Edited version of private advice

Authorisation Number: 1051672341915

Date of advice: 5 May 2020

Ruling

Subject: Control test - aggregated turnover

Question

For the purpose of calculating the aggregated turnover of the Rulee under section 328-115 of the Income Tax assessment Act 1997 (1997), will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that Company Z does not control the Rulee?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

During the income year ended 30 June 20XX

Relevant facts and circumstances

The Rulee is an Australian resident company the total of its ordinary shares are held in the following proportions:

·         51% by Company X; and

·         49% by Company Z.

These are the proportions in which rights to voting and receiving income and capital distributions are held.

Company X is owned in equal proportions by two unrelated shareholders who were the founders of the Rulee's business. There is no relationship of whatsoever kind between Company X and Company Z.

The Rulee's board consists of two Company X appointed directors, and two Company Z appointed directors.

The Rulee's board does not report, and is not subject, to the board of Company Z and the boards function separately with no directors in common.

The Company X appointed Directors normally set the agenda and run the Rulee's Board meetings. The Company Z appointed Directors' involvement has been limited to asking questions about the financial information.

The Shareholders' Agreement is the only agreement which establishes the relationship between the Rulee and Company Z.

There are no financial interrelationships including loans or debtor facilities provided by Company Z.

The Rulee and Company Z do not share common resources and do not operate together.

The Rulee does not have any affiliates with, relationships or interest in, any entities that have an interest in Company Z. The Rulee does not have any other relationship with, or interests in entities, that have a connection with Company Z that would be covered by section 328-130 of the ITAA 1997.

The strategic direction, decision making and actions of the Rulee is determined by the Company X appointed directors, without involvement of Company Z or any entity controlled by Company Z.

As Company X hold 51% of the shareholder voting rights, ultimate control of the strategic operations and decision making aspects of the Rulee is held by the Company X appointed directors.

In their role as executive managers, the Company X appointed directors control the decision making and management of the day to day operations, including administration, legal and finance functions of the Rulee. They do not act on the instructions of Company Z or their appointed directors, nor do they report to them. Further, the Company X appointed directors and the Rulee's finance manager are the only signatories to the Rulee's bank accounts.

Relevant legislative provisions

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)

Income Tax Assessment Act 1997, section 328-130

Reasons for decision

The Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Company Z does not control the Rulee.

Detailed reasoning

The meaning of 'aggregated turnover' is included in section 328-115 of the ITAA 1997 and consists of the sum of the relevant 'annual turnovers'.

For the purposes of this calculation, subsection 328-115(2) of the ITAA 1997 indicates that a taxpayer will include their own annual turnover together with the annual turnovers of any 'connected entities' or 'affiliates'.

Connected with an entity

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.

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.

Direct control of a company

Subsection 328-125(2) 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:

·         interests in the company that give them the right to receive at least 40% (the control percentage) of any distribution of income or capital; or

·         equity interests in the company that carry between them the right to exercise at least 40% (the control percentage) of the voting power in the company.

An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you (section

328-130 of the ITAA 1997). A trust, partnership or superannuation fund cannot be an affiliate.

Commissioner may determine that an entity does not control another entity

In the Rulee's case, 49% of its ordinary shares are owned by Company Z. As per paragraph

328-125(2)(b) this gives Company Z (the first entity) control of the Rulee (the second entity), meaning that the annual turnover of the first entity must be included in the Rulee's aggregated turnover.

However, subsection 328-125(6) of the ITAA 1997 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 an entity's control percentage (as referred to in subsection 328-125(2) of the ITAA 1997) in an entity ('the other entity') 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 other entity is controlled by a third entity (other than an affiliate of the first entity).

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.

Application to your circumstances

In this case, Company Z has a control percentage of 49% in the Rulee. Therefore it is accepted that Company Z is taken to control the Rulee for the purposes of section 328-125 of the ITAA 1997.

However, as this control percentage is between 40% and 50%, the Commissioner may exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that Company Z does not control the Rulee if he is satisfied that the Rulee is controlled by an entity other than, or by entities that do not include, Company Z or any of its affiliates.

Company X holds 51% of the shares in the Rulee, which carries the right to exercise, or control the exercise of, 51 %, of the voting power in the company.

In determining the controlling entities of the Rulee, the Commissioner must also consider who is responsible for the strategic decision making on behalf of the company and the day to day running of the company.

The strategic direction, decision making and actions of the Rulee is determined by the Company X appointed directors, without involvement of Company Z or any entity controlled by Company Z. As Company X holds 51% of the shareholder voting rights, ultimate control of the strategic operations and decision making aspects of the Rulee is held by the Company X appointed directors.

In their role as executive managers, the Company X appointed directors control the decision making and management of the day to day operations, including administration, legal and finance functions of the Rulee. They do not act on the instructions of Company Z or their appointed directors, nor do they report to them. Therefore the ultimate decision making responsibility rests with the Company X appointed directors.

Conclusion

Based on the facts of this case, the Commissioner is satisfied that the strategic decision making and day to day running of the Rulee is controlled by the Company X appointed directors and that the Company X appointed directors control the Rulee are not controlled by, nor affiliates of, Company Z and/or its affiliates.

Therefore, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Company Z does not control the Rulee.