Edited version of your written advice

Authorisation Number: 1051522828478

Date of advice: 27 May 2019

Ruling

Subject: Meaning of connected with an entity – Commissioner’s determination in subsection 328-125(6)

Question 1

Will the Commissioner exercise the discretion in subsection 328-125(6) of the Income Tax Assessment act 1997 (ITAA 1997) to determine that Company X does not ‘control’ The ABC Family Trust for the 20XX income year?

Answer

Yes

Question 2

If yes, can the Commissioner confirm that Mr Z does not ‘control’ The ABC Family Trust for the 20XX income year under subsection 328-125(7) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company X

Company X is acting in its own right and was incorporated on May 20XX and its sole director is Mr Z.

Company X was purely set up for the benefit of Mr Z. The shares in Company X are 100% owned by Company Y as trustee of The Mr Z Family Trust.

Mr Z is the sole director of Company Y holding 100% of the shares in the company. Mr Z had been made presently entitled to 100% of the income distributions from The Mr Z Family Trust for the 20XX to 20XX income years. No capital distributions were made by the Mr Z Family Trust in those income years.

Company X received 42% of income distributions from The ABC Family Trust in the 20XX income year.

The ABC Family Trust

The ABC Family Trust was established by Deed and Company H is the trustee of the Family Trust and the Appointer is Mr K.

Mr K is the parent of Mr Z.

Mr K owns 100% of the shares in Company H following the death of their spouse, was appointed as the company secretary shortly after.

The percentages of income distributions by The ABC Family Trust for each of the preceding four income years from 20XX to 20XX are as follows:

No capital distributions were made by The ABC Family Trust during the last four income years.

Other entities connected to Mr Z and Mr K

The ZN Trust

The ZN Trust is a discretionary trust established for the benefit of Mr Z who operates a business via The ZN Trust.

Company N is the trustee of The ZN Trust. Mr Z is the sole director of the trustee company and he owns 100% of the shares in Company N.

Mr Z and Company W (trustee of The W Trust) had been made presently entitled to more than 40% of the income distributions from The ZN Trust for 20XX to 20XX income years. No capital distributions were made for those income years.

The W Trust

The W Trust is a discretionary trust established for the benefit of Mr Z. Company W is the trustee of The W Trust. A business is conducted via The W Trust.

Mr Z and Mr K are appointors of The W Trust. Mr Z and Mr K are also directors of Company W holding 50:50 of the shares in the trustee company.

Mr Z received over 40% of the income distributions from The W Trust for 20XX to 20XX income years. No capital distributions were made for those income years.

Company Q

Company Q is a company acting in its own right which is an investment company operated and controlled by Mr K.

Mr K holds 100% of the shares in Company Q and he’s a director of the company.

Company R

Company R is a company acting in its own right which is an investment company operated and controlled by Mr K.

Mr K holds 100% of the shares in Company R and is a director of the company.

Company R holds 75% of the shares in Company S which in turn holds 30% of the ordinary shares in Company V. The remaining 25% in Company S is held by a third party.

Following Mr K’s family situation, Mr Z (child of Mr K) was appointed as director of Company Q, Company R and Company S in addition to Mr K who has always been a director of the three companies since their inception.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 328-125

subsection 328-125(1)

subsection 328-125(2)

subsection 328-125(3)

subsection 328-125(4)

subsection 328-125(6)

subsection 328-125(7)

subsection 328-125(8)

subsection 328-130(1)

subsection 328-130(2)

Income Tax Rates Act 1986

section 23AA

paragraph 23AA(b)

Reasons for decision

Meaning of connected with an entity

Section 328-125 of the ITAA 1997 contains the ‘control’ rules for determining whether an entity is connected with another entity.

Subsection 328-125(1) provides that an entity is connected with another entity if:

a) either entity controls the other entity in a way described in section 328-125; or

b) both entities are controlled in a way described in section 328-125 by the same third entity.

Subsection 328-125(2) provides for the direct control rules of an entity other than a discretionary trust where it states:

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.

Subsections 328-125(3) and (4) set out the two specific direct ‘control’ rules for discretionary trusts as follows:

1) Influence over the trustee test

The ‘influence over the trustee’ test is provided by subsection 328-125(3) of the ITAA 1997 where it states that 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. This test focuses on the underlying relationship between an entity and a trustee.

2) Distribution test

Subsection 328-125(4) of the ITAA 1997 provides for a control percentage of at least 40% applying retrospectively by examining the trust distributions for any of the previous four income years. Under the subsection, an entity is taken to control a discretionary trust for an income year if, for any of the four preceding income years:

a) any income or capital of the trust was distributed for the benefit of the entity and/or its affiliates; and

b) the amount distributed was at least 40% of the total amount of income or capital distributed by the trustee for that income year.

If control is established at any time during an income year, the connected entity’s annual turnover must be included in the test entity’s aggregated turnover calculation for that income year.

Subsection 328-125(6) of the ITAA 1997 allows the Commissioner with a discretion to determine that an entity does not control another entity. The subsection provides that 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.

Subsection 328-125(7) provides for an indirect control test which applies to all entities where it states:

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.

The application of subsection 328-125(7) is subject to certain exceptions set out in subsection 328-125(8).

Meaning of affiliate

Subsection 328-130(1) of the ITAA 1997 provides that 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. 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 – see subsection 328-130(2).

Application to the facts

Under the ‘distribution test’ in subsection 328-125(4) of the ITAA 1997, Company X is connected with The ABC Family Trust for the 20XX income year because it has received an income distribution of 42% from the Trustee of The ABC Family Trust in the 20XX income year. Therefore, Company X is taken to control The ABC Family Trust in the 20XX income year.

Company X is 100% owned by Company Y as Trustee for The Mr Z Family Trust. Mr Z is the sole director of Company X.

Mr Z is the sole director of Company Y and he holds 100% of the shares in the company. He has been made presently entitled to 100% of the income distributions from The Mr Z Family Trust for the 20XX to 20XX income years. No capital distributions made in those income years.

Therefore, Mr Z is taken to control Company X via The Mr Z Family Trust under subsection 328-125(2) of the ITAA 1997. Given that Company X is taken to control The ABC Family Trust, Mr Z is also taken to control The ABC Family Trust under subsection 328-125(7).

The control percentage of Company X in The ABC Family Trust is 42% which satisfies the control percentage condition in subsection 328-125(6). That subsection requires that if the control percentage is at least 40%, but less than 50%, the Commissioner may determine Company X does not control The ABC Family Trust if the Commissioner thinks that there is another entity controlling The ABC Family Trust.

In the present case, Mr K owns 100% of the shares in Company H, the company trustee of The ABC Family Trust. The Trust Deed shows that Mr K is the Appointor of The ABC Family Trust. Therefore under the ‘influence over the trustee test’ Mr K controls The ABC Family Trust.

Company R received 82% of income distribution in the 20XX income year and 54% of income distribution in the 20XX income year from The ABC Family Trust. Therefore under the ‘distribution test’ Company R is taken to control The ABC Family Trust. It is noted that Mr K also controls Company R owning 100% of the shares in the company.

There are no affiliates of Mr Z other than Company X that can be taken to control The ABC Family Trust. Company Q, Company R, Company S and Company H are not affiliates of Mr Z within the meaning of section 328-130 of the ITAA 1997 merely because Mr Z is a director of these three companies. It’s confirmed that that the day to day running and investment decisions for the three companies rest solely with Mr K. In this context Mr K could not reasonably be expected to act, in accordance with Mr Z’s directions or wishes so it could not be said that Mr Z is an affiliate of Mr K for the purposes of section 328-130.

Company X is operated and owned 100% by Mr Z and so Mr Z has control of Company X. However, Mr K is not a director of Company X and Mr K does not control that company. As such Company X is also not an affiliate of Mr K for the purposes of section 328-130.

It is noted Mr Z and Mr K are both Appointors of The W Trust. They are also directors of Company W (trustee of The W Trust) holding 50:50 of the shares in the company. However, Company W and Mr Z did not receive any income or capital distributions from The ABC Family Trust in the last four income years. So Company W is not connected to The ABC Family Trust and Mr Z and Mr K could not be said to be affiliates for the purposes of section 328-130 of the ITAA 1997.

Considering that Mr K controls The ABC Family Trust under the ‘influence over the trustee test’ and Company R controls The ABC Family Trust under the ‘distribution test’ and the control percentage test is also satisfied, all of the conditions in subsection 328-125(6) are met. Therefore, the Commissioner will exercise the discretion provided in that subsection and determine that Company X does not control The ABC Family Trust.

Consequently, as the control of Company X in The ABC Family Trust is ignored when the Commissioner exercises the discretion in subsection 328-125(6), the indirect control of Mr Z in The ABC Family Trust under subsection 328-125(7) is also ignored. Therefore, Mr Z does not control The ABC Family Trust.