Edited version of private advice

Authorisation Number: 1052111787018

Date of advice: 28 April 2023

Ruling

Subject: Commissioner's discretion - control

Question 1

For the purposes of calculating the aggregated turnover of Holdco for the years ended 30 June 2021 and 30 June 2022 under section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997), does Top control Holdco under subsection 328-125(2) of the ITAA 1997?

Answer

Yes.

Question 2

For the purposes of calculating the aggregated turnover of Holdco for the years ended 30 June 2021 and 30 June 2022 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 Top does not control Holdco?

Answer

Yes.

Question 3

For the purposes of calculating the aggregated turnover of Holdco for the years ended 30 June 2021 and 30 June 2022 under section 328-115 of the ITAA 1997, is Top an affiliate of Holdco under section 328-130 of the ITAA 1997?

Answer

No.

This private ruling applies for the following period:

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

The Group is comprised of a number of companies including Holdco.

Holdco only has ordinary shares on issue that are held in the following proportions:

•         <30% by individual A

•         <30% by individual B

•         >40% but <50% by Top a non-resident company.

The above percentages represent the proportions to which rights to voting, dividends and capital distributions are held by the relevant shareholders.

Top's investment in Holdco has been undertaken for passive investment purposes.

Holdco is an Australian resident company.

The Board of Holdco is made up of 3 directors, individual A, B and an individual appointed by Top.

The Group was established with the purpose of carrying on business and generating profit. Its operations are substantial and conducted in a business-like manner.

The Group is not consolidated for tax purposes.

The turnover of Top for the year ended 31 March 2021 and 2022 is more than $XXX billion.

Holdco Shareholders' Agreement

The Shareholders' Agreement sets out the obligations between Holdco, Top, individuals A and B.

Board voting of Holdco

Under Clause X.X of the Shareholders' Agreement, Top may appoint an additional 'Representative Director' however, no formal appointments have been made.

The Board of Holdco does not report to the Board of Top. The two boards function separately with no directors in common.

Each director has one vote to cast on board resolutions for Holdco.

Clause Y.Y of the Shareholders' Agreement provides that the Chairman is entitled to a second or casting vote in matters where equal votes are cast by directors. This does not extend to shareholder meetings.

•         During the period 1 July 2020 to 30 June 2022, no Additional Directors and therefore no Chairman was appointed to the Board of Holdco.

•         As there were only 3 directors during the period in question, there was no possibility of equal votes being cast by directors and therefore there would never be a situation where a Chairman's vote was required.

The matters dealt with by the board have been limited to reporting in relation to the agreed business plan and the financial data.

All board meetings have been held in Australia via teleconference to allow the US resident Top appointed director to attend.

Individuals A and B typically set the agenda and run the board meetings.

Control of the Group

The strategic direction, decision making and actions of the Group is determined by individuals A and B. This is always done prior to the board meetings and does not include the involvement of Top's appointed director.

Individuals A and B Group's executive management team.

Holdco is operated in accordance with a business plan that was developed by the executive management team and was approved by the board of Holdco under Clause Z.Z(z) of the Shareholders' Agreement. The executive management team ensures that the business plan is followed as part of the day-to-day operations

The decision making and management of the day-to-day operations, including administration, legal and finance functions of the Group rests with individuals A and B.

Individual A, B and the finance manager are the only signatories on the Group's bank accounts. No representative from Top is eligible to transact on the bank accounts.

Relationship between Top and the Group.

Top has provided debt funding to the Group. This is the only financial relationship between the Group and Top.

Under Clause A.A of the Shareholders' Agreement, Top is required to provide the Group with access to its distribution channels. However, in practice the Group has never utilised Top to access these distribution channels.

The Group has also had direct dealings with some of Top's distributors. These dealings have been negotiated without any direct or indirect assistance or involvement from Top.

The only business dealing the Group has with Top is the use of one of Top's products in its R&D activities. Top is not involved in these activities. The product provided by Top is a standard product that has been modified by the Group, as it could be by any other customer.

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

•         They use different accounting systems.

•         The Group is not dependent on Top 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 entity are derived and received separately.

•         Although they might share several suppliers, they purchase goods and services independently of each other and are not provided with any volume purchasing discounts.

•         They maintain separate client bases.

•         They have different employees.

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

•         Top does not communicate or negotiate with suppliers, clients or other key external stakeholders on behalf of the Group.

•         There are no close personal relationships between any key employees, including board members and directors. There are no common directors.

•         There are no financial dependencies between the two groups.

•         Their affairs are conducted independently of each other.

Relationship of individuals A and B

Individuals A and B are married to each other.

Individuals A and B always vote in the same way in relation to all decisions of the Group, in both their capacity as directors and shareholders.

Individuals A and B have entered into an agreement stating that they will vote as a block in respect of board matters and shareholder matters.

Relationship between Top, individuals A and B

No personal relationships, financial dependencies or shared strategic decision making exists between Top, individuals A and B, that indicate that individual A and B could be expected to act in accordance with the directions or wishes of, or in concert with, Top, or vice versa.

Relationship between Top's appointed director and individuals A and B

There are no family or close personal relationships between Top's appointed director, and individuals A and B.

There are no circumstances that indicate that either entity could be expected to act in accordance with the directions or wishes of, or in concert with, the other in relation to its business.

There are no other relationships between these parties other than the requirements outlined in the Shareholders' Agreement.

Relevant legislative provisions

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

Reasons for decision

Question 1

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.

The ordinary shares that constitute the issued capital of Holdco have equal rights to voting and the distribution of income and capital.

Top has shareholding of more than 40% but less than 50% in Holdco and it satisfies the control percentage requirement in paragraph 128-125(2)(b) of the ITAA 1997. As such Top satisfies the direct control test contained in subsection 328-125(2) of the ITAA 1997.

In this case the Commissioner will exercise his discretion under subsection 328-125(6) to determine that Top does not control Holdco (refer to question 2). As such, the direct control test in subsection 328-125(2) of the ITAA 1997 will not apply.

Question 2

Subsection 328-125(6) of the ITAA 1997 states:

Commissioner may determine that an entity does not control another entity

328-125(6) 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

Top has a control percentage of more than 40% but less than 50% 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 Top does not control Holdco.

The Commissioner will need to be able to determine who has actual control of Holdco, and be satisfied that Holdco is controlled by an entity other than, or by entities that do not include, Top or any of its affiliates.

Individuals A and B each hold less than 30% of the shares in Holdco. Individuals A and B may control Holdco as together they control the right to exercise more than 50% of the voting power in Holdco.

Control of Holdco

In determining the control of Holdco, the Commissioner will consider who has actual control of Holdco 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

Individuals A and B can vote together to control the decisions made by the Board by combining the one vote that they each have. They cannot be defeated by a vote by the Top appointed Director, even if this Director is the Chairman as the Chairman only has a casting vote in a situation where there are equal votes.

Individuals A and B can also vote together as shareholders in the event a shareholders meeting is called. They can also vote together on matters that require an Ordinary Resolution under the Shareholder's Agreement. The Chairman is not entitled to a second or casting vote at Shareholder meetings. As such, individuals A and B can pass or block resolutions for Schedule 2 matters at shareholder meetings in relation to the Strategic direction of Holdco.

Individuals A and B can vote together at the Board level to control the Board decisions. They can vote together as shareholders to control strategic decisions requiring an Ordinary Resolution. Individuals A and B have clearly demonstrated that they can control the strategic decisions of Holdco without the involvement of Top.

Conclusion

The strategic decision making and the day to day running of Holdco are controlled by individuals A and B.

The Commissioner is satisfied that individuals A and B control Holdco and that it is not controlled by Top and/or its affiliates. Therefore, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Top does not control Holdco.

Question 3

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.

328-130              Meaning 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.

If a company is an affiliate of yours you are required to calculate an aggregated turnover as required by section 328-115 of the ITAA 1997.

Meaning of 'could reasonably be expected'

To determine if Topcon and Holdco 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 Holdco.

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 Top and Holdco 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 28 April 2023 relevantly defines the phrase 'in concert' to mean:

6. in concert,

a. in a coordinated or organised way; 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 Top an affiliate of Holdco

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 Top and Holdco will act in accordance with the other's wishes or act in concert with each other. Top has invested funds into the Holdco's business as a commercial investment. Top and Holdco do not share employees, resources, facilities or services. There are no financial interdependencies between them. Their businesses are unrelated and operate independently of each other with separate directors and separate Boards.

The only relationship the entities have is that Top holds a substantial shareholding in Holdco, and some direct dealings with some of Top's distributors. These dealings have been negotiated without any assistance or involvement from Top.

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 Top is an affiliate of Holdco 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 Top is not an affiliate of Holdco, under section 328-130 of the ITAA 1997 at any time during the income years in the ruling period.

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