Edited version of private advice

Authorisation Number: 1051952563304

Date of advice: 23 February 2022

Ruling

Subject: Trust/associates

Question

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

Answer

No.

This ruling applies for the following period:

Year ended XX June 20XX

The scheme commences on:

XX July 20XX

Relevant facts and circumstances

The Company operates a printing business.

Person A and Person B formed The Company in 20XX.

Person A and Person B were the founding managers and directors.

The Company had two shareholders:

•         Person A, in his capacity as trustee for Trust A: 40%, and

•         Person B, in his capacity as trustee for Trust B: 60%.

All shares carry equal rights to votes, income, and capital distributions.

Person A controls Trust A by virtue of acting as trustee.

Person B controls Trust B by virtue of acting as trustee.

Person A and Person B jointly control the decision-making and management of The Company's day-to-day operations.

Person A held the position of Production Director in The Company.

Person B held the position of Managing Director in The Company.

On XX July 20XX Trust A entered into a share sale deed for the disposal of its shares in The Company.

Person B was retained by the purchases to continue in his role as the Managing Director of The Company.

The Constitution

To summarise, the effect of some of the provisions governing voting and meetings are as follows:

•         The business of The Company is managed by the directors, who may pay all expenses incurred in promoting and forming The Company and may exercise all such powers of The Company as are not, by the Corporations Act or by this constitution, required to be exercised by The Company in general meeting (clause 29)

•         Two members personally present constitute a quorum at general meetings, and two directors constitute a quorum at director meetings (clauses 7 and 37)

•         Members have one vote, and on a poll every person present in person or by proxy has one vote for each share held by the member (clause 15)

•         Shareholder resolutions are carried by majority, and in case of an equality of votes, the chairman of the meeting, in addition to his or her deliberative vote (if any), has a casting vote (clause 33)

•         The Company may, by resolution:

a)    Remove any director from office

b)    Appoint a new director to replace a director whose office has been vacated pursuant to this constitution, or

c)    Appoint an additional director or additional directors (clause 25); and

•         If all the directors have signed a document containing a statement that they are in favour of a resolution of the directors, a resolution in those terms is taken to have been passed at a meeting (clause 42).

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-115

Income Tax Assessment Act 1997 Section 328-125

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

Income Tax Assessment Act 1997 Section 328-130

Reasons for decision

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

The effect of subsection 328-125(2) of the ITAA 1997 for entities other than discretionary trusts, is that an entity controls a company if, together with its affiliates, it has rights to, or rights to acquire interests to at least 40% of either income, capital, or voting rights.

For discretionary trusts, subsections 328-125(3) and 328-125(4) of the ITAA 1997 provide control tests where an entity is considered to control a discretionary trust if the trustee either:

a)    acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity or its affiliates, or

b)    pays or applies at least 40% of any distributions of income or capital to the entity or its affiliates.

Between 40% and 50%

In accordance with subsection 328-125(6) of the ITAA 1997 if an entity's control percentage in another entity is at least 40% but less than 50%, the Commissioner may determine that the first entity does not control the other entity if he is satisfied that a third entity (not including any affiliates of the first entity) controls the other entity.

Whether or not a third entity has a control percentage of at least 40% may assist in determining whether the third entity controls the other entity, but it is not decisive. For example, a third entity may control a discretionary trust because the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the third entity even if the third entity's control percentage is zero. In working out the third entity's control percentage, the interests of any affiliates of the third entity are considered.

Alternatively, it is possible that both of the entities with a control percentage of at least 40%, or both an entity with a control percentage of at least 40% and an entity that controls the other entity in another way, may control the other entity if responsibilities are shared. Factors such as who was responsible for the day-to-day and strategic running of an entity will be relevant when determining whether an entity is controlled by a third entity. The following example, available at ato.gov.au, considers the Commissioner's discretion:

Lachlan owns 48% of the shares in Ayoubi Art Supplies. He plays no part in the day-to-day or strategic decision-making of the business. Daniel owns 42% of the shares in the company. The remaining 10% of shares are beneficially owned by a third shareholder who does not take part in the management of the business. All shares carry the same voting rights and Daniel makes all day-to-day and strategic decisions for the company. Even though Lachlan owns 48% of the shares in Ayoubi Art Supplies, he would not be taken to control the company if the Commissioner was satisfied that the company is controlled by Daniel.

Application to your circumstances

In this case, Trust A holds 40% of the shares in The Company and another entity holds the remaining 60%. As outlined above, whether or not an entity has a control percentage of at least 40% is not decisive.

In this case, the strategic direction, decision-making and day-to-day operations of The Company are the joint responsibility of the directors, who are also the controllers of their respective family trusts. No single director has complete control over the investment and operational policy, including matters of finance and borrowings of The Company.

Having considered the circumstances, the Commissioner will not grant the discretion outlined in subsection 328-125(6) of the ITAA 1997.