Edited version of private advice

Authorisation Number: 1051683787316

Date of advice: 22 May 2020

Ruling

Subject: Connected entity

Question 1

For the purposes of the entitlement to R&D tax offset outlined in Item 2 of section 355-100 of the Income Tax Assessment Act 1997 (ITAA 1997), is the Association, as the sole shareholder of ABC, a controlling income tax exempt entity of XYZ with reference to the modified test in section 328-125 of the ITAA 1997?

Answer

No

Question 2

Assuming the answer to Question 1 is no, for the purposes of the entitlement to R&D tax offset outlined in Item 1 of section 355-100 of the ITAA 1997, is the Association, as the sole shareholder of ABC, a connected entity of XYZ with reference to the aggregated turnover test in section 328-115 of the ITAA 1997?

Answer

Yes

Question 3

Will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that the Association as the sole shareholder of ABC is not a connected entity of XYZ for the purpose of section 328-125 of the ITAA 1997?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commences on

1 July 2016

Relevant facts and circumstances

Background

XYZ is registered as a company.

XYZ develops and sells products. The objects of XYZ are to carry on the business to develop, market and sell the products and to develop and expand the business in accordance with the business plan.

At the time of registration as a company 2 shares were on issue.

A number of additional share issues and changes to member shareholdings took place. As a result, the number of shares on issue increased.

As a result of the share transactions, in 2015 and December 2016, the shares in XYZ were held in the following proportions:

ABC is wholly owned by the Association which is an income tax exempt entity.

KLM is not an affiliate of The Trust or ABC.

The commercial relationship between the shareholders of XYZ is governed by a Shareholders Agreement.

Option agreement

In December 2016, ABC provided an option to The Trust and KLM to allow those shareholders to acquire 15% of ABC's interest in XYZ. A Call Option Deed was entered in respect of the option agreement.

The purpose of the option agreement was to facilitate equal ownership of XYZ between the three parties so that on exercise of the option all three shareholders would hold 33.3% each.

The option was exercised in late April 2018 and pursuant to that call option, ABC transferred a % of its interest, reducing its interest in XYZ to 33.3%.

Board of Directors and Board decisions

The Trust, KLM and ABC each have the right to appoint a single Director to the Board of XYZ, and those Directors are entitled to a single vote each. Additional Directors can be appointed by a simple majority vote of shareholders. The Chairperson of the Board does not have a casting vote. A Board meeting requires the attendance of a majority of Directors.

The Directors of XYZ in the years ended 30 June 2017 and 2018 are:

Individual A is a member of the Association's Board of Directors and the ABC Board of Directors. Individual C is a Director of KLM.

Board decisions are generally made on the basis of a Simple Majority Vote which means in the case of a resolution of the Board, directors who together constitute a majority of directors.

Critical business decisions are made by a Special Majority Vote which means a vote by the Board that is supported by a majority of Directors including Directors who represent shareholders holding at least 70% of the Shares.

Minutes of the Board meetings of XYZ Pty Ltd (the Minutes) have been provided for the period

1 July 2016 to 30 June 2018.

Shareholder meetings and decisions

All shareholder decisions require a Simple Majority Vote which means a vote or resolution passed by shareholders who together hold more than 50% of the shares.

Shareholder meetings cannot proceed unless there are representatives of 70% of shares present (by share) unless there is a unanimous decision of shareholders otherwise. Each share entitles that shareholder to one vote. The Chairman of a Shareholder meeting does not have a casting vote.

Day to day management

Individual B, the Director appointed by The Trust, has been employed by XYZ since its inception and is currently the Chief Executive Officer (CEO) and Managing Director. The Shareholders Agreement vests day to day control of the business in the CEO. The CEO will report and be responsible to the Board for the activities and operations of the Business. The CEO is appointed by the Board of Directors.

Individual C, the Director appointed by KLM, works 3 days per week in the XYZ business and is heavily involved in the day to day and strategic direction of the business. From a day to day perspective, Individual C is responsible for client management, providing commercial and legal guidance as well as managing the human resources of the business. Individual B works alongside Individual C and is responsible for product sales and marketing.

Collectively, Individual B and Individual C are responsible for the development and implementation of the strategic direction of XYZ. Individual C works with Individual B to develop and write business strategy, prepare Board papers, present strategy to the Board and ultimately implement any strategic changes within the business.

The Director appointed by ABC, Individual A, does not play a role in the day to day or strategic direction of the business. Individual A sits on the Board of XYZ, as a shareholder representative. Individual A attends Board meetings and during these meetings undertakes a high level review of the strategic direction of the business, but is not involved in the development or implementation of such.

Business Plans, Budget and Financial Reports

The CEO is responsible for preparation of the Business Plan and Budget. The Board will consider, for approval, the Budget and Business Plan.

Dividends

The Board of Directors must approve the distribution of dividends.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-115

Income Tax Assessment Act 1997 subsection 328-115(1)

Income Tax Assessment Act 1997 subsection 328-115(2)

Income Tax Assessment Act 1997 subsection 328-115(3)

Income Tax Assessment Act 1997 section 328-120

Income Tax Assessment Act 1997 section 328-125

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

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 subsection 328-125(6)

Income Tax Assessment Act 1997 section 328-130

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

Income Tax Assessment Act 1997 subsection 355-100(1)

Reasons for decision

All references to legislation in the 'Reasons for decision' are references to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

The Association is not a controlling income tax exempt entity of XYZ with reference to the modified test specified in Item 2 of the table in subsection 355-100(1) for the purposes of section 328-125.

Detailed reasoning

Generally, where a R&D entity has engaged in R&D activities, subsection 355-100(1) allows the entity to claim a R&D tax offset at one of two specified rates. The applicable rate depends on certain circumstances as detailed in the table in subsection 355-100(1).

One of the circumstances in the table in subsection 355-100(1) is outlined in Item 2 which states:

...an exempt entity, or a combination of exempt entities, would control the R&D in a way described in section 328-125 (connected entities) if:

(a) references in section 328-125 to 40% were references to 50%; and

(b) subsection 328-125(6) [which concerns the Commissioner's discretion] were ignored.

Subsection 328-125(1) provides:

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) sets out how an entity (other than a discretionary trust) directly controls another entity 'in a way described in section 328-125 of the ITAA 1997'. Broadly, a company will be directly controlled by another entity, if that other entity, its affiliates, or that other entity together with its affiliates, own or have the right to acquire at least 40% of the company's income distribution, capital distribution or its voting rights.

In addition to direct control of an entity, subsection 328-125(7) contains an indirect control test. It 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 controlled by the second entity.

As stated in Item 2 of the table in subsection 355-100(1) the reference to 40% in subsection

328-125(2) is modified to 50%.

Application to XYZ

The Association, an income tax exempt entity, does not directly own shares in XYZ. The Association therefore does not directly control XYZ because the Association does not satisfy the direct control requirements specified in subsection 328-125(2).

The Association does however own 100% of the shares in ABC in the years ended 30 June 2017 and 2018. Therefore, provided ABC directly controls XYZ, the Association will indirectly control XYZ as provided for in subsection 328-125(7).

The relevant control test in subsection 328-125(2), as modified, is whether at any time during the years ended 30 June 2017 and 30 June 2018 ABC controlled XYZ because it owned or had the right to acquire at least 50% of the company's income distribution, capital distribution or its voting rights.

ABC did not own or have the right to acquire at least 50% of XYZ's income distribution, capital distribution or its voting rights at any time during the years ended 30 June 2017 and 30 June 2018. During these periods the maximum amount of shares held by ABC was 48% from December 2016 until late April 2018.

The direct control test in subsection 328-125(2), when modified by Item 2 of subsection

355-100(1), is not satisfied. Therefore ABC does not control XYZ and the Association does not control XYZ as required by subsection 328-125.

XYZ is not controlled by an income tax exempt entity for the purposes of Item 2 of subsection

355-100(1).

Question 2

Summary

The Association is a connected entity of XYZ with reference to the aggregated turnover test in section 328-115.

Detailed reasoning

Item 1 of the table in subsection 355-100(1) states:

the R&D entity's aggregated turnover for the income year is less than $20 million (and item 2 of this table does not apply)

'Aggregated turnover' is defined in section 328-115. Subsection 328-115(1) states, your aggregated turnover for an income year is the sum of the 'relevant annual turnovers' excluding any amounts covered by subsection 328-115(3).

Subsection 328-115(2) states the 'relevant annual turnovers' are:

·        your annual turnover (as defined in section 328-120) for the income year, and

·        the annual turnover for the income year of any entity (a relevant entity) that is connected and/or affiliated with you at any time during the income year.

Subsection 328-115(3) excludes from your aggregated turnover:

(a) amounts derived in the income year by you or a relevant entity from dealings between you and the relevant entity while the relevant entity is connected with you or is your affiliate;

(b) amounts derived in the income year by a relevant entity from dealings between the relevant entity and another relevant entity while each relevant entity is connected with you or is your affiliate;

(c) amounts derived in the income year by a relevant entity while the relevant entity is not connected with you and is not your affiliate.

Therefore, in order for a R&D entity to calculate its aggregated turnover for the purposes of Item 1 of the table in subsection 355-100(1), it is necessary to determine whether the R&D entity is connected with or affiliated with any other entity.

Section 328-125 provides several control tests which govern when an entity will be deemed to be 'connected with' another entity. Subsection 328-125(1) provides:

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) sets out how an entity (other than a discretionary trust) directly controls another entity 'in a way described in section 328-125 of the ITAA 1997'. Broadly, a company will be directly controlled by another entity, if that other entity, its affiliates, or that other entity together with its affiliates, own or have the right to acquire at least 40% of the company's income distribution, capital distribution or its voting rights.

In addition, subsection 328-125(7) contains an indirect control test. It 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 controlled by the second entity.

Application to XYZ

ABC owned 48% of the voting rights of XYZ from December 2016 until late April 2018. ABC therefore controlled XYZ as provided for in subsection 328-125(2) at some time during each of the years ended 30 June 2017 and 30 June 2018 because it owned at least 40% of the company's voting rights.

ABC was wholly owned by the Association in the years ended 30 June 2017 and 2018, therefore the Association indirectly controlled XYZ as provided by subsection 328-125(7).

The Association controls XYZ in a way described in section 328-125. The Association is therefore connected to XYZ because subsection 328-125(1) is satisfied.

The Association is a connected entity of XYZ for the purposes of the aggregated turnover test in section 328-115 and for the purposes of XYZ's entitlement to R&D tax offset in Item 1 of the table in subsection 355-100(1).

Question 3

Summary

The Commissioner will not exercise his discretion pursuant to subsection 328-125(6).

Detailed reasoning

Section 328-125 provides several control tests which govern when an entity will be deemed to be 'connected with' another entity. Subsection 328-125(1) provides:

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

Apart from the 'actual control' test in subsection 328-125(3) (i.e. Direct control of a discretionary trust), all other control tests in section 328-125 deem an entity to control another entity regardless of whether they in fact control the entity or not.

The Commissioner is however provided with discretion in subsection 328-125(6) to determine that an entity does not control another entity. Subsection 328-125(6) states:

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 the Commissioner's view, the discretion in subsection 328-125(6) adopts the ordinary meaning of 'controlled'. The term 'controlled', for the purposes of subsection 328-125(6), is undefined.

The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 (the EM) states:

2.59 Where an entity's interest in another entity is at least 40 per cent but less than 50 per cent the Commissioner may choose to ignore the interest of that entity in the other entity if the Commissioner determines that a third entity actually controls the other entity.

2.60 The Commissioner may think that another entity controls the entity either based on fact or on a reasonable assumption or inference. Whether or not the third entity has a 40 per cent interest may assist in determining whether the third entity controls the other entity, but it is not decisive.

Thus, it is actual control that is taken into account.

Further, the use of the words 'a reasonable assumption or inference' indicates the intention of the legislation was to give the broadest powers possible to the Commissioner. Example 2.10 in the EM states:

Chandra owns a restaurant with a turnover of less than $2 million and has inherited his father's 42 per cent interest in a software company. The other 58 per cent of the software company is owned by the manager of the company, and Chandra has had no dealings with the manager whatsoever.

The turnover of Chandra's restaurant will not be aggregated with the turnover of the software company if the Commissioner thinks that the software company is actually controlled by the other person with the 58 per cent interest

Example 2.10 suggests that in considering whether 'the software company is actually controlled by the other person with the 58 per cent interest' the Commissioner turns his mind to who controls the software company in the ordinary sense, regardless of the percentage interest held.

The term 'control' is defined in the Macquarie Dictionary and includes:

(i)  To exercise restraint or director over; dominate; command.

(ii) To hold in check; curb.

Therefore, to determine whether the third entity controls the other entity in the ordinary sense of that term, all relevant facts and evidence will be considered to determine actual control. The Commissioner is not restricted by an entity's interest

Taxation Ruling TR 2018/5 Income tax: central management and control test of residency

(TR 2018/5) provides some guidance as to what matters the Commissioner will consider when determining control of an entity. TR 2018/5 states:

11. The key element in the control and direction of a company's operations is the making of high level decisions that set the company's general policies, and determine the direction of its operations and the type of transactions it will enter.

12. The control and direction of a company is different from the day-to-day conduct and management of its activities and operations. The day-to-day conduct and management of a company's activities and operations is not ordinarily an act of central management and control. Nor is the management of day-to-day activities under the authority and supervision of higher-level managers or controllers.

13. The day-to-day conduct and management of a company's operations might be an exercise of central management and control in circumstances where they are effectively the same. For example, for a small passive investment company with a very small number of investments, the decisions to make, hold and dispose of those investments, would be both the day-to-day management and the central management and control of the company.

14. Merely because a person is a majority shareholder, or has the power to appoint those who control and direct a company's operations does not, by itself, mean the person controls and directs a company's operations and activities.

Paragraph 16 of TR 2018/5 outlines acts that would indicate the exercise of central management and control of a company:

16. Exercising central management and control of a company can involve:

·        setting investment and operational policy including:

- setting the policy on disposal of trading stock, and/or the use and development of capital assets

- deciding to buy and sell significant assets of the company

·        appointing company officers and agents and granting them power to carry on the company's business (and the revocation of such appointments and powers)

·        overseeing and controlling those appointed to carry out the day-to-day business of the company, and

·        matters of finance, including determining how profits are used and the declaration of dividends.

Paragraph 17 of TR 2018/5 states matters of company administration are not acts of central management and control. In addition, TR 2018/5 states:

20. Normally, where a company is run by its directors in accordance with its constitution and the company law rules applicable to that company, which give its directors the power to manage the company, the company's directors will control and direct its operations. It follows that ordinarily it is a company's directors who exercise its central management and control.

21. However, the actions of a company's directors, or others with the legal power and authority to control and manage the company, are not the end of the enquiry as to who exercises central management and control. There is no presumption that the directors of a company will always exercise its central management and control.

22. When determining who exercises a company's central management and control, all the relevant facts and circumstances must be considered. Facts and circumstances to be considered in determining who exercises a company's central management and control include the role of anyone who assumes the role of the directors' role in managing and controlling the company's affairs or has a role in the decision-making processes or governance of the company.

23. A person who has legal power or authority to control and direct a company, but does not use it, does not exercise central management and control. For example, in Bywater, the court disregarded the role of those directors who were formally appointed but did not play any real role in the affairs of the company.

24. A person may control and direct a company without actively intervening in the company's affairs on an ongoing basis provided they:

· have appointed agents or managers whom they tacitly control to conduct the company's day-to-day business

· tacitly control and regularly exercise oversight of the affairs of the company, including monitoring the company's performance, and

· do not need to actively intervene because the company's affairs are running smoothly and in the manner they desire.

Application to XYZ

An entity is 'connected with another entity' as provided in subsection 328-125(1) if at any time during the year the entity controls the other entity in a way described in section 328-125.

XYZ has three shareholders, ABC, The Trust and KLM. ABC owned 48% of the voting rights of XYZ from December 2016 until late April 2018, after which its interest was reduced to 33.3%. ABC therefore exceeded the 40% direct control percentage specified in subsection 328-125(2) at a time during the years ended 30 June 2017 and 2018, and controlled XYZ in a way described in section 328-125.

In addition to direct control of an entity, subsection 328-125(7) contains an indirect control test. The Association owned 100% of the shares in ABC in the years ended 30 June 2017 and 2018 and it therefore indirectly controlled XYZ from December 2016 until late April 2018 when ABC's interest in XYZ was greater than 40%. The Association therefore controlled XYZ in a way described in section 328-125 and is connected with XYZ as provided by subsection 328-125(1).

Subsection 328-125(6) provides the Commissioner with discretion to consider if XYZ was not controlled by ABC and the Association, from December 2016 until late April 2018, and therefore that the Association is not a connected entity of XYZ for the purposes of section 328-125.

To determine whether ABC, and the Association, control XYZ in the ordinary sense of that term and whether the Commissioner will exercise discretion pursuant to subsection 328-125(6), all relevant facts and evidence will be considered, including the following:

-   The three Shareholders of XYZ are ABC, The Trust and KLM.

-   KLM is not an affiliate of The Trust or ABC.

-   During the period December 2016 to 30 April 2018 the shareholdings in XYZ were ABC 48%, The Trust 26% and KLM 26%.

-   The Board of Directors of XYZ consists of three Directors, one appointed by and representing each of the three shareholders; Individual A appointed by ABC, Individual B appointed by The Trust and Individual C appointed by KLM.

-   Individual A is a member of the Association's Board of Directors and the ABC Board of Directors.

-   Individual C is a Director of KLM.

-   The Board of Directors of XYZ has full power to direct the activities of XYZ.

-   Each Director of the Board of Directors of XYZ is entitled to a single vote each. The Chairperson of the Board of Directors does not have a casting vote.

-   All decisions of the Board of Directors require a simple majority vote unless otherwise provided. This means directors who together constitute a majority of the Board.

-   A Special Majority Vote, which means a vote by the Board that is supported by a majority of Directors, is required for the decisions specifically detailed in the Shareholders Agreement. Those decisions include decisions in relation to the declaration and payment of dividends, distribution of Company assets, mergers, profit sharing arrangements, acceptance of Business Plan, loans or advances, reduction of share capital and various transactions exceeding specified amounts.

-   A unanimous vote of the Board is required in respect of XYZ undertaking any business that is not a related business.

-   A quorum for meetings of the Board of Directors is constituted by the attendance of a majority of Directors.

-   All of the Directors were in attendance at the Board Meetings held from 1 July 2016 to

-   30 June 2018.

-   Individual A attends XYZ Board Meetings and during these meetings undertakes a high level review of the strategic direction of the business. Individual A does not play a role in the day to day management and is not involved in developing or implementing the strategic direction of the business.

-   Individual B has been employed by XYZ since its inception and is the CEO and Managing Director.

-   Day to day control of the business vests with the CEO. The CEO reports and is responsible to the Board for the activities and operations of the business.

-   The CEO is responsible for preparation of the Business Plan and the Budget for approval by the Board by Special Majority Vote.

-   Individual C works three days per week in the XYZ business and is heavily involved in the day to day and strategic direction of the business. From a day to day perspective, Individual C is responsible for client management, providing commercial and legal guidance as well as managing the human resources of the business. Individual B works alongside Individual C and is responsible for product sales and marketing.

-   Collectively, Individual B and Individual C are responsible for the development and implementation of the strategic direction of XYZ. Specifically, Individual C works with Individual B to develop and write business strategy, prepare Board papers, present strategy to the Board and ultimately implement any strategic changes within the business.

-   All Shareholder decisions require a simple majority vote unless otherwise specified in the Shareholders Agreement. This means a vote or resolution passed by shareholders who together hold more than 50% of the shares. A quorum of Shareholders for the purposes of Shareholder Meetings is a group of Shareholders collectively holding 70% of the shares unless all Shareholders unanimously determine otherwise.

-   Each shareholder is entitled to a single vote for each share registered in its name. The chairman of a Shareholders Meeting does not have a casting vote.

-   Certain decisions of the shareholders may only be made by Special Majority Vote. Those decisions include amendment of the constitution, changes to the share capital and undertaking business of a material nature not related to a related business.

The circumstances of XYZ clearly indicate the day to day control, management and running of XYZ is vested in the CEO, Individual B, by the Shareholders Agreement which provides that the business will be managed by the CEO in accordance with the Budget and the Business Plan. In addition to Individual B, Individual C is also involved in the day to day running of the XYZ business. The Shareholders Agreement also states the CEO is responsible for preparing the Budget and the Business Plan and will report and be responsible to the Board for the activities and operations of the Business. Therefore Individual B and Individual C, through their day to day running of the business and through the formulation of the Budget and Business Plan, are responsible for developing and implementing the strategic direction of XYZ.

However, as stated in TR 2018/5, the control of a company is different from the day to day conduct and management of its activities and operations, even where these occur under the authority and supervision of higher-level managers or controllers. As stated at paragraph 11 of TR 2018/5 'The key element in the control and direction of a company's operations is the making of high level decisions that set the company's general policies, and determine the direction of its operations and the type of transactions it will enter.'

In the case of XYZ, the high level decisions made to determine the direction of the operations and business are made by the Board of Directors. Even though Individual B and Individual C as Directors, or in the words of TR 2018/5 as 'higher-level managers or controllers', are conducting and managing the operations of XYZ on a daily basis, and are formulating and implementing the Budget and Business Plan, the Budget and Business Plan must be approved by the Board of Directors by Special Majority Vote as specified in the Shareholders Agreement. That is, even though the strategic direction of XYZ is largely formulated by two directors, it is the Board of Directors, comprising three Directors, who ultimately determine the strategic direction of the business by approving the Budget and Business Plan.

The Shareholders Agreement also specifies those other decisions which can only be made by Special Majority Vote by the Board of Directors. The decisions specified are those high level decisions that set the company's general policies, and determine the direction of its operations and the type of transactions it will enter. Paragraph 16 of TR 2018/5 specifies the type of 'acts' that indicate the exercise of central management and control of a company including setting investment and operational policy including decisions to buy and sell significant assets of the company, appointments of company officers and agents and granting them power to carry on the company's business, overseeing and controlling those appointed to carry out the day-to-day business of the company, and matters of finance, including determining how profits are used and the declaration of dividends. The Shareholders Agreement includes decisions in relation to the declaration and payment of dividends, distribution of Company assets, mergers, profit sharing arrangements, acceptance of Business Plan, loans or advances, reduction of share capital and various transactions exceeding specified amounts. The acts described in paragraph 16 of TR 2018/5 are included in the Shareholders Agreement and require the Board's approval by Special Majority Vote.

A Special Majority Vote by the Board of Directors of XYZ is a vote supported by a majority of Directors. No Director has a casting vote and a quorum of the board is constituted by a majority of Directors. In terms of voting, any two Directors may vote together to form a majority however they are not bound to do so and no Director has a casting vote. Further, a Director cannot be excluded from participating in decisions that require either a Simple Majority Vote or a Special Majority Vote.

In addition to decisions requiring Board approval, certain decisions can only be made by Shareholder vote and approval as specified in the Shareholders Agreement. The decisions listed in the Shareholders Agreement concern matters that will affect the strategic direction of the company and include decisions relating to the share capital of the company and the undertaking of any business that is not related. A quorum of shareholders is a group of Shareholders collectively holding 70% of the shares unless all shareholders unanimously agree otherwise. No Shareholder has a casting vote.

The Shareholders Agreement does not provide any one Director or Shareholder with the ability to approve a decision by themselves, therefore two Directors and two Shareholders must always vote together to have a majority to approve a decision. No Director or Shareholder has the ability to approve strategic decisions in the absence of support from another.

Whilst ABC held 48% of the shares of XYZ during the period December 2016 to late April 2018 it could not alone make decisions requiring Shareholder approval in respect of the strategic direction of XYZ. ABC is entitled to a single vote for each share registered in its name but all Shareholder decisions require a vote or resolution passed by shareholders who together hold more than 50% of the shares (unless otherwise specified). ABC cannot on its own form a quorum for the purposes of Shareholder Meetings unless unanimously agreed by other Shareholders. There is no evidence to suggest that the other Shareholders have or would unanimously agree to forego participation, even if it was not to the detriment of their own shareholding. ABC does not have a casting vote and there is no evidence to indicate that ABC can compel the other Shareholders to vote in a certain way. The provisions within the Shareholders Agreement, that govern Shareholder decisions and votes, ensure that ABC as a Shareholder cannot control XYZ by making Shareholder decisions by itself.

Similarly, in respect of decisions requiring Board approval Individual A, as the Director appointed to the Board of Directors by ABC, cannot make Board decisions alone. Decisions of the Board of Directors requiring a Simple Majority Vote or a Special Majority Vote require a vote by directors who together constitute a majority of the Board. That is, two out of three Directors, and Individual A does not have a casting vote. In addition, a unanimous vote of the Board is required in respect of XYZ undertaking any business that is not a related business. Further, a quorum for meetings of the Board of Directors is constituted by the attendance of a majority of Directors; therefore at least two Directors must be present. There is no evidence to indicate that either of the other Directors is bound to vote in unison with Individual A or that Individual A can compel the other Directors to vote in a certain way, including in a manner that was detrimental to their interests.

Individual A cannot be excluded from participating as a Director in Board Meetings and from participating in decisions that require a Board vote. There is nothing to indicate that Individual A did not participate in Board votes or that Individual A relinquished all control on decisions that required Board approval. The opposite is indicated by the fact that Individual A attends Board meetings and during the period December 2016 to late April 2018 attended Board Meetings. Whilst Individual A is not involved in the day to day running of the business and does not develop and implement the Budget and Business Plan, this does not indicate that Individual A has relinquished control. As stated in paragraph 24 of TR 2018/5, a person may control a company without actively intervening in its affairs on an ongoing basis provided they regularly exercise oversight of the company's affairs and monitor its performance, and do not need to intervene because the company's affairs are running smoothly and in the manner they desire. Individual A attends Board meetings and can thereby participate in strategic decisions and influence the strategic direction of the company without actively intervening in its affairs on an ongoing basis.

The Board of Directors of XYZ is comprised of three Directors, therefore in any Board vote there will always be at least two Directors voting together. Whilst Individual B and Individual C may vote together in respect of decisions requiring Board approval there is no evidence to indicate that they always vote in unison on all decisions, that they are bound to do so, or that either can compel the other to vote in a certain way. Neither Director has a casting vote and neither Director alone can constitute a majority vote. There is no evidence to indicate that Individual B would always support operational and strategic decisions put forward by Individual C, including in circumstances where they were clearly not in the best interests of The Trust. Similarly, there is no evidence to suggest Individual C would do likewise in relation to decisions put forward by Individual B, if not in the best interests of KLM.

During the period December 2016 to late April 2018 The Trust and KLM each held 26% of the shares in XYZ. Together they could not form a quorum for decisions requiring Shareholder approval, unless by unanimous agreement ABC chose not to participate. There is nothing to indicate that ABC did not participate in any Shareholder votes or that ABC relinquished all control on all decisions that required Shareholder approval. Whilst The Trust and KLM may vote together, they are not bound to do so and neither has a casting vote. XYZ has three Shareholders therefore in any Shareholder vote there will always be at least two Shareholders voting together in order to form a majority. There is also nothing to suggest that either The Trust or KLM would vote in a manner that was detrimental to their shareholding in order to ensure they voted in unison with the other.

Conclusion

In order for the Commissioner to exercise discretion under subsection 328-125(6) he must be satisfied 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 this case the Commissioner must therefore be satisfied that XYZ is actually controlled by an entity or entities that do not include ABC. That is, the Commissioner must determine that XYZ is controlled by The Trust or KLM; or by those two entities jointly.

For the reasons explained above it is considered that The Trust and KLM did not control XYZ, either alone or jointly. The facts and circumstances indicate that XYZ was controlled by all of its Shareholders (and Directors), which includes ABC and the Association (by its 100% ownership of ABC).

The Commissioner therefore will not exercise discretion pursuant to subsection 328-125(6) to determine that during the period December 2016 to late April 2018 ABC, and the Association, did not control XYZ.

The Association is therefore a connected entity of XYZ for the purposes of section 328-125.