Edited version of private advice

Authorisation Number: 1051865152628

Date of advice: 9 July 2021

Ruling

Subject: Commissioner's discretion under subsection 328-125(6)

Question

Will the Commissioner exercise his discretion pursuant to subsection 328-125(6) of the Income Tax Assessment Act 1997 to determine that the Trust does not control Company A?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.               The Trust owned 100% of shares in Company A.

2.               In XX of 20XX the Trust sold 51% of its shares in Company A to Company B.

3.               As part of the sale the Trust entered into a Shareholders Deed (SD) with Company B. The SD states that the Trust owns 49% of the capital whilst Company B owns 51%.

4.               Schedule X in the SD lists the following matters that the Trust is unable to do without the prior written approval of an executive director of Company B, including by a director's resolution or being part of the annual business plan and budget:

•                  corporate

•                  financial

•                  commercial, and

•                  general.

5.               Schedule X in the SD states that the business plan and budget must be approved in writing by Company B and all financial reporting is directed by Company B.

6.               Schedule X in the SD entitled Company B two directors and the Trust one director on Company A's board and Company B 51% and the Trust 49% of the voting rights in Company A.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 328-125

Income Tax Assessment Act 1997, paragraph 328-125(2)

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

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1:

Will the Commissioner exercise his discretion pursuant to subsection 328-125(6) to determine that the Trust does not control Company A?

Summary

The Commissioner will exercise his discretion under subsection 328-125(6) to determine that the Trust does not control Company A.

Detailed reasoning

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

2.               Subsection 328-125(1) states:

An entity is connected with another entity if:

(a)             either entity controls the other 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.

3.               In relation to entities other than discretionary trusts (i.e. companies and fixed trusts), the relevant control test is set out in subsection 328-125(2) as follows:

•                  an entity (the first entity) 'controls' another entity if the first entity, its affiliates, or the first entity together with its affiliates own or have the right to acquire 40% of the other entity's:

-                 income distribution

-                 capital distribution, or

-                 if the entity is a company - 40% of its voting rights.

4.               Accordingly, if an entity (the first entity) has at least 40% (but under 50%) interest in another entity and is deemed to control the other entity under either subsection 328-125(2) or (4) - the first entity can apply to the Commissioner under subsection 328-125(6) to exercise his discretion to determine the first entity does not 'control' the other entity for the purposes of section 328-125. For the first entity to get the Commissioner's discretion, the first entity must prove that a third party entity or entities actually controls the other entity.

5.               The Trust owned 49% of shares in Company A, is entitled to receive 49% of any capital or income distribution from Company A and has 49% of the voting rights in Company A. Therefore, the Trust is taken to control Company A under the direct control test in subsection 328-125(2).

6.               In addition, Company B owned 51% of shares in Company A, is entitled to receive 51% of income and capital distributions and 51% of voting rights in Company A. Therefore, Company B is also taken to control Company A under the direct control test in subsection 328-125(2).

Commissioner's discretion

7.               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.

8.               The Trust is seeking the Commissioner to exercise his discretion that it did not control Company A, instead Company B controlled Company A.

9.               After examining the SD, the Commissioner will determine that the Trust does not control Company A and that Company B controlled Company A, as:

•                  there are a number of matters that the Trust is unable to do without the prior written approval of an executive director of Company B (Schedule X)

•                  the business plan and budget must be approved in writing by Company B and all financial reporting is directed by Company B (Schedule 5), and

•                  Company B controls the voting power of the board of Company A, as the board consists of two members from Company B and one from the Trust (Schedule 9).