Edited version of private advice

Authorisation Number: 1052155263953

Date of advice: 14 August 2023

Ruling

Subject: Commissioner's discretion - control

Question 1

Will the Commissioner exercise his discretion in accordance with subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) and determine that, despite the fact that G received a distribution of more than 40% of the income of the A Trust in the year ended 30 June 20ZW, he does not control A Trust?

Answer

Yes

Question 2

Are the basic conditions in section 152-10 ITAA 1997 satisfied for the CGT event that happened in relation to the D Property in the year ended 30 June 20ZZ?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20ZZ

The scheme commenced on:

1 July 20ZY

Relevant facts and circumstances

The taxpayer, F, has derived a capital gain on the sale of her half share of a property known as D Property. The other half share was owned by the taxpayer's ex-spouse, E.

F and E each acquired their interest in D Property as follows:

•                     a one eight (1/8) share of the property under a deed of assignment dated 29 June 20ZQ;

•                     a further one quarter (1/4) share under a deed of assignment dated 1 July 20ZR; and

•                     the remaining one eight (1/8) share under a contract of sale dated 1 December 20ZS, from which time they each held a one half (1/2) share in the property.

The majority of the purchase price for the interests in the property was provided by way of gift from G and H. The D Property was transferred to F and E as part of G's succession plans which involved moving to a property that was closer to where H's elderly parents were living, and also included transferring other family property to F's sibling.

The D Property and improvements were valued by a Certified Practicing Valuer as at 5 May 20ZR at $XX.

H originally provided vendor finance to F and E for the acquisition of the final transfer of interests in D Property and this loan was repaid by F and E in the year ended 30 June 20ZU. There were no other loans owing by F and E or A Trust to G and H or B Trust.

E and F married in 20YY and divorced on 20ZY.

E and F sold the property to a 3rd party under a contract of sale dated YY 20ZY that settled on YY 20ZY. That sale was a direct consequence of the breakdown in their relationship.

The D Property was used to conduct a grazing and farming business by the A Trust in a partnership with G and H from 29 June 20ZQ to 1 July 20ZR. From 1 July 20ZR until sale of the property on 11 October 20ZY, the grazing and farming business conducted on the property was carried on solely by the A Trust.

The turnover of the A Trust in the year ended 30 June 20ZY was $XX, including $XX of cattle sales and other minor amounts.

The A Trust was a family trust established for the benefit of E and F and their family. E and F were the joint appointors of the A Trust, however F has been removed as joint appointor of the Trust under their property settlement dated 14 February 2023. The trustee of the A Trust is Y Co. E has always been the sole director of Y Co and F and E each held 50% of the ordinary shares until F transferred her shares to E in accordance with their property settlement.

E made the high-level decisions in relation to the A Trust's operations including purchase of cattle to commence business operations, making improvements to the property and sale of the business operations.

E also exercised the trustee's discretion in making distributions of income and capital of the A Trust each year and approved financial statements and income tax returns. This is evidenced by E's role as the public officer of the trustee of the A Trust, having signed all financial statements and A Trust distribution minutes.

E also made decisions in relation to recruitment and retention of staff and contracting decisions for land clearing, dozing, mustering and retention of unused land.

E also conducted the day-to-day business operations of the A Trust. This included managing the property and cattle operations such as improving the property and business by clearing land, ploughing and improving fencing, implementing better management practices such as rotational grazing, converting the property to certified organic and increasing the carrying capacity of the property. E approved all business expenditure and entered into all business contracts as sole director.

In respect of the A Trust:

•                     E was sole director and public officer of the corporate trustee and held 50% of the shareholding in the corporate trustee. E could not be removed as a director without his approval or consent.

•                     E was also joint appointor of the A Trust, together with F.

•                     E effectively held authority to make the high-level decisions that determined the directions of the A Trust's operations and the types of transactions it entered.

•                     E also exercised the trustee's discretion in making distributions of income and capital of the A Trust each year and approved financial statements and income tax returns.

The A Trust has primarily made distributions of income to E, F and their children - L and M. However, both E's parents, J and K, and F's parents, G and H, have received distributions of income from the A Trust.

The A Trust made the following income distributions in the years ended 30 June 20ZR to 30 June 20ZY:

Table Redacted.

The payments the A Trust made to G and H and to K and J were made to them as beneficiaries following the valid exercise by the trustee of its discretion to distribute the income of the A Trust in various years. The payments did not relate to any loans or other arrangements. Nor were the payments connected to any condition attaching to the earlier transfer of the D Property or in relation to any directions or understandings as to how the A Trust would be operated.

E was the sole director of the trustee of the A Trust. He decided how the trustee would exercise its discretion to distribute trust income. E took into account various family and financial considerations in deciding the amount of the distribution made to particular beneficiaries in each year, but he did not follow the directions of other persons, including G, in making those decisions about how trust income was to be distributed.

G received a distribution of approximately XX% of the total income from the A Trust in the year ended 30 June 20ZW. G is the appointor and sole trustee of The B Trust. G also received a distribution of 100% of the income of the B Trust in the year ended 30 June 20ZW as the default beneficiary of that trust.

The B Trust carried on a cattle grazing business and had an annual turnover of approximately $1.6m in the year ended 30 June 20ZY.

H, received a distribution of approximately XX% of the total trust income distributed by the A Trust in the year ended 30 June 20ZW. H does not carry on a business and did not have interests in, or did not receive distributions from, any other entities.

J received a distribution of approximately XX% of the total income from the A Trust in the year ended 30 June 20ZX and her husband, K, received a distribution of approximately XX%. J and K do not carry on a business and did not have interests in, or did not receive distributions from, any other entities.

X Co is wholly owned by the C Trust. It carried on a tourist accommodation business on the D Property from 20ZU until 11 October 20ZY. X Co's turnover in the year ended 30 June 20ZY was $XX.

F is the sole director and shareholder of Z Co, which is the corporate trustee of the C Trust. The C Trust did not carry on a business and its turnover in the year ended 30 June 20ZY was nil.

There are no arrangements, obligations or expectations that payments will be made directly or indirectly by E to G, H, J or K subsequent to the sale of D Property. E and F divorced in February 20ZY and sold the D Property later that year as a result of the breakdown of their marriage. They undertook mediation in relation to their property settlement, which included division of the proceeds of sale of the D Property. The mediation was settled in YY 20YZ with the Family and Federal Court issuing orders by consent. The property settlement contains no provision for payments to be made to G, H, J or K, other than payments by the A Trust of existing unpaid present entitlements to K, J and H.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-47

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-115

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Question 1

Will the Commissioner exercise his discretion in accordance with subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) and determine that, despite the fact that G received a distribution of more than 40% of the income of the A Trust in the year ended 30 June 20ZW, he does not control the A Trust?

Summary

Yes. The A Trust is controlled by entities other than G, and consequently G does not control the A Trust for the purposes of subsection 328-125(4).

Detailed reasoning

Division 152 of the ITAA 1997 provides CGT concessions to some small business taxpayers. The concessions potentially enable these taxpayers to reduce or disregard certain capital gains in relation to CGT assets used in their small businesses. The small business concessions under Division 152 are:

•                     the 15 year exemption (subdivision 152-B);

•                     the 50% reduction (subdivision 152-C);

•                     the retirement exemption (subdivision 152-D); and

•                     the replacement asset roll-over (subdivision 152-E).

The 15 year exemption allows a taxpayer to disregard the entire capital gain. The remaining three concessions have effect in addition to the CGT discount (where applicable) and can be applied successively to reduce or roll-over the gain.

In determining whether a capital gain may be reduced or disregarded under Division 152, an entity may need to aggregate its annual turnover or its maximum net asset value with that of other entities to determine its eligibility. Aggregation will be necessary where there is a connection between the entities based on 'control'. Subsections 328-125(2) and (4) set out the primary tests of control for the purposes of section 328-125. These subsections provide for the calculation of a 'control percentage' that outlines when the first entity is considered to control the test entity where there is a discretionary trust.

In respect of discretionary trusts, section 328-125 provides:

(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 a discretionary trust

(3) An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

(4) An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

Commissioner may determine that an entity does not control another entity

(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.

Section 328-130 provides the meaning of affiliate:

(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.

(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.

Note: For small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47.

Draft Tax Determination TD 2023/D2 Income Tax: aggregated turnover and connected entities - Commissioner's discretion that an entity does not 'control' another entity - outlines the ATO views on the exercise of the discretion by the Commissioner under subsection 328-125(6). The determination considers the application of the provisions primarily in the context of corporate groups, but includes general guidance on the approach the Commissioner will take to exercising the discretion:

5. Where the first entity has a control percentage of at least 40% but less than 50%, subsection 328-125(6) provides the Commissioner with a discretion to determine that it does not control the test entity (the Commissioner's discretion). To make that determination, the Commissioner must think the test entity is controlled by an entity or entities (the third entity or entities) that is not, or does not include, the first entity or any of its affiliates.

6. The statutory condition for exercising the Commissioner's discretion requires that the Commissioner positively conclude that there is actual control by a third entity or entities. It is not sufficient to merely show that the first entity is not a controller.

TD 2023/D2 further provides:

10. This Determination does not seek to deal comprehensively with the concept of 'control' for the purposes of considering the Commissioner's discretion, nor the wide range of circumstances in which it will be relevant for the exercise of the Commissioner's discretion. The Commissioner's conclusion on control in a given case will turn on its specific facts and circumstances. General statements on the concept, supported by generic examples with narrow fact patterns, would be of limited assistance as guidance for individual cases and may even mislead. Additional public guidance may be considered in future if there is a need to clarify our views on further discrete issues arising from the ongoing administration of the discretion.

13. Having regard to the statutory context, the nature of control relevant for the Commissioner's discretion is control over those matters typically associated with ownership of a business entity. That is, entitlements to income and capital of the entity as well as participation in decision making on key matters affecting the entity's constitution, funding, structure and management. The latter would ordinarily include matters such as:

•                    decision making on the composition and oversight of the management team

•                    amending the entity's constituent documents

•                    deciding on capital and entity restructuring proposals, the issue of new ownership interests or winding up, and

•                    authorising significant changes in the direction of the entity's business operations.

14. Other ways in which an entity may be said to be 'controlled', such as the control exercised by managers with responsibility for the day-to-day conduct of the business of the entity, do not of themselves constitute control of the entity in the sense contemplated by the aggregation rules. It is necessary to distinguish control of an entity from powers in respect of the conduct of an entity's business.

15. Managers or directors with responsibility for the day-to-day conduct of a company's business may have considerable autonomy in making significant business decisions, but this of itself is not considered relevant 'control' of the entity for the purposes of subsection 328-125(6).

Application to the specific facts and circumstances

For the year ended 30 June 20ZW, G received a distribution of approximately XX% of the income or capital paid by the trustee and G's spouse H, received a distribution of approximately XX% of the income or capital paid by the trustee. In that year the two children (L and M) received approximately XX% each of the income or capital paid by the trustee (the remaining amount paid).

H is not an affiliate of G under section 328-130 ITAA 1997. H did not carry on a business at the time of the sale of D Property and did not carry on a business in the year ended 30 June 20ZW. Subsection 152-47 relating to certain passively held assets will not make H an affiliate of G for the purpose of the test in subsection 328-125(4).

Under subsection 328-125(6) the Commissioner may determine that G does not control the A Trust if the Commissioner thinks that the A Trust is controlled by another entity that does not include G or his affiliates.

On the facts and circumstances in this case, the Commissioner is of the view the A Trust was controlled by E and the A Trust is therefore connected with E. F may also have controlled the A Trust in her own right (s328-125(3)), however there is no need to consider this for the purposes of this ruling as F and E are affiliates (s152-47) and F is deemed to control the A Trust and is therefore also connected (s328-125(3) and s328-125(4)).

The following factors are relevant to the conclusion that E controlled the A Trust under ss328-125(3) and (4):

•                     E held the legal power to make the high-level decisions that determined the directions of the A Trust's operations and the types of transactions it entered.

•                     E was sole director of the corporate trustee of the A Trust and held 50% of the shareholding in the corporate trustee. E could not be removed as a director of the corporate trustee without his approval or consent.

•                     E was also joint appointor of the A Trust, together with F. A change of trustee to facilitate a change of directors of the trustee company would require E's approval or consent.

•                     E also exercised the trustee's discretion in making distributions of income and capital of the A Trust each year and approved financial statements and income tax returns.

•                     The percentage of the income or capital of the A Trust paid to E and F (affiliates) was greater than 40% for the years ended 30 June 20ZT and 30 June 20ZV.

In addition, G did not have any input into the high-level decision making in relation to the A Trust's operations. G purchased a cattle property in 20ZT and lived on the property. This property was over 400kms away from D Property and that property was operated by G and The B Trust completely independently from E, F and the A Trust.

On this basis F and E controlled the A Trust under s328-125. As the control percentage for G under s328-125(4) is at least 40% but less than 50% the Commissioner may determine that G does not control the A Trust. On the facts and circumstances in this case the Commissioner has determined that G does not control the A Trust.

Question 2

Are the basic conditions in section 152-10 ITAA 1997 satisfied for the CGT event that happened in relation to the D Property in the year ended 30 June 20ZZ?

Summary

Yes. The basic conditions are met in respect of the capital gain F made from the sale of her interest in D Property. Consequently, the capital gain may potentially be reduced or disregarded under Division 152 subject to further conditions and requirements of the individual concessions of Division 152. The basic conditions have been met:

•                     A CGT event has happened in respect of F's interest in D Property;

•                     The conditions mentioned in subsection 1A are satisfied in respect of the CGT asset, and

•                     The CGT asset satisfies the active asset test.

Detailed reasoning

Division 152 ITAA 1997 provides CGT concessions to taxpayers who make a capital gain on an active asset used in a small business. The small business concessions under division 152 are:

•                     the 15 year exemption (subdivision 152-B);

•                     the 50% reduction (subdivision 152-C);

•                     the retirement exemption (subdivision 152-D); and

•                     the replacement asset roll-over (subdivision 152-E).

The 15 year exemption allows a taxpayer to disregard the entire capital gain. The remaining three concessions have effect in addition to the CGT discount (where applicable) and can be applied successively to reduce or roll-over the gain.

To qualify for the Division 152 concessions, an entity must satisfy each of the following requirements in Subdivision 152-A:

•                     the 'basic conditions' in s152-10(1) which include the $2 million aggregated turnover CGT small business entity test or the $6 million maximum net asset value test, and the active asset test;

•                     the additional basic conditions in s 152-10(2) if the CGT asset is a company share or a trust interest;

•                     if the CGT event concerns a right or interest to partnership income or capital, the 'additional basic condition' in 152-10(2C); and

•                     any specific requirements applying to a particular Div 152 concession.

The following provisions are relevant to the consideration in this case.

Section 152-10 Basic conditions for relief

(1) A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would (apart from this Division) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a CGT small business entity for the income year;

(ii) you satisfy the maximum net asset value test (see section 152-15);

(iii) you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test (see section 152- 35).

CGT small business entity

(1AA) You are a CGT small business entity for an income year if:

(a) you are a small business entity for the income year; and

(b) you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

Note: For the purposes of subsection (1A) or (1B), in determining whether an entity would be a small business entity, see also sections 152-48 and 152-78.

Passively held assets--affiliates and entities connected with you

(1A) The conditions in this subsection are satisfied in relation to the CGT asset in the income year if:

(a) your affiliate, or an entity that is connected with you, is a CGT small business entity for the income year; and

(b) you do not carry on a business in the income year (other than in partnership); and

(c) if you carry on a business in partnership--the CGT asset is not an interest in an asset of the partnership; and

(d) in any case--the CGT small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Note 1: The meaning of connected with is affected by section 152-78.

Section 152-35 Active asset test:

(1) A CGT asset satisfies the active asset test if:

(a) you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period specified in subsection (2); or

(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 1 / 2 years during the period specified in subsection (2).

(2) The period:

(a) begins when you acquired the asset; and

(b) ends at the earlier of:

(i) the CGT event; and

(ii) if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows--the cessation of the business.

Section 328-110 Meaning of small business entity

General rule: based on aggregated turnover worked out as at the beginning of the current income year

(1) You are a small business entity for an income year (the current year ) if:

(a) you carry on a business in the current year; and

(b) one or both of the following applies:

(i) you carried on a business in the income year (the previous year ) before the current year and your aggregated turnover for the previous year was less than $10 million;

(ii) your aggregated turnover for the current year is likely to be less than $10 million.

Note 1: The $10 million thresholds in this subsection and in subsections (3) and (4) have been increased to $50 million for certain concessions (for example, see subsection 328-285(2)).

Note 2: If you are or would (if the $10 million thresholds in this subsection and subsection (3) were increased to $50 million) be a small business entity for an income year, you may apply for permission:

(2) You work out your aggregated turnover for the current year for the purposes of subparagraph (1)(b)(ii):

(a) as at the first day of the current year; or

(b) if you start to carry on a business during the current year--as at the day you start to carry on the business.

Note: Subsection 328-120(5) provides for how to work out your annual turnover (which is relevant to working out your aggregated turnover) if you do not carry on a business for the whole of an income year.

Exception: aggregated turnover for 2 previous income years was $10 million or more

(3) However, you are not a small business entity for an income year (the current year ) because of subparagraph (1)(b)(ii) if:

(a) you carried on a business in each of the 2 income years before the current year; and

(b) your aggregated turnover for each of those income years was $10 million or more.

Note: Section 328- 110 of the Income Tax (Transitional Provisions) Act 1997 affects the operation of this subsection in relation to the 2007-08 and 2008-09 income years.

Additional rule: based on aggregated turnover worked out as at the end of the current income year

(4) You are also a small business entity for an income year (the current year ) if:

(a) you carry on a business in the current year; and

(b) your aggregated turnover for the current year, worked out as at the end of that year, is less than $10 million.

Winding up a business previously carried on

(5) This Subdivision applies to you as if you carried on a business in an income year if:

(a) in that year you were winding up a business you previously carried on; and

(b) you were a small business entity for the income year in which you stopped carrying on that business.

Note 1: Subsection 328-120(5) provides for how to work out your annual turnover (which is relevant to working out your aggregated turnover) if you do not carry on a business for the whole of an income year.

Section 328-115 Meaning of aggregated turnover:

(1) Your aggregated turnover for an income year is the sum of the relevant annual turnovers (see subsection (2)) excluding any amounts covered by subsection (3).

Note: For small business CGT relief purposes, additional entities may be treated as being connected with you or your affiliate under sections 152-48 and 152-78.

(2) The relevant annual turnovers are:

(a) your annual turnover for the income year; and

(b) the annual turnover for the income year of any entity (a relevant entity) that is connected with you at any time during the income year; and

(c) the annual turnover for the income year of any entity (a relevant entity) that is an affiliate of yours at any time during the income year.

(3) Your aggregated turnover for an income year does not include the following amounts:

(a) amounts derived in the income year by you or a relevant entity from dealings between you and the relevant entity while the relevant entity is connected with you or is your affiliate;

(b) amounts derived in the income year by a relevant entity from dealings between the relevant entity and another relevant entity while each relevant entity is connected with you or is your affiliate;

(c) amounts derived in the income year by a relevant entity while the relevant entity is not connected with you and is not your affiliate.

Application to the specific facts and circumstances

Under subdivision 152-10, the capital gain F has made from the sale of her interest in D Property may be reduced or disregarded under Division 152 (subject to further conditions and requirements of the individual concessions of Division 152) as the basic conditions have been met:

•                     A CGT event has happened in respect of F's interest in D Property.

•                     The conditions mentioned in subsection 1A are satisfied in respect of the CGT asset, and

•                     The CGT asset satisfies the active asset test.

CGT event happened in relation to a CGT asset

A CGT event happened in respect of F's interest in D Property and F derived a capital gain (subject to the application of the provisions of Division 152) on the sale of her half share of D Property under the contract dated YY 20ZY and subsequently settled on YY 20ZY.

Your affiliate, or an entity connected with you, is a CGT Small Business Entity.

The A Trust will be an entity connected with E and F.

As discussed in Question 1, on the facts and circumstances in this case, the Commissioner is of the view the A Trust was controlled by F and E for the purposes of s328-125 and F and E are connected with the A Trust.

As also outlined in Question 1, G does not control the A Trust and is not connected with the A Trust notwithstanding the distribution of more than 40% (but less than 50%) of the income of the A Trust in the year ended 30 June 20ZW. It is not necessary to consider further the impact of the payments by the Trust to H in the 20ZW year and to J and K in the 20ZX year as these individuals are not affiliates of G, and did not carry on a business in the relevant years and therefore do not change the aggregated turnover.

Under section 152-10(1AA) and s328-110 the A Trust meets the requirement of a CGT Small Business Entity and Small Business Entity. The aggregated turnover for the A Trust (and its connected entity, X Co), is below the $2 million threshold for the years ended 30 June 20ZY and 30 June 20ZZ.

The CGT Asset satisfies the active asset test

D Property was used to conduct a grazing and farming business by the A Trust from the period YY 20ZQ until YY 20ZY and was an active asset for that period. D Property was also used by X Co to carry on a tourist accommodation business from 20ZU until 11 October 20ZY. Under s152-35, D Property (the CGT asset) satisfies the active asset test.

Basic Conditions are satisfied

The basic conditions are met in respect of the capital gain F has made from the sale of her interest in D Property.