Edited version of private advice

Authorisation Number: 1052301340638

Date of advice: 11 September 2024

Ruling

Subject: CGT - small business concessions - affiliates

Question

Was Company A an affiliate of Company B for the purposes of subparagraph 152-10(2)(c)(iii) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

The Trust held 25% of shares issued in the object entity.

Company A held the remaining 75% of ordinary shares issued in the object entity at the share sale date.

The object entity was part of a group of entities that formed the Group.

A third party wanted to buy-out and become the sole owner of all the entitlements in the Group.

As Company A held shares in all of the entities in the Group this buy out was to be effected by the various other shareholders in the entities in the Group transferring their shares to Company A and then Company A selling those shares to the third party, resulting in the third party acquiring 100% of the shares in Company A (the takeover).

To allow for the takeover to occur, Company A purchased the shares held by the trust in the object entity pursuant to a Share Purchase Agreement on the share sale date.

In 2024 the takeover was completed and the third party acquired the Group.

Each of these entities were built-up to operate as stand-alone businesses, with separate client bases, and whom each would invoice separately. Each business also prepares their own independent financial statements, including balance sheets and profit and loss statements, each financial year.

Company A

Company A was founded by Person A. Their primary involvement was in the day to day running of Company A as the CEO.

Person A was a director of Company A just before the share sale date.

Company A offered software distribution to technology vendors.

There was some cross-over of work between the entities, however it was not material and any transactions between the entities were performed on an arm's length basis.

Object Entity

The object entity provides specialist advisory services in relation to cloud based software and economics.

The object entity also has its own core team of personnel, which it specifically employs.

The object entity had a loan from Company A.

The directors of the object entity just before the share sale date Person A and Person B.

Person A was a non-executive director of the object entity and was not therefore involved in the day to day running of the object entity. His function was to represent the majority stake held by Company A in the object entity.

The object entity had its own clientele but did provide some services to Company A's customers. Company A paid the object entity an arm's length fee to provide those services, but also added its own fee to the customer on top of the object entity's charge to Company A.

Both Company A and the object entity have separate bank accounts and separate employees.

The object entity has a fully remote workforce and therefore does not have or require its own physical work premise.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 152-10(2)

Income Tax Assessment Act 1997 subparagraph 152-10(2)(c)(iii)

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Summary

Company A is not acting in accordance with the directions or wishes of, or in concert with the object entity, as there is a significant degree of separation of the 2 businesses. Company A is not an affiliate of the object entity for the purposes of subparagraph 152-10(2)(c)(iii) of the ITAA 1997.

Detailed reasoning

Additional basic conditions for shares in a company

Under subsection 152-10(2) of the ITAA 1997 the following additional basic conditions must be satisfied if the CGT asset being disposed of is a share in a company, or an interest in a trust (the object entity):

(a)  the CGT asset would still satisfy the active asset test if the assumptions in subsection (2A) were made;

(b)  if you do not satisfy the maximum net asset value test - you are carrying on a business just before the CGT event;

(c)   either:

i)              the object entity would be a CGT small business entity for the income year; or

ii)             the object entity would satisfy the maximum net asset value test;

if the following assumptions were made:

iii)           the only CGT assets or annual turnovers considered were those of the object entity, each affiliate of the object entity, and each entity controlled by the object entity in a way described in section 328-125;

iv)           each reference in section 328-125 to 40% were a reference to 20%;

v)            no determination under subsection 328-125(6) were in force;

(d)  just before the CGT event, either:

i)              you are a CGT concession stakeholder in the object entity; or

ii)             CGT concession stakeholders in the object entity together have a small business participation percentage of at least 90%.

Meaning of affiliate

The definition of affiliate is contained in section 328-130 of the ITAA 1997 and is set out below:

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.

Acting in concert

Acting 'in concert' in relation to a potential affiliate's business affairs means there is a substantial degree of dependence on, or connection with, the taxpayer.

The Explanatory Memorandum to the amending legislation (the Tax Laws Amendment (2012 Measures No 6) Act 2013) notes the following factors may have a bearing on whether an individual or company acts in concert with the entity or according to the entity's directions or wishes:

•         family or close personal relationships;

•         financial relationships or dependencies (e.g. shared banking arrangements);

•         relationships created through links such as common directors, partners, co-trustees or shareholders

•         the degree to which the entities consult with each other on business matters; and

•         whether one entity is under a formal or informal obligation to purchase goods or services or conduct aspects of its business with the other entity.

Other relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:

•         the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

•         the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations

•         the actions of the parties.

All relevant factors need to be considered in combination to determine whether an entity is an affiliate of the entity under section 328-130 of the ITAA 1997. None of these factors are determinative in their own right.

Meaning of connected with an entity

Section 328-125(1) of the ITAA 1997 states 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

Section 328-125(2) states an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

a)    except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage ) that is at least 40% of:

i)      any distribution of income by the other entity; or

ii)     if the other entity is a partnership - the net income of the partnership; or

iii)   any distribution of capital by the other entity; or

b)    if the other entity is a company - 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, a percentage (the control percentage ) that is at least 40% of the voting power in the company.

Application to circumstances

The object entity does not have control of Company A, and it does not have any shareholdings in Company A.

Company A controls the object entity as it has 75% of the shareholding in the object entity. Company A has also provided a loan to the object entity.

Person A is a common director of the two companies. Their involvement in the object entity was as a non-executive director and was not involved in the day to day running of the object entity. Their function was to represent the majority stake held by Company A in the object entity.

In relation to the affiliate test, we note the following about Company A and the object entity:

•         both entities have separate employees, separate bank accounts and premises

•         their businesses appear separate (although all part of the Group)

•         both entities prepare separate financial statements

•         while Person A was a common director their role in the object entity was passive

•         the object entity had its own clientele but did provide some services to Company A's customers. Company A paid the object entity an arm's length fee to provide those services.

Therefore, at the share sale date, we are satisfied that Company A was not acting in accordance with the directions or wishes of, or in concert with the object entity, as there is a significant degree of separation of the 2 businesses. As such, Company A is not an affiliate of the object entity for the purposes of subparagraph 152-10(2)(c)(iii) of the ITAA 1997.