusion

The Family member 1 does not control the Trust, in accordance with subsection 328-125(3) of the ITAA 1997.

¹