Edited version of private advice

Authorisation Number: 1051891137177

Date of advice: 24 August 2021

Ruling

Subject: Income tax - Commissioner's discretion - connected entity test

Question

Will the Commissioner exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) and make a determination that the Family Trust A does not control the Trust for the purposes of section 328-125 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Income year ending 30 June 20XX

Relevant facts and circumstances

The Trust is a unit trust which operates a General Practice Medical Centre business. The trustee of the Trust is Company X.

The directors of Company X are Individual 1, Individual 2 and Individual 3. Each director is the beneficial owner of one ordinary class share in Company X.

The total number of shares issued in Company X is three ordinary class shares.

The directors are not related within the meaning of section 26-35 of the ITAA 1997.

The current Unit holders register of the Trust is:

•                    Entity A as trustee for Family Trust A (150 Ordinary units);

•                    Entity B as trustee for Family Trust B (150 Ordinary units); and

•                    Entity C as trustee for Family Trust C (150 Ordinary units).

Sub-clause XYZ of the Trust Deed to the Trust provides that the Trustee may make a determination in writing subject to the written consent of each Unit holder as to how the net income of the Trust for a financial year may be allocated.

If the Trustee fails to allocate net income of a financial year under sub-clause XYZ, the net income shall be deemed to be allocated to the Unit holders in accordance with the 'Unit holders' Proportions' at the end of the financial year.

The percentage of the net income of the Trust paid or applied to the Unit holders in each of the 20XA, 20XB and 20XC income years is as provided in the following table:

The 20XD income distribution amounts have not yet been determined but are expected to be substantially similar to 20XC.

There has been nil distribution of capital by the Trust to Unit holders in each of the 20XA, 20XB, 20XC and 20XD income years.

In practice, no single entity controls the Trust. Each Unit holder, via their units and the terms and mechanics of the Trust Deed has a one-third controlling interest in the Trust. It is the Trust Deed that provides the basis for how decisions of the Trust are made (by the directors of Company X) rather than the influence of any single entity.

Commercially, factors affecting the distribution decision of net income each year includes attendance, strategic direction, contribution to revenue and oversight of the day-to-day administrative and operational functions of the business.

If any of Individual1, Individual 2 and Individual 3 do not agree in writing on or before 30 June each year how the net income of the Trust will be allocated for that financial year, default distributions will be made in accordance with the Unit holders' Proportions at the end of the financial year under sub-clause XYV of the Trust Deed.

Assumption

The percentage of the net income of the Trust paid or applied to any of the Unit holders in respect of the 20XD income year will be less than 40% of the total amount of income paid or applied by Company X for that year.

Relevant legislative provisions

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(3)

Income Tax Assessment Act 1997 subsection 328-125(4)

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

Reasons for decision

Summary

The Commissioner will not exercise his discretion under subsection 328-125(6) of the ITAA 1997 and make a determination that the Family Trust A does not control the Trust for the purposes of section 328-125 of the ITAA 1997.

Detailed reasoning

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

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.

There are two separate control tests for discretionary trusts under subsections 328-125(3) & (4) of the ITAA 1997.

Subsection 328-125(3) of the ITAA 1997 adopts an actual control test by stating that an entity (the first entity) controls a discretionary trust if a trustee of the trust acts or could reasonably expected to act, in accordance with the directions or wishes of the first entity, its affiliates or the first entity together with its affiliates.

The other control test in subsection 328-125(4) of the ITAA 1997 states that if an entity (the first entity), its affiliates, or the entity with its affiliates, receives (or has applied for their benefit) 40% or more of the income or capital paid or applied by the trustee in any of the last four income years, then the first entity is deemed to control that discretionary trust.

Subsection 328-125(6) of the ITAA 1997 allows the Commissioner to determine that the first entity does not control the other entity if the control percentage referred to in subsection 328-125(4) is at least 40% but less than 50%, and 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.

Application to your circumstances

Under subsection 328-125(4) of the ITAA 1997, the Family Trust A will be deemed to control the Trust for the 20XX income year as a result of having received at least 40% of the total amount of trust income paid or applied by Company X in the 20XA and 20XB income years.

However, the Commissioner may exercise his discretion under subsection 328-125(6) of the ITAA 1997 to make a determination that the Family Trust A does not control the Trust for the 20XX income year, if:

1.            income received by the Family Trust A from the Trust was less than 50% of the total amount of income paid or applied by Company X in either of the 20XA or 20XB income years; and

2.            the Commissioner thinks that the Trust is controlled by an entity other than the Family Trust A, or by entities that do not include the Family Trust A or any of its affiliates.

In this case, although the first condition (the 'control percentage') has been met, the discretion will only be exercised by the Commissioner if it can be demonstrated that one or more entities other than the Family Trust A actually controls the Trust. That is, if Company X acts or might reasonably be expected to act, in accordance with the directions or wishes of a third entity or multiple entity's that do not include the Family Trust A or any affiliates of the Family Trust A.

You have submitted that there is no single entity that controls the Trust and it is the Trust Deed that provides the basis for how decisions of the Trust are made, rather than the influence or control of any single entity. Additionally, factors affecting the distribution decisions of net income each year include attendance, strategic direction, contribution to revenue and oversight of the day-to-day administrative and operational functions of the business.

Based on these facts, the Commissioner does not think there is an identifiable third entity that controls the Trust in a way described in section 328-125 of the ITAA 1997. Therefore, the discretion under subsection 328-125(6) of the ITAA 1997 will not be exercised to make a determination that the Family Trust A does not control the Trust for the purposes of section 328-125 of the ITAA 1997.