Edited version of private advice

Authorisation Number: 1052019881055

Date of advice: 15 August 2022

Ruling

Subject: Commissioner's discretion - connected with test

Question

Will the Commissioner exercise the discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company A is not a connected entity of Company B for the year ended 30 June 2022, for the purposes of section 328-125 of the ITAA 1997?

Answer

Yes.

This private ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Since December 20XX Company A's shareholders have been:

•         40% Company B and

•         60% Company C.

Prior to December 2021, the shares in Company A were held 100% by Company C.

Company B has never held a shareholding greater than 40%.

On completion of the Share Sale Agreement, Company C granted Company B a call option to purchase the remaining shares in Company A, subject to the terms and conditions of the Put and Call Option Deed after the end of the 20XX-XX financial year.

The aggregated turnover of the wider Company B Group is in excess of $XXM.

The turnover of Company A (excluding Company B) is less than $XXM.

All of the shares held by each of the shareholders of Company A carry the same rights with respect to voting, dividends and capital distributions.

Company A has a Board comprising X directors, X are executive and X are non-executive directors.

The executive directors have management responsibilities and work in the business.

The non-executive directors do not have any responsibilities for daily management or operations of the business.

Company B appointed a director as there was no benefit or advantage at the time to appoint a second director from Company B as it would not change the voting ability which is based on shareholding.

The managing director of Company A was appointed by Company C.

Company A does not share banking facilities with Company B.

Employees of Company A are not signatories on Company B' accounts, nor are employees of Company B signatories on Company A's accounts. This includes the Company B appointed director of Company A, who is not a signatory on Company A's bank accounts

Company A's client base in entirely separate to the client base of Company B such that the two businesses run separate to each other.

There are no common employees, the Company B appointed director of Company A is a non-executive director who does not receive a salary or wage from Company A.

Company A and Company B operate from different locations.

Company A has full control over negotiations with its suppliers, customers, and other key external stakeholders.

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

Company A has no ownership interest in Company B.

Relevant legislative provisions

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

Reasons for decision

The meaning of a connected entity is defined under section 328-125 of the ITAA 1997 which states as follows:

An entity is connected with another entity if:

(a) either entity controls the other entity in the 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 a company

Paragraph 328-125(2)(b) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

In this case Company A Pty Ltd has two shareholders; Company B holds a 40% interest and Company C holds the remaining 60% interest. All the shares carry the same rights with respect to voting, dividends and capital distributions.

As Company B holds a control percentage of 40% it controls Company A in accordance with subsection 325-125(2) of the ITAA 1997.

Commissioner's discretion

If an entity's control percentage in a company is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by a third entity (other than an affiliate of the first entity).

For the Commissioner to be able to consider the exercise of discretion in subsection 328-125(6) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage of at least 40% of the company

Where there is a third entity with a control percentage of 40% or more it is necessary to consider additional factors such as who is responsible for the day to day and strategic running of the company to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least 40% may control the company if such responsibilities are shared.

Application to your circumstances

Given Company B and Company A Pty Ltd have separate employees, banking facilities and client bases we accept that each business is operated independently.

Company A's board is comprised of X directors: X executive and X non-executive. Company B appointed a director and they hold a non-executive director position. This means they do not have any responsibility for daily management or operations of Company A. Conversely, Company C, the 60% shareholder, appointed the managing director and executive directors which do have management responsibilities and work in the business. Having considered the information provided we accept that Company C is responsible for the day to day and strategic running of Company A.

Therefore, the Commissioner will exercise the discretion set out in subsection 328-125(6)of the ITAA 1997 and make a determination that Company B did not control Company A in the 2021-22 financial year.