Edited version of private advice

Authorisation Number: 1052111984888

Date of advice: 18 May 2023

Ruling

Subject: Commissioner's discretion - control

Question

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

Answer

Yes.

This ruling applies for the following:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Company was incorporated in Australia in 19XX.

In 20XX, the Trust acquired the Company's XX ordinary shares, being 100% of the Company's issued shares at the time.

In 20XX, the Company undertook a share split whereby its XX ordinary shares were split to XX ordinary shares.

In 20XX, Company B acquired XX Ordinary shares in the Company form the Trust. Concurrently, the Company also issued a further XX Ordinary shares to Company B.

Accordingly, the shareholdings of the Company from April 20XX to the present date have been as follows:

The Company carries on a business.

The Trust was established by deed in 20XX. The nominator of the Trust is individual A, and the nominated beneficiaries of the Trust are the family members of individual A.

The trustee of the Trust is Company C. The directors and equal shareholders of Company C are individual A and their spouse.

From 20XX until 20XX, individual A was the only director of the Company.

From April 20XX, being when Company B became shareholder of the Company, individual A continued as director and was also formerly appointed as Chief Executive Officer and Managing Director of the Company pursuant to an Executive Service Agreement.

The Company office is separate and independent from the office of its shareholder, Company B.

Before and throughout his formal appointment as Chief Executive Officer and Managing Director, individual A has made decisions in relation to the day to day and strategic decision making regarding the Company. This includes, but is not limited to, the following responsibilities:

a)    Administration (recruitment of new staff)

b)    Legal functions (responsibility for obtaining legal advice on various matters relating to business transactions)

c)    Finance functions (forecasting and budgeting for new revenues)

d)    Service delivery to clients including management of client projects (responsibility for all creative work)

e)    Business planning and budgeting processes

The Shareholders Agreement contains various clauses outlining the rights and responsibilities of the shareholders, including but not limited to:

a)    Quorum

b)    Votes

c)    Management

At clause 5.4(a), Quorum for a Board meeting is the attendance at the time of the meeting of one director appointed by each shareholder.

At clause 5.5, each director has one vote and a resolution is passed by majority vote case by the directors entitled to vote on the resolution. However, the Shareholders Agreement also provides that certain matters require unanimous vote, at clause 5.6.

The Shareholders Agreement, at clause 7, provides that the management of the Company vests in the Board. It also provides that no Director acting individually has authority to enter agreements, incur expenditure on behalf of or otherwise commit the Company.

Nowithstanding the above, Clause 7.3 of the Shareholders Agreement provides that no shareholder may interfere with the management of the company nor has the authority to give directions to any officers or employees of the Company.

In April 20XX the composition of the Company's board of directors changed to reflect a representative of each shareholder as well a third independent director.

Board meetings are held once a quarter. A Company B representative attends quarterly board meetings as required under the Shareholders Agreement.

At the time that Company B became a shareholder, a strategic relationship between the Company and Company B's business was being pursued. However, such a relationship never developed.

Although a Company B representative is present at board meetings, the representative is never involved in discussions regarding the business of the Company and attends board meetings in an observational role only.

All action items and voting during board meetings has always been approved unanimously by the board.

Relevant legislative provisions

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

Reasons for decision

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.

With regard to companies, you may establish control via either the right to distribution control rule (paragraph 328-125(2)(a) of the ITAA 1997) or the voting power control rule (paragraph 328-125(2)(b) of the ITAA 1997).

Paragraph 328-125(2)(a) of the ITAA 1997 provides that you control a company if you, your affiliates, or you together with your affiliates beneficially own, or have the right to acquire the beneficial ownership of, interests in the company that carry between them the right to receive a percentage (the control percentage) that is at least 40% of any distribution of income or capital by the company.

Paragraph 328-125(2)(b) of the ITAA 1997 provides that you control a company if you, your affiliates, or you together with your affiliates 'beneficially own, or have the right to acquire the beneficial ownership of, 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'.

If your 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 you do not control the other entity if the Commissioner thinks that the entity is controlled by a third entity (other than your affiliate).

The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 (EM) contains the following example:

Example 2.10

Chandra owns a restaurant with a turnover of less than $2 million and has inherited his father's 42 per cent interest in a software company. The other 58 per cent of the software company is owned by the manager of the company, and Chandra has had no dealings with the manager whatsoever.

The turnover of Chandra's restaurant will not be aggregated with the turnover of the software company if the Commissioner thinks that the software company is actually controlled by the other person with the 58 per cent interest.

Application to your circumstances

In this case, Company B holds XX% of the shares in the Company while the remaining XX% of the shares are held by the Trust. We accept that the Trust via its nominated controller, individual A, have responsibility for the day-to-day operations and strategic decision making of the Company. Further, based on the information provided Company B does not participate in Company operations and merely attends board meetings as required under the Shareholders Agreement.

We consider the circumstances in the application for private ruling are similar to the example outlined in the EM. Given actual control of the Company sits with the Trust which holds a XX% interest the Commissioner will exercise the discretion under subsection 328-125(6) of the ITAA 1997 to determine that Company B does not control the Company.