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Edited version of private advice
Authorisation Number: 1051633157784
Date of advice: 5 February 2020
Ruling
Subject: Thin capitalisation
Question
Is Company A an 'associate entity' of Company B for the purpose of applying table item 3 of subsection 820-85(2) of the Income Tax Assessment Act 1997 (ITAA 1997) in determining whether Company A is an outward investing entity (non-ADI)?
Answer
No
This ruling applies for the following period:
1 July 2018 to 30 June 2021
The scheme commences on:
1 July 2018
Relevant facts and circumstances
Company A and Company B are 'associates' for the purposes of section 318 of the ITAA 1936.
Three entities, not including Company B, hold an interest in Company A.
There is a commonality of the directors of Company A and Company B.
Assumption(s)
The threshold tests and exemptions in section 820-35 and section 820-37 of the ITAA 1997 do not apply to the scheme facts such that they will not, of themselves, prevent Division 820 from applying.
Relevant legislative provisions
Income Tax Assessment Act 1936
Section 318
Paragraph 318(2)(d)
Subsection 318(6)
Paragraph 318(6)(b)
Income Tax Assessment Act 1997
Division 820
Section 820-35
Section 820-37
Subsection 820-85(2)
Subsection 820-905(1)
Paragraph 820-905(1)(a)
Paragraph 820-905(1)(b)
Subsection 820-905(4)
Subsection 820-905(5)
New Business Tax System (Thin Capitalisation) Bill 2001
Reasons for decision
Question
Summary
Company A is not an 'associate entity' of Company B for the purpose of applying table item 3 of subsection 820-85(2) of the ITAA 1997 in determining whether Company A is an outward investing entity (non-ADI).
Detailed reasoning
For outward investing entities subsection 820-85(2) of the ITAA 1997 states that:
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3 |
(a) |
the entity (the relevant entity) is an *Australian entity throughout a period that is all or a part of an income year; and |
the relevant entity is not a *financial entity, nor an *ADI, at anytime during that period |
the relevant entity is an outward investor (general) for that period |
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(b) |
throughout that period, the relevant entity is an *associate entity of another Australian entity; and |
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(c) |
that other Australian entity is an *outward investing entity (non-ADI) or an *outward investing entity (ADI) for that period |
Relevantly, the conditions in Column 1 of table item 3(b) of subsection 820-85(2) of the ITAA 1997 need to be considered.
Subsection 820-905(1) of the ITAA 1997 applies where the first entity (in this case Company A) is not an individual or an entity which is a responsible entity of a 'registered scheme'.
Subsection 820-905(1) of the ITAA 1997 reads as follows:
An entity (the first entity) that is not an individual is an associate entity of another entity at a particular time if, at that time, the first entity is an *associate of that other entity and at least one of the following paragraphs applies:
(a) that other entity holds an *associate interest of 50% or more in the first entity (see subsections (4) to (8));
(b) the first entity is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of that other entity in relation to:
(i) the distribution or retention of the first entity's profits; or
(ii) the financial policies relating to the first entity's assets, *debt capital or *equity capital;
whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed entities.
Accordingly, applying the above section to the facts, Company A (the 'first entity') will be considered an 'associate entity' of Company B (the 'other entity') if they are 'associates' under section 318 of the ITAA 1936 and at least one of the following paragraphs applies:
(a) Company B holds an associate interest of 50% or more in Company A, or
(b) Company A is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of Company B in relation to certain financial decisions.
As per the facts, Company A and Company B are 'associates' for the purposes of section 318 of the ITAA 1936.
Subsection 820-905(4) of the ITAA 1997 defines 'associate interest' and reads as follows:
An associate interest that an entity holds in a company (except a *corporate limited partnership) at a particular time is the percentage of the direct control interest (if any) that the entity holds in the company at that time under the provisions applied by subsection (5).
Subsection 820-905(5) of the ITAA 1997 reads as follows:
For the purposes of subsection (4), provisions of Part X of the ITAA 1936 are applied with the modifications set out in the following table:
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Modifications of provisions in Part X of the Income Tax Assessment Act 1936 |
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Item |
Provisions |
Modifications |
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1 |
Section 350 (including any other provision in Part X of the Income Tax Assessment Act 1936 that defines a term used in the section) |
The section applies for the purposes of this subsection rather than only for the purposes of Part X of the Income Tax Assessment Act 1936 |
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2 |
Subsections 350(6) and (7) |
The subsections do not apply |
Section 350 of the ITAA 1936 defines the direct control interest of an entity in the company as the percentage the entity holds or is entitled to acquire in:
· the total paid up capital
· the rights to vote, or
· the rights to a distribution of capital or profits.
Company B does not hold an 'associate interest' of 50% or more in Company A for the purposes of paragraph 820-905(1)(a) of the ITAA 1997. Therefore, Company B does not hold an 'associate interest' of 50% or more in Company A which is required to achieve the necessary degree of control under paragraph 820-905(1)(a) of the ITAA 1997.
Paragraph 820-905(1)(b) of the ITAA 1997 tests to see if Company A is (in relation to another entity) under an obligation or might reasonably be expected to act in accordance with the directions, instructions or wishes of an associate in relation to distribution or retention of profits or financial policies in relation to debt capital or equity capital.
In relation to the term 'sufficient influence' the EM that accompanied the New Business Tax System (Thin Capitalisation) Bill 2001 explains that:
Associate entities
7.86 A definition of associate entity is introduced in Subdivision 820-I for the purposes of the thin capitalisation legislation. This narrows the Part X definition of associate to ensure that only those entities with a sufficient influence on another entity will be subject to the new regime. In particular, paragraph 318(2)(d) of the ITAA 1936 determines that in certain circumstances a company is an associate of its subsidiary. The effect of the narrower definition is that under the thin capitalisation rules a company will not normally be an associate entity of its subsidiary.
7.87 ...
What is sufficient influence?
7.88 Sufficient influence is a term explained in subsection 318(6) of the ITAA 1936. It may arise in circumstances where an entity has influence or may reasonably be expected to have influence over another entity or its directors, partners, trustees or committees of management respectively, to direct the actions of the entity either directly or through interposed entities. This influence may arise formally, informally, because of obligation, custom or via membership of a corporate group.
7.89 For the purposes of thin capitalisation rules, sufficient influence is confined to influence over decisions made in relation to financial matters of the entity.
That test of 'sufficient influence' is described in paragraph 318(6)(b) of the ITAA 1936 in the following terms:
'... a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts). '
In this case, the question is (effectively) whether the directors of Company A are sufficiently influenced by the directors of Company B in relation to the distribution or retention of the profits of Company A or in relation to certain financial policies.
There is a commonality of the directors of Company A and Company B.
The mere commonality of the directors on the respective boards of Company A and Company B would not, of itself, be enough to constitute 'sufficient influence'.
A conclusion that there is a reasonable expectation that either of Company A and Company B would act in accordance with the directions or wishes of the other entity could be reached having regard to the nature of the relationship between the two entities and any other relevant matters.
However, overall, there is insufficient evidence to support a conclusion that Company A and/or its directors act 'in accordance with' the 'directions, instructions or wishes' of Company B and/or its directors (FC of T v BHP Billiton Ltd [2019] FCAFC 4 [at 170]).
Company A is not an 'associate entity' of Company B for the purposes of applying table item 3 of subsection 820-85(2) of the ITAA 1997, in accordance with an application of the facts of this case to the meaning of that term in section 820-905.