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Edited version of your written advice
Authorisation Number: 1051344123901
Date of advice: 28 February 2018
Ruling
Subject: Connected entity – control test
Question
Is the Commissioner able to exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 to determine that a company does not control the Company?
Answer
No. The Commissioner is unable to exercise the discretion.
This ruling applies for the following periods:
Period ended 30 June 2017
The scheme commences on:
1 July 2016
Relevant facts and circumstances
The Company has a turnover of less than $7m for the year ended 30 June 2017.
The Company’s share structure and ownership shows 50% of ordinary shares are owned by another company.
Relevant legislative provisions
Income Tax Assessment Act 1997, section 328-110
Income Tax Assessment Act 1997, section 328-115
Income Tax Assessment Act 1997, paragraph 328-115(2)
Income Tax Assessment Act 1997, section 328-125
Income Tax Assessment Act 1997, paragraph 328-125(2)
Income Tax Assessment Act 1997, paragraph 328-125(2)(b)
Income Tax Assessment Act 1997, subsection 328-125(6)
Reasons for decision
Summary
The Commissioner cannot exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 to determine that the Company is not controlled by another company. The other company is a connected entity for the purposes of the aggregated turnover calculation.
Detailed reasoning
Note: All subsequent legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.
To be considered a ‘small business entity’ for the purposes of section 328-110 the taxpayer’s ‘aggregated turnover’ must first be determined.
The meaning of ‘aggregated turnover’ is included in section 328-115 and consists of the sum of the relevant ‘annual turnovers’.
For the purposes of this calculation, subsection 328-115(2) indicates that a taxpayer will include their own annual turnover together with the annual turnovers of any ‘connected entities’ or ‘affiliates’.
The meaning of ‘connected with’ an entity is discussed at section 328-125. It introduces the concept of ‘control’ and at subsection 328-125(2)(b) provides that for companies, a first entity directly controls a second entity if the first entity owns equity interests in the second entity 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 that company.
In the Company’s case, 50% of its ordinary shares are owned by another company. As per paragraph 328-125(2)(b) this gives the other company (the first entity) control of the Company (the second entity), meaning that the annual turnover of the first entity must be included in the Company’s aggregated turnover.
However, subsection 328-125(6) provides that the Commissioner may determine that the first entity does not control the second entity if the Commissioner thinks that the second entity is controlled by another entity or entities that do not include the first entity or any of its affiliates:
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.
In other words, where the control percentage is at least 40% but less than 50% the Commissioner may exercise discretion to determine that the first entity does not control the second entity. Section 328-125 does not provide the Commissioner with any discretion to determine that control lies elsewhere when the control percentage is 50% or more.
Since the first entity does not hold less than 50% of the shareholdings in the Company (i.e. it holds exactly 50%) it is clear that the Commissioner has no discretion to determine that control lies elsewhere. The two entities are confirmed as being connected for the purposes of the aggregated turnover calculation. The annual turnover of the other company must be taken into account when calculating the aggregate turnover of the Company.