Edited version of private advice

Authorisation Number: 1052220223312

Date of advice: 8 February 2024

Ruling

Subject: Commissioner's discretion - control

Question

For the purposes of calculating the aggregated turnover of Company A for the years ended 30 June 2020, 30 June 2021, 30 June 2022 and 30 June 2023 under section 328-115 of the ITAA 1997, will the Commissioner exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company C does not control Company A?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

Year ended 30 June 2023

The scheme commenced on:

1 July 2019

Relevant facts and circumstances

Company A was incorporated in the 2017 income year. Company B, a wholly owned subsidiary of Company B, was incorporated in the 2010 income year.

Company A has three shareholders:

Table 1: Company A has three shareholders as such:

All shares held by Company D are in the capacity as trustee of Trust A. Individual A is the director of Company D and the controller of Trust A.

All shares held by Company E are held in the capacity as trustee of Trust B. Individual B is the director of Company E.

Company C is controlled by Company F, an Australian ASX listed company.

Company A's board of directors has two board members, one member for each of the major shareholders. The appointee of Company C is individual C, a resident of the United States. The appointee of Company D is individual D, a resident of Australia. Individual D's role as director is as a representative appointment of Company D.

The consolidated annual turnover for Company A and Company B (the group) is less than $X million.

Company C owns 47.5% of the voting shares in Company A and is a large company that has a turnover in excess of $X.

Company B carries on a business.

Company C is the provider of services.

Individual A is the CEO of the group and has full operational control of the business. He reports to the board and participates in the board meetings. His opinion is sought in the board meetings but doesn't have a vote in matters except through his nominee and representative on the board, individual D.

In his capacity as CEO, individual A has strategic and day-to-day control over the following aspects of the organisation:

•         development and execution of business plans and strategic development of the group and the taxpayer

•         operational running of the group and taxpayer

•         financial and accounting control over the group and the taxpayer

•         payroll control over the taxpayer

•         HR control over the taxpayer.

Individual B is the COO of the group.

Company C's representative individual C attends bi-monthly board meetings, in line with their investment interests in the group. Individual C participates as part of the board in ratifying board decisions as raised and reported by the CEO of the group and taxpayer. Individual C is a non-executive director representing the interest of Company C. Input is sought in particular in respect of this director's role and his market knowledge.

Outside of this non-executive director role, individual C is the CEO of Company G and he is the global CIO of Company G. Individual C's experience in his executive roles with Company G make him uniquely placed to advise on market trends and provide perspective on the future of the industry.

Company B and Company C operate their businesses independently and Company C has no involvement or representation in the day-to-day management of the group.

Both have their own bank accounts, employees, office space, etc. The signatories on Company B's bank account are individual E, individual A and individual D.

There are no close personal relationships between any key employees, including directors and there are no cross shareholdings between the shareholders.

Company A's Constitution

Company A's Constitution defines rules related to corporate governance, business activities and rights and obligations of its internal members. It contains various clauses included but not limited to quorum, votes and management.

At clause 6.6(a), if the company has more than one Director and unless the Board determines otherwise, the quorum for a Board meeting is two Directors and the quorum must be present at all times during the meeting.

At clause 6.7, in case of an equality of votes on a resolution at a Board meeting, the Chair of that meeting does not have a casting vote on that resolution in addition to any vote the Chair of that meeting has in his or her capacity as a Director in respect of that resolution.

At clause 6.8, a resolution of the Board will be passed if a majority of votes cast by Directors entitled to vote on the resolution are in favour of the resolution.

At clause 7.18, except where the Company has only one member, the quorum for a general meeting or an adjourned general meeting is two Members and the quorum must be present at all times during the meeting.

At clause 7.29, in case of an equality of votes on a resolution at a general meeting, the Chair does not have a second or casting vote on that resolution in addition to any vote the Chair has in his or her other capacity.

At clauses 11.5 and 11.6, the rights of each share class:

•         Class A Shares

o   rights to receive in common with other holders of the same class, share dividends, franked or unfranked, capital distributions, bonuses and other profits as determined by the Directors

o   no right to vote

o   upon winding up to participate with the other classes of shares as entirely determined by the directors

•         Class B Shares

o   right to vote

o   no right to receive share dividends, franked or unfranked, capital distributions, bonuses and other profits

o   no rights upon winding up

Company A's Shareholders Deed

The Shareholders Deed sets out the obligations between Company A, Company D, Company C and Company E. It contains various clauses including but not limited to quorum, votes and management.

Board of Company A

At clause 3.2(a), each Shareholder will have the right to appoint 1 Director for each whole 20% of the total issued Class A Shares in Company A owned by that Shareholder.

At clause 3.4, the right to appoint the chairperson will reside in that Shareholder who is the registered holder of a proportion of the total issued Class A Shares greater than any other Shareholder.

Meetings and resolutions of directors

At clause 4.2(a), the quorum for a meeting of Directors requires the presence at the meeting of the Directors appointed by Company C and Company D.

At clause 4.3, each Director has one vote and the chairperson has a second or casting vote as well as a deliberative vote.

Meetings and resolutions of shareholders

At clause 5.1(a), the quorum for a meeting of Shareholders is the presence in person (including a representative) or by proxy or attorney of at least 2 Shareholders of whom one must be Company C (either by representative, proxy or attorney) for as long as Company C remains a Shareholder, and at least one must be Company D (either by representative, by proxy or attorney) for so long as Company D remains a Shareholder.

Company C Call Option

At clause 13.1(a), Computershare Call Option trigger means any of the following:

(1)  Company C Call Option Trigger A: means 30 June 2019; and

(2)  Company C Call Option Trigger B: means 30 June 2020; and

(3)  Company C Call Option Trigger C: means 30 June 2021

At clause 13.1(b), call option window means on the occurrence of a Company C Call Option Trigger, the period ending 3 months after the Relevant Call Option Trigger.

At clause 13.2, subject to clause 13.7, each Other Shareholder grants to Company C the option to acquire of the Class A Shares and the Class B Shares (Call Shares) held by that Other Shareholder (Company C Call Option) on the terms of this clause 13.....The Company C Call Option applies over all Class A and Class B Shares held by each Other Shareholder and cannot be exercised in part or across a single class of Shares only.

At clause 13.5(c), the Company C Call Option under this clause 13 will lapse on the expiry of the Company C Call Option window in respect of Company C Call Option Trigger D.

Company D Call Option

At clause 14.2, Company C grants to Company D the options to acquire all (and not part only) of the Class A Shares and the Class B Shares (Company D Call Shares) held by Company C on the terms of this clause 14....The Company D Call Option applies over all Class A and Class B Shares held by Company C and cannot be exercised in part of across a single class of Shares only.

All call options have expired with the exception of Company D's option over the Company E Restricted Shares. Apart from the Company E option, no call option has been extended or renewed and there are no option agreements between the shareholders.

All resolutions passed to date have been done so by the board of directors under the powers conferred under the constitution, with no requirement to obtain shareholder consensus. The most recent decision which required a resolution by shareholders was the share split executed in the 2017 income year. At this time, only Company C (49%) and Company D (51%) were shareholders.

Relevant legislative provisions

Income Tax Assessment 1997 Subsection 328-125(1)

Income Tax Assessment 1997 Subsection 328-125(2)

Income Tax Assessment 1997 Subsection 328-125(6)

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidancerule for income tax'.

Reasons for decision

Subsection 328-125(1) of the ITAA 1997 provides that:

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 class B shares in Company A have voting rights but no rights to distributions of income. The class A shares have no voting rights but have rights to distributions of income and capital.

Company D has 43.5% A class shares and 47.5% B class shares in Company A and it satisfies the control percentage requirement in paragraph 128-125(2)(b) of the ITAA 1997. As such Company D satisfied the direct control test contained in subsection 328-125(2) of the ITAA 1997.

Company C has 46.5% A class shares and 47.5 B class shares in Company A and it satisfies the control percentage requirement in paragraph 128-125(2)(b) of the ITAA 1997. As such Company C satisfies the direct control test contained in subsection 328-125(2) of the ITAA 1997.

Commissioner may determine that an entity does not control another entity

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).

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 (paragraph 1).

Paragraph 13 provides that 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, entitlement 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 constitution 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.

Paragraph 14 provides 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.

Paragraph 15 provides that 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 'control' of the entity for the purposes of subsection 328-125(6).

Paragraph 24 provides that the exercise of the Commissioner's discretion is based on a conclusion that the test entity is controlled by a third entity (or entities) that does not include the first entity or any of its affiliates. This is clear from the statutory text.

Paragraphs 25 provides that we do not accept as correct that an entity's control percentage of between 40% and 50% should be disregarded on the basis that the remaining interest holders together necessarily control the test entity, irrespective of their number or relationship to each other. While we may look beyond a single third entity for relevant control, the discretion would not be exercised merely on the basis of identifying a group of unrelated entities that, when individual control percentages are aggregated, holds interests in the test entity amounting to a control percentage of more than 50%.

Paragraph 27 provides in order to form a view that a group of third entities controls the test entity, we would expect to see that the group has agreed to operate, and does operate, as a single controlling mind when it comes to decision-making generally in respect of the test entity. This might be in accordance with proxy arrangements that put voting power in the hands of one member of the group, or other legal arrangements under which the entities are broadly bound to act jointly in respect of the affairs of the test entity.

Paragraph 28 provides that while control by a group of entities could be established without the existence of a formal agreement to act jointly, strong evidence would be required to support assertions that there is joint control in such circumstances. We would closely scrutinise the nature of the relationship between the entities and ongoing patterns of behaviour in relation to the test entity to determine if there is a sound evidentiary basis for the Commissioner to think there is control of the test entity by a group.

Application to the circumstances

We consider Company C and Company D both have control over Company A.

Company C has some control over the voting of Company A. The Shareholders Deed (clause 3.4) provides that Company C has the right to appoint the chairperson and the chairperson has a second or casting vote as well as a deliberative vote for the meetings and resolutions of directors. Company C has the right to appoint the chairperson as Company C holds a higher proportion of A class shares than Company D or Company E.

The Shareholders Deed (clause 5.1) provides that the quorum for meetings and resolutions of shareholders is two of which one must be a representative of Company C and one must be a representative of Company D.

Based on the information provided, Company A relies on Company C's representative individual C who provides input into the company through his knowledge.

We consider Company D also has control over Company A. As mentioned, the Shareholders Deed provides that the quorum for meetings and resolutions of shareholders is two which must include a representative of Company D. Also, individual A is responsible for the day to day management and strategic decision making of the business.

As we consider both Company C and Company D control Company A, the Commissioner will not exercise the discretion under subsection 328-125(6) of the ITAA 1997.