Edited version of private advice

Authorisation Number: 1051691512361

Date of advice: 2 June 2020

Ruling

Subject: Exercise of the Commissioners discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997

Question 1

For the purposes of calculating the aggregated turnover of the subsidiary under section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997), does Company A control the subsidiary under section 328-125 of the ITAA 1997?

Answer

No

Question 2

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

Answer

Yes

Question 3

For the purpose of calculating the aggregated turnover of the subsidiary under section 328-115 of the ITAA 1997, is Company A an affiliate of the subsidiary under section 328-130 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Years ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Background

The subsidiary is seeking a ruling to establish whether Company A, is connected with, or an affiliate of the subsidiary for the purposes of section 328-125 of the ITAA 1997. This will provide clarity on whether the annual turnover of Company A is aggregated with the annual turnover of the subsidiary for the ruling years.

Structure of the subsidiary and the company

The subsidiary is an Australian resident company. All of the subsidiaries ordinary shares are held by the Company.

The Company is an Australian resident company with its ordinary shares held in the following proportions:

·        x% by person a, an Australian resident

·        xx% by person b, an Australian resident

·        xxx% by Company A, a non-resident foreign company.

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

Control of voting rights in the Company

Person a and person b are Australian residents for tax purposes. They each carry the right to exercise their voting rights in the Company.

Company A controls the remaining xxx% of the voting rights in the Company.

The Shareholders' Agreement

The Shareholders' Agreement dated xx of xx 20xx sets out the obligations between the Company, Company A, person a and person b.

The Shareholders' Agreement was amended dated xx of xx of 20xx. Clause x states that the effective date of these amendments are x of xx of 20xx.

Relevant extracts of the Shareholders' Agreement state:

.......

Board of the Company

The members of the Board from xx of xx of 20xx are:

·        person a

·        person b

·        director c.

The board of the Company does not report to, and is not subject to the board of Company A. The two boards function separately with no directors in common.

Since Company A acquired their interest in the Company there have been no xx matters under the Shareholders' Agreement voted on by the Board. The matters dealt with by the Board have been limited to reporting in relation to the agreed business plan and the financial data to director c.

All Board meetings have been held in Australia via a teleconference to allow Company A's director to attend. Person a and person b set the agenda and run the Board meetings. Director c's involvement has been limited to asking questions about the financial information.

The strategic direction, decision making and actions of the Company and subsidiary entities, including the subsidiary, are determined by person a and person b prior to the Board meetings without the involvement of director c.

Day to day operations of the subsidiary

The decision making and management of the day to day operations, including administration, legal and finance functions of the Company and the subsidiary rests with person a and person b who are the sole directors of the subsidiary and the xx management team.

Company A has passive involvement in the operations of the subsidiary through the Company with the position taken that any decision made by the Company's Board should be in the best interests of the xx Group (the Company, the subsidiary and other subsidiaries).

Person a and person b are not required to act, and do not act in accordance with the directions of Company A. There are times when person a and person b request support and assistance from Company A on various matters but the ultimate responsibility rests with person a and person b.

The Company is operated in accordance with a business plan that was developed by the xx team (consisting of person a and person b) and was approved by the Board of the Company under xx of the xx. The xx team ensures that the business plan is followed as part of day to day operations.

Person a and person b established their own xx for the Group. The xx consists of person a and person b and two independent advisors who are xx. The two independent advisors have no relationships with or to Company A. Meetings are held xx.

Person a and person b and the Company's xx are the only signatories on the Group's bank accounts. There is no one from Company A eligible to transact on the accounts.

.......

Relationship between Company A, person a and person b

There are no personal relationships, financial dependencies, common links or shared strategic decision making that exist between the parties that would indicate that person a and person b could be expected to act in accordance with the directions or wishes of, or in concert with, Company A; or that Company A could be expected to act in accordance with the directions or wishes of, or in concert with, person a and person b.

Relationship between the Company, subsidiary and Company A

The Company's Shareholders' Agreement is an agreement which establishes the relationship between the Group and Company A. There are no financial interrelationships other than a $xxxx provided by Company A to the Group.

The Company, subsidiary, person a and person b do not own any shares in, or any rights to vote or receive any distributions of income or capital from, Company A.

All x, x and xx matters of the Group are handled without any input from Company A.

Under Clause xx, Company A is required to provide the group with xx. However, in practise the group has never utilised the Company A to xx. The Group has also had direct dealings with some of Company A's xx. These dealings have been negotiated without any direct or indirect assistance or involvement from Company A.

The Group and Company A do not undertake business dealings with each other except for the use of x which the Group is using as part of x. Company A has no involvement in these activities and ....

The relationship between the Group and Company A is purely based on a decision of Company A to invest in the Company as a passive investment only. Company A does not have any rights or power to prevent any decisions or actions of the Group.

The Group and Company A do not share common resources and do not operate together. In particular:

·        They use different accounting systems.

·        The Group is not dependent on Company A for access to loans or guarantees.

·        They do not share common banking facilities and are not signatories on each other's accounts.

·        There are no common flows of revenues. Revenues of each are derived and received separately.

·        Although they might share x, they purchase goods and services independently of each other.

·        They maintain separate client bases.

·        They have different employees.

·        They operate from different locations.

·        They do not seek to pursue marketing opportunities through each other.

·        Company A does not communicate or negotiate with suppliers, clients or other key external stakeholders on behalf of the Group.

·        There are no financial dependencies between the two groups.

·        Their affairs are conducted independently of each other.

·        There are no close personal relationships between any key employees, including directors.

·        The Group has no ownership interest in Company A.

The Group does not have any affiliates with, relationships or interest in, any entities that have an interest in Company A.

Relationship between Directors

There are no family or close personal relationships between person a and person b, and director c. No directors are common to both Company A and the Company.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-115

Income Tax Assessment Act 1997 paragraph 328-115(2)(b)

Income Tax Assessment Act 1997 paragraph 328-115(2)(c)

Income Tax Assessment Act 1997 section 328-125

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 Division 355

Income Tax Assessment Act 1997 section 355-100

Reasons for decision

Question 1

Summary

Company A is connected to subsidiary under paragraph 328-115(2)(b) of the ITAA 1997 because it meets the requirements of the direct control test of company contained in subsection 328-125(2) of the ITAA 1997.

However, the Commissioner may determine that an entity does not control another entity by exercising his discretion under subsection 328-125(6) of the ITAA 1997.

In this case the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that Company A does not control subsidiary.

The exercise of the discretion means that Company A is not connected with subsidiary for the purposes of the application of the direct control rules in subsection 328-125(2) of the ITAA 1997.

Detailed reasoning

Subsection 328-125(1) of the ITAA 1997 provides that:

328-125(1)

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.

Direct control of an entity other than a discretionary trust, such as a Company, is defined in subsection 328-125(2) of the ITAA 1997.

Under paragraph 328-125(2)(b) of the ITAA 1997, an entity controls a company where the entity and/or its affiliates 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 at least 40% of the voting power in the company (the control percentage).

Paragraphs 2.46 and 2.47 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill2007 provides:

2.46 An additional test applies for the control by entities of companies. If either this test, or the 40 per cent ownership test is satisfied, then that entity controls the company.

2.47 control of a company will be established if an entity alone or together with affiliates beneficially own, or has the right to acquire beneficial ownership of, interests in the company with at least 40 per cent of the voting power in the company.

...

Company A has shareholding of xxx% cent in the Company and it satisfies the control percentage requirement in paragraph 128-125(2)(b) of the ITAA 1997. As such Company A satisfies the direct control test contained in subsection 328-125(2) of the ITAA 1997.

Under subsection 328-125(7) of the ITAA 1997, if an entity (the first entity) directly controls a second entity, and that second entity also controls (directly or indirectly) a third entity, the first entity is taken to control the third entity. As such by having a controlling percentage in the Company, Company A also controls the subsidiary of the Company, xx.

...

In this case the Commissioner will exercise his discretion under subsection 328-125(6) to determine that Company A does not control the Company, or xx as a subsidiary of the Company (refer to question 2). As such, the direct control test in subsection 328-125(2) of the ITAA 1997 will not apply. Company A will not be connected with subsidiary within the meaning of 'connected' for the purposes of the application of subsection 328-125(2) of the ITAA 1997 and paragraph 328-115(2)(b) of the ITAA 1997.

Question 2

Summary

Yes, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that Company A does not control the Company, or its subsidiary xx.

Detailed reasoning

Subsection 328-125(6) of the ITAA 1997 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.

Referring to the Commissioner's discretion in subsection 328-125(6) of the ITAA 1997, paragraph 2.60 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill2007 states,

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 or entities has a control percentage of at least 40% may assist in determining whether the third entity or entities control the other entity, but it is not decisive.

Control percentages

Company A

Topcon has a control percentage of xxx% under subsection 328-125(2) of the ITAA 1997. 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 A does not control the Company.

The Commissioner will need to be able to determine who controls the Company, and be satisfied that the Company is controlled by an entity other than, or by entities that do not include, Company A or any of its affiliates.

....

Control of the Company

In determining the controlling entity/entities of the Company, the Commissioner will also consider who has actual control of the Company by examining who is responsible for:

·        the strategic decision of the company, and

·        the day to day running of the company.

Strategic decision making of the Company

The strategic direction, decision making and actions of the Company and subsidiaries is set by the Board of the Company. The Commissioner has considered the xx of the Company and the xx.

Consideration of the documents establishes that the Board of the Company from xx of xx 20xx consists of:

·        person a

·        person b

·        director c.

.....

Person a and person b can vote together to control the decisions made by the Board.... They cannot be defeated by a vote by director c, even if this Director is the Chairman .... As such person a and person b have hold control of the Board.

Person a and person b can also vote together as shareholders in the event a shareholders meeting is called. Person a and person b hold zz% of the shareholder voting rights. They can also vote together on matters that require an xx under the xx. ....As such, person a and person b can pass or block resolutions for ....... at shareholder meetings in relation to the Strategic direction of the Company.

Person a and person b, can vote together at the Board level control the Board decisions. They can vote together as shareholders to control ...... Person a and person b have clearly demonstrated that they can control the strategic decisions of the Company without the involvement of Company A.

Day to Day Management of the Company

... person a and person b control the decision making and management of the day to day operations, including administration, legal and finance functions of the Company and the subsidiary.

....

Person a and person b do not act on the instructions of Company A or director c, nor do they report to them.

Person a, person b and the Company's finance manager are the only signatories on the Group's bank accounts, and there is no one from Company A eligible to transact on the accounts.

All ....matters of the Group are handled without any input from Company A.

Under Clause xx of the xx, .....

....

As such person a and person b can, without involvement of Company A control the day to day operations of the Company. .....

......It has no direct involvement or control over the day to day activities of the Company, and its subsidiary xx.

Conclusion

The strategic decision making and the day to day running of the Company are controlled by person a and person b.

The Commissioner is satisfied that person a and person b control the Company and its subsidiary xx (through their direct control of the Company). The Company is not controlled by Company A and/or its affiliates. Therefore, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Company A does not control subsidiary.

Question 3

Summary

Company A is not an affiliate of the Company, or its subsidiary xx, under section 328-130 of the ITAA 1997 at any time during the income years in the ruling period. The turnover of subsidiary will not be aggregated with the turnover of Company A under paragraph 328-115(2)(c) of the ITAA 1997 for the income years during the ruling period.

Detailed reasoning

Meaning of affiliates

Section 995-1 of the ITAA 1997 provides that 'affiliate' has the meaning given by section 328-130 of the ITAA 1997.

Section 328-130 of the ITAA 1997 provides the meaning of affiliate.

328-130Meaning of affiliate

328-130(1) 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.

328-130(2) 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.

....

Example: ...

Directors of the same company, or the company and a director of the company, would be in a similar position.

If a company is an affiliate of yours you are required to calculate an aggregated turnover as required by section 328-115.

328-115 Meaning of aggregated turnover

328-115(1) Your aggregated turnover for an income year is the sum of the relevant annual turnovers (see subsection (2)) excluding any amounts covered by subsection (3).

328-115(2) The relevant annual turnovers are:

(a)   your annual turnover for the income year; and

(b)   the annual turnover for the income year of any entity (a relevant entity) that is *connected with you at any time during the income year; and

(c)   the annual turnover for the income year of any entity (a relevant entity) that is an *affiliate of yours at any time during the income year.

....

Meaning of 'could reasonably be expected'

To determine if Company A and the Company are affiliates, consideration is required as to whether they could reasonably be expected to act in concert in respect to the affairs of the business of the Company.

The Full High Court, in Commissioner of Taxation (Cth) v Peabody [1994] HCA 43, held that the phrase 'might reasonably be expected' requires more than a possibility.

An entity, the first entity, 'could reasonably be expected' to act in accordance with another entity's, the second entity's, wishes where the second entity has a relationship of control or influence over the first entity. Such a relationship can be evidenced by the entities' behaviours and the presence of any influential relationships, such as:

(a) family or other close personal relationships;

(b) financial relationships and dependencies; and

(c) relationships created through links such as common directors, partners or shareholders.

Conversely, the entities' behaviours, obligations to each other and external parties, and their own interests may evidence the lack of such a relationship.

For a company, this relationship depends on whether the majority shareholders and/or directors of the company can reasonably be expected to act in accordance with another entity's directions.

Meaning of 'in concert'

To determine if Company A and the Company are affiliates, consideration is required on whether they could reasonably be expected to act in concert.

'In concert' is not defined in the ITAA 1997, therefore it needs to be interpreted according to its ordinary meaning and in accordance with Subdivision 328-C of the ITAA 1997.

The Macquarie dictionary (Macmillan Publishers Australia, The Macquarie Dictionary online, www.macquariedictionary.com.au, viewed 12 June 2019) relevantly defines the phrase 'in concert' to mean '5. to plan or act together'.

This ordinary meaning suggests that the term 'in concert' is used in the affiliate definition to describe entities that cannot be seen as independent of each other because of the degree to which their business activities are combined or organised together.

The term 'in concert' was considered in Re Excellar Pty Ltd and Federal Commission of Taxation2015 ATC 10-391 where Senior Member Lazanas stated, at ATC 6699:

75. I agree with the authorities that a director or shareholder is not a small business CGT affiliate of the relevant company merely because of the office they hold or the formal relationship they have with the company and that the definition of "small business CGT affiliate" requires something more than, or different to, those relationships that are dictated by legal requirements, fiduciary duties and the like. ...

and, at ATC 6700:

76. Excellar contended that the phrase "in concert with" was incorrectly treated as being synonymous with "control" in the tax cases referred to above and they should not be followed. I disagree. The meaning of the phrase "to act in concert with" has been held (in non-tax contexts) to mean "at least an understanding between the parties as to their common purpose or object:

Adsteam Building Industries Pty Ltd v The Queensland Cement and Lime Co Ltd (No 4) [1985] 1 Qd R 127.

Consistent with these views and the ordinary meaning of the phrase, an entity will be viewed as acting in concert with another entity where it and the other entity act together in pursuit of a common purpose or goal.

In the context of the definition of affiliate in section 328-130 of the ITAA 1997, that purpose or goal must be in relation to the affairs of the business of the individual or company.

In determining whether two entities are acting in concert for the purpose of the affiliate rules, paragraph 2.36 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill2007, which introduced the definition of 'affiliate', states:

2.36 The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert:

·        family or close personal relationships;

·        financial relationships or dependencies;

·        relationships created through links such as common directors, partners, or shareholders;

·        the degree to which the entities consult with each other on business matters; or

·        whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

2.37 None of these factors are determinative in their own right.

Is Company A an affiliate of the Company or subsidiary

The Commissioner has considered the relationships of influence between the parties to determine who may be affiliates.

There is nothing in the facts provided which suggest that Company A and subsidiary will act in accordance with the other's wishes or act in concert with each other. Company A has invested funds into the subsidiary business as a commercial investment. Company A and subsidiary do not share employees, resources, facilities or services. There are no financial interdependencies between them. Company A may .... Their businesses are unrelated and operate independently of each other with separate directors and separate Boards.

The only relationship the entities have is that Company A ....

There are no other routes of control by one entity over the other and no routes of common control of both companies by any third parties. They do not consult or defer to each other on the affairs of each company and how they should work together for a common purpose or goal.

The Commissioner does not consider that Company A is an affiliate of the Company or subsidiary under section 328-130 of the ITAA 1997. This is because there is no strong evidence between the two separate businesses that the companies can reasonably be expected to act in concert.

Conclusion

The Commissioner considers that Company A is not an affiliate of the Company, or its subsidiary xx, under section 328-130 of the ITAA 1997 at any time during the income years in the ruling period.

As Company A and subsidiary are not affiliates the turnover of Company A will not be aggregated with the turnover of subsidiary under paragraph 328-115(2)(c) of the ITAA 1997 for the income years during the ruling period.