Edited version of private advice

Authorisation Number: 1052197100264

Date of advice: 21 December 2023

Ruling

Subject: Commissioner's discretion - control

Question 1

For the purposes of determining aggregated turnover in accordance with section 328-115 of the Income Tax Assessment Act (ITAA 1997), for the years ended 30 June 2022 and 2023, and further for years ending 30 June 2024 and 30 June 2025, is the 49% shareholder in Company A, being Company B connected with Company A within the meaning given by section 328-125 of the ITAA 1997?

Answer

Yes.

Question 2

Is Company A a base rate entity within the meaning of Section 23AA of the Income Tax Rates Act 1986?

Answer

No.

Question 3

Will the Commissioner exercise the discretion granted to him under Section 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company B does not control Company A, for the purposes of calculating aggregated turnover?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2022

Year ended 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

Company A is an Australian incorporated company and a resident of Australia for tax purposes.

Company A was co-founded by the other entity and 2 individuals. The other entity held a 51% shareholding whilst entities controlled by 2 individuals held the remaining 49% in equal shares of 24.5% each.

A total of 200 ordinary shares have been issued in the Company A.

The current shareholders of the Company A are the other entity who has 51% (102 shares) of the total issued ordinary share capital and Company B which holds 49% (98 shares) of the total issued ordinary share capital.

Company B annual turnover has exceeded $XX million for the year ended 30 June 20XX.

In the year ended 30 June 20XX, 2 individuals sold their respective 24.5% shareholdings in the company to the other shareholder. The other entity retained his original shareholding of 51% of the total issued ordinary share capital.

In accordance with one of the clauses of the Company A Constitution, each ordinary share has the following rights attached:

•         the right to vote at all meetings of the Company;

•         the right to participate in any dividend declared on the class of shares held;

•         the right to participate in any division or distribution of any surplus assets or profits of the Company equally with all other Members having similar rights.

As the other entity has a 51% shareholding, the other entity has the majority vote on all significant business decisions made by the shareholders. The other entity also serves as a Director on the Company A's Board of Management, along with three other Directors.

Assumptions

It is assumed that throughout the ruling period, over 50% of shares held in the Company A by the other entity will allow to control Company A by this other entity.

Company B annual turnover will exceed $50 million for the relevant ruling period.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-115

Income Tax Assessment Act 1997 section 328-120

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Income Tax Rates Act 1986 section 23AA

Reasons for decision

Question 1

For the purposes of determining aggregated turnover in accordance with section 328-115 of the Income Tax Assessment Act (ITAA 1997), for the years ended 30 June 2022 and 2023, and further for years ending 30 June 2024 and 30 June 2025, is the 49% shareholder in Company A, being Company B connected with Company A within the meaning given by section 328-125 of the ITAA 1997?

Summary

The entities are connected within the meaning given by section 328-125 of the ITAA 1997. Company B has shareholding of more than 40% but less than 50% in Company A, Company B satisfies the control percentage requirement in paragraph 328-125(2)(b) of the ITAA 1997. As such Company B satisfies the direct control test contained in subsection 328-125(2) of the ITAA 1997.

Detailed Reasoning

Subsection 328-125(1) of the Income Tax Assessment Act 1997 (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) Bill 2007 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.

Application to your circumstances

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

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

Question 2

Is Company A a base rate entity within the meaning of Section 23AA of the Income Tax Rates Act 1986 (ITRA1986)?

Summary

The aggregated turnover of Company B for the year ended 30 June 2022 exceeds $50 million, so Company A is not a base rate entity. As a result, Company A does not qualify as a base rate entity and a 30% tax rate applies for Company A.

Detailed reasoning

Section 23 of the ITRA 1986 provides the rates of tax payable by a company, other than a company in the capacity of a trustee.

Paragraph 23(2)(a) of the ITRA 1986 provides that if a company is a base rate entity for a year of income, the applicable tax rate from 1 July 2021 in respect of its taxable income is 25%.

Otherwise, paragraph 23(2)(b) of the ITRA 1986 states the rate of tax payable is 30%.

Eligibility for the lower corporate tax rate depends on an entity's base rate entity passive income and aggregated turnover in an income year.

Base Rate Entities

Section 23AA states that an entity is a base rate entity for the income year if

a) no more than 80% of its assessable income for the year of income is base rate entity passive income; and,

b) its aggregated turnover (within the meaning of ITAA 1997) for the year of income, worked out as at the end of that year, is less than $50 million.

The aggregated turnover amount of $XX million referred to in subsection 23AA(b) of the Income Tax Rates Act 1986 became effective on 1 July 2018, and is applicable to the 2018-2019 year of income and onwards (in the 2018 year of income, the aggregated turnover threshold amount to be a base rate entity was $25 million).

Base rate entity passive income

Section 23AB of the ITRA 1986 defines the term base rate entity passive income assessable income as:

•         a distribution by a corporate tax entity, other than a non-portfolio dividend

•         an amount of franking credit on such a distribution

•         a non-share dividend by a company

•         interest (or a payment in the nature of interest), royalties and rent

•         a gain on a qualifying security

•         a net capital gain; or

•         an amount included in the assessable income of a partner in a partnership or of a beneficiary of a trust, to the extent that the amount is referable directly or indirectly to another amount that is BREPI.

Aggregated turnover

Section 328-115 of the ITAA 1997 provides the meaning of aggregated turnover for an income year (which is the sum of the relevant annual turnovers) and includes:

(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.

'Connected with' & affiliates

Pursuant to section 328-125 of the ITAA 1997 an entity is connected with another entity if either entity controls the other entity or both entities are controlled by the same third entity.

Section 328-130 of the ITAA 1997 provides that an individual or a company is an affiliate 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 but is not an affiliate merely because of the nature of the business relationship between the you and the individual or company.

Application to your circumstances

Company A is connected with Company B, as Company B has 49% shareholding in Company A.

As Company B has over 40% shareholding in Company A, they 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.

Therefore, the aggregated turnover of Company B should be included in the aggregated turnover of Company A.

Conclusion

The aggregated turnover of Company A for the year ended 30 June 20XX exceeds $XX million, so Company A is not a base rate entity. As a result, Company A does not qualify as a base rate entity and a 30% tax rate applies for Company A.

Question 3

Will the Commissioner exercise the discretion granted to him under Section 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company B does not control Company A for the purposes of calculating aggregated turnover?

Answer

Both conditions from subsection 328-125(6) are satisfied. Therefore, the Commissioner will exercise discretion under subsection 328-125(6) to confirm that Company A is not controlled by Company B.

In your case the other entity has control and management at the Board level, the shareholder level and also ultimate control over day-to-day activities and management.

Accordingly, the Commissioner will exercise the discretion contained in subsection 328-125(6) of the ITAA 1997 to determine that Company B does not control Company A for the relevant ruling period as the Commissioner accepts that Company A is controlled by the other entity.

Reasons for decision

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.

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.

Taxation Determination TD 2023/5 Income tax: aggregated turnover and connected entities - Commissioner's discretion that an entity does not 'control' another entity (TD 2023/5) provides guidance on particular issues that have emerged from the administration of the discretion in subsection 328-125(6) of the ITAA 1997 to determine that an entity does not "control" another entity. The relevant paragraphs from TD 2023/5 are presented and discussed in more detail below.

Sole or primary responsibility for the day-to-day management of the affairs of the test entity, while not irrelevant to the question of who controls that entity, does not of itself constitute control for the purposes of the Commissioner's discretion in subsection 328-125(6). The context of the aggregated turnover rules in Subdivision 328-C, and the concept of 'control' that underpins the primary control tests, support this view.

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.

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.

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).

Example 2.10 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 (EM) illustrates when the discretion might be exercised to disregard a control percentage interest of between 40% and 50% on the basis of a conclusion that a third entity controls the test entity. The example refers to a manager of the test entity with a 58% shareholding in that entity, and another person with a 42% shareholding who has no dealings at all with the manager.

We consider that, in these circumstances, the significance of who manages the business of the test entity stems from the relative ownership interests which dictate who has the power to determine who performs the managerial function. The identity of who actually performs the managerial function is generally of limited relevance to the question of control of the test entity. The manager in Example 2.10 of the EM, with the 58% shareholding, would not cease to control the test entity merely because they decided to appoint a new manager with full responsibility for the day-to-day conduct of the business of the entity.

We also consider that Example 2.10 of the EM illustrates circumstances in which we would be likely to conclude that the test entity is controlled by a third entity (the 58% shareholder) and exercise the discretion to disregard the 42% shareholding accordingly. The holding of interests carrying rights to more than 50% of the income, capital and voting power in a company is consistent with control of the company for the purposes of subsection 328-125(6). Assuming that the majority ordinary shareholding is sufficient to carry the vote on most or all of the fundamental matters relating to the test entity, we would think there is control by the third entity unless the third entity's control through its majority shareholding is in some way qualified or compromised by other circumstances or arrangements.

Application to your circumstances

Company B has at least 40%, but less than 50% of control in the Company A. Therefore, the first condition set out in subsection 328-125(6) is satisfied.

In addition, over 50% of shares held by the other entity allow to control Company A by this other entity in a way presented in the example 2.10 of the EM. Consequently, the second condition set out in subsection 328-125(6) is also satisfied.

Accordingly, the Commissioner will exercise the discretion contained in subsection 328-125(6) of the ITAA 1997 to determine that the Company B does not control Company A for the relevant ruling period as the Commissioner accepts that Company A is controlled by the other entity.

Conclusion

As a result, because both conditions set out in subsection 328-125(6) are satisfied, the Commissioner will exercise his discretion under subsection 328-125(6) to confirm that Company A is not controlled by Company B.