Edited version of private advice

Authorisation Number: 1052304140329

Date of advice: 13 September 2024

Ruling

Subject: Commissioner's discretion - control of entities

Question 1

Will the Commissioner exercise his discretion pursuant to subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that the Taxpayer does not "control" Company A prior to the sale of its shareholding in Company A on a specified date?

Answer

No.

Question 2

Will the Commissioner exercise his discretion pursuant to subsection 328-125(6) of the ITAA 1997 to determine that the Taxpayer does not "control" Trust A prior to a specified date?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

The Taxpayer is a discretionary trust.

A primary beneficiary of the Taxpayer is Individual A.

The appointors of the trustee of the Taxpayer are Individual A and their spouse.

Company A is a private company registered with ASIC on a specified date.

Trust A is a unit trust established on a specified date.

The trustee of Trust A is Company A. Company A operates both in its own capacity and in its capacity as trustee for Trust A.

The directors of Company A were Individual B and Individual A.

The Chairman of the directors of Company A throughout the relevant testing period was Individual B.

The shares in Company A and the units in Trust A were stapled together by way of a stapling deed, executed in a specified year.

This stapling arrangement was terminated by a deed which was executed in a specified year.

Company A carries on a business and Trust A is a holding entity.

Trust A owned 100% of the shares in two Australian resident companies, Company B and Company C. Both of these companies conduct activities that support the business operations of the relevant entities.

Trust A also owns 100% of the shares in Company D. These shares were not disposed of to Company A and are still owned by Trust A.

As at a specified date:

•         The Taxpayer owned X% of the ordinary shares in Company A.

•         Trust 2 owned X% of the ordinary shares in Company A.

•         Trust 3 owned X% of the ordinary shares in Company A.

•         There were no other shares in any other class on issue in relation to Company A.

As at a specified date:

•         The Taxpayer owned X% of the issued units in the Trust A.

•         Trust 2 owned X% of the issued units in Trust A.

•         Trust 3 owned X% of the issued units in Trust A.

•         There were no other units of any other class on issue in relation to Trust A.

Under an agreement entered into on a specified date, all of the shares in Company A were disposed of to Company E. As a part of the same agreement all of the shares held by Trust A in Company B and Company C were purchased by Company A.

The consideration that Company E provided to purchase Y% of the shares in Company A consisted of specified amounts of cash, shares and earnout rights.

The consideration provided to Trust A for the purchase of Y% of the shares in Company B and Company C was $XXX cash. There was no other consideration provided to Trust A for the shares in these two companies.

Constitution of Company A

To summarise the effect of some of the provisions in the Constitution governing voting, meetings and decision making:

•         The Company may hold a General Meeting at two or more venues using any technology that gives Members as a whole a reasonable opportunity to participate.

•         A quorum is constituted by two persons or one-third of the persons entitled to attend and vote at a General Meeting whichever is the greater.

•         The Board may elect an individual to act as Chairman of General Meetings.

•         In the case of a deadlock on a particular motion the chairman of the meeting shall not be entitled to a casting vote in addition to any vote the chairman may have in his capacity as a Member and the motion will not be carried.

•         Every person present who is a Member or a Member's Representative has one vote for each share held by the Member.

•         If the Company has more than one Member, those Members may pass a resolution, other than a resolution under section 329 of the Act to remove an auditor, without a General Meeting if all Members entitled to vote on the resolution sign a document containing a statement that they are in favour of the resolution set out in the document.

•         The number of Directors shall not be less than one.

•         Directors shall manage the business of the Company and pay expenses in promoting and forming the Company. Directors may exercise all the powers of the Company to borrow money, to charge any property or business of the Company and to issue debentures or give any other security for a debt, liability or obligation of the Company.

•         A quorum for board meetings is constituted by two persons providing each person is a Director or Alternate Director.

•         The Board shall elect a chairman and another as deputy chairman of its meetings.

•         Questions arising at a Board meeting shall be decided by a majority of votes and unless otherwise provided each Director is entitled to cast one vote on each matter for determination.

•         In the case of a deadlock on a particular motion the chairman of the meeting shall not have a casting vote in addition to any vote the chairman may have in his capacity as a Director and the motion will not be carried.

•         If the Company has more than one Director, those Directors may pass a resolution without a meeting if all of the Board entitled to vote on the resolution sign a document containing a statement that they are in favour of the resolution set out in the document.

Trust Deed of Trust A

To summarise the effect of some of the provisions in the Trust Deed governing voting, meetings and decision making:

•         Authorisation means an authorisation given to the Trustee by those Voting Unit Holders who, unless a higher majority is stated, holds a majority of the simple majority of Voting Units.

•         With Authorisation, the Trustee may at any time or from time to time revoke, add to or vary all or any one of the trusts terms and conditions.

•         With Authorisation the Trustee may resign as Trustee, appoint an additional Trustee or appoint a new Trustee.

•         The Voting Unit Holders can appoint a new trustee in place of an existing trustee or appoint an additional trustee provided consent is given by Unit Holders holding no less than three quarters of the Voting Units.

•         Where the Trustee is a company the exercise of any discretion or power conferred or imposed on the Trustee may be exercised or made by resolution of its directors or the governing body of the Trustee.

•         The Trustee will nominate a person to act as chair of every meeting of Voting Unit Holders and in the event of equality of votes the chair shall not have a casting vote.

•         The quorum for a meeting shall be two Voting Unit Holders representing in aggregate not less than 51% of the Voting Units.

Stapling Deed between Company A and Trust A

As per specified Recitals of the Stapling Deed:

•         The Shareholders of the Company are currently identical to the Unitholders of the Trust. Furthermore, the ownership of the Company by its Shareholders is identical to the ownership of the Trust by its Unitholders.

•         The Company and the Trustee wish to make provision to ensure that the ownership of the Company will at all times be identical to the ownership of the Trust and that thew ownership of the Trust will at all times be identical to the ownership of the Company.

•         The Constitution which governs the Company, the Trust Deed which governs the Trust and the Agreement which governs the Shareholders and the Agreement which governs the Unitholders contain provisions consistent with the intention of the Parties as expressed in Recital D.

•         The Parties wish to enter into this Agreement to record their mutual obligations and agreements.

As per a specified Decision-Maker means:

•         In the case of the Company its board of directors unless the Act or its Constitution requires a specific decision to be made by its Shareholders; and then and only then its Shareholders.

•         In the case of the Trust, the Trustee through its board of directors unless its Trust Deed requires a specific decision to be made by its Unitholders; and then and only then its Unitholders.

Under a specified clause the Parties must co-operate with each other and must:

•         Co-ordinate all disclosures and communications generally to Shareholders and Unitholders

•         Co-ordinate the issue of certificates for the Shares and Units

•         Co-ordinate the announcement and payment of dividend and distributions

•         Co-ordinate the announcement and implementation of any dividend re-investment plans or distribution re-investment plans

•         Mutually agree to the terms and timing of all new issues, bonus and rights issues, placements, redemptions, buy-backs and the like

•         Hold meetings of Shareholders and Unitholders concurrently or consecutively

•         Adopt consistent accounting and valuation policies

•         Adopt a consistent approach and policies to proposed investments

•         Consult with each other before taking any action (or deciding to take action) which may materially affect the value of the Shares or the Units

•         Appoint the same auditor from time to time and agree on any change of auditor so that both Parties are audited by the same auditor at the same time

•         Engage, to the extent possible, identical natural persons as the Decision-Makers for the Company and the Trustee.

Other relevant information about ownership matters

The primary beneficiary of the Trust 2 is Individual B. Individual B is also an appointor of the trustee of Trust 2.

Trust 3 is ultimately controlled by Individual C.

Individual A, Individual B and Individual C are not related to each other.

Other matters to consider

For most of the time since a specified year, Individual B has lived in a specified location. Individual A has lived in a different specified location part time during a specified period and fulltime from a specified year.

The office of the relevant entities is located in the same specified location of Individual B and that this is where the employees of the relevant entities are based.

Individual B has been the sole Chief Executive Officer of the relevant entities, since the incorporation of Company A in a specified year.

For any board meetings of Company A and other companies within the group, Individual B would customarily be the Chairman of the meeting.

Individual B was the Public Officer of the relevant entities.

Evidence

The following information was provided with the private ruling application:

•         Unit Trust Deed for Trust A.

•         Certificate of Duty Trust Deed for Trust A.

•         Share Purchase Agreement between:

o   Trust 2

o   The Taxpayer

o   Trust 3

o   Individual C

o   Individual B

o   Individual C

o   Company E.

•         Constitution of Company A.

•         Certificate of Registration of a Company issued by ASIC for Company A.

•         Stapling Deed between Company A and Trust A.

•         Unstapling and Termination Deed between:

o   Company A

o   Trust A

o   Trust 2

o   The Taxpayer

o   Trust 3.

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 an entity, other than a discretionary trust, 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 an entity, other than a discretionary trust, 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'.

Commissioner's discretion

Broadly, if your control percentage in a company or a unit trust 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 affiliates).

Paragraphs 2.59 and 2.60 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 (EM) state that:

Where an entity's interest in another entity is at least 40 per cent but less than 50 per cent the Commissioner may choose to ignore the interest of that entity in the other entity if the Commissioner determines that a third entity actually controls the other entity. [Schedule 1, item 1, subsection 328-125(6) of the ITAA 1997]

The Commissioner may think that another entity controls the entity either based on fact or on a reasonable assumption or inference. Whether or not the third entity has a 40 per cent interest may assist in determining whether the third entity controls the other entity, but it is not decisive.

Taxation Determination TD 2023/5 Income tax: aggregated turnover and connected entities - Commissioner's discretion that an entity does not 'control' another entity states at paragraphs 13 - 14:

(Paragraph 13)

Having regard to the statutory context, the nature of 'control' relevant for the purpose of subsection

328-125(6) 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:

a.            decision-making on the composition and oversight of the management team

b.            amending the entity's constituent documents

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

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

(Paragraph 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 connected entity rules. It is necessary to distinguish control of an entity from powers in respect of the conduct of an entity's business.

We consider that the discretion in subsection 328-125(6) of the ITAA 1997 is a strict test of legal control. Control over day-to-day management, may be a factor that points towards control, but on its own is not enough to establish control. Merely pointing towards another entity that has a control percentage of greater than 40% under subsection 328-125(2) of the ITAA 1997 does not establish that that entity has control for the purposes of s 328-125(6) of the ITAA 1997. The basis for a determination that the first entity does not control the company requires a positive conclusion that the company is actually controlled by a third entity or entities. We do not consider that two or more unrelated entities habitually acting together, or conducting the business on a 'consensus basis' necessarily would have control of an entity, for the purposes of determining whether the discretion in subsection 328-125(6) of the ITAA 1997 is available.

For the purposes of subsection 328-125(6) of the ITAA 1997, it is relevant to consider the legal powers which entities can exercise under the relevant law, including applicable governing documents. For the Company, this means the Company's Constitution, the Shareholders Deed, as affected by Australian company law.

Application to your circumstances

In this case, the Taxpayer held a X% shareholding in Company A and a X% unitholding in Trust A just prior to the sale of the shares. Individual A, a primary beneficiary and an appointor of the Taxpayer, was also a director of Company A at this time and continues to hold this position. Company A was also the trustee and held decision making powers in respect of Trust A.

As per the Constitution and Trust Deed any decisions made by shareholders, unitholders or directors required majority support to be passed. In this case as there were only two directors this required unanimous approval.

It is the Commissioner's view, based on the evidence provided that there was no legal impediment to the Taxpayer partaking in decision making or asserting control by way of the Taxpayer's X% interest in the two entities or to Individual A in their role as director of Company A.

Both the Taxpayer and Individual A in their role as a director, and in fact other shareholders, unitholders and directors, were free to exercise their vote in whichever they best saw fit.

The application for private ruling suggests that Individual B exercised control of the two entities through their indirect shareholding and unitholding interests, their role as a director and through their employment as a CEO. The application contends this gave Individual B control of all strategic and operational decisions made in respect of Company A and Trust A. However, in your contentions it states that various decisions were ultimately made upon the recommendations by Individual B. There is a difference between having 'control' and simply providing a recommendation.

Whilst it may be expected that all the parties agree or accept recommendations as provided this does not constitute 'control'.

As per the Constitution and the Trust Deed the relevant shareholders, unitholders and directors all had the right to exercise their respective vote as they deemed fit. Additionally, where a majority was not reached or there was a deadlock the chairman did not get any additional voting rights and subsequently the motion would not be passed. This is even more relevant where decisions were made by directors as there were only two so each director must agree.

Whilst Individual B may have been a contact point for external parties this is not unexpected and would be consistent with a role of CEO. Again, being the contact point to provide information and receive advice from an external party does not constitute 'control'. Nor does making a recommendation to the Board or shareholders based on this advice constitute 'control'. It could be argued that these are normal day to day responsibilities of a CEO. Any decisions made upon this recommendation still require approval by the relevant shareholders, unitholders or directors. This approval process is where the 'control' is exercised. As above if approval is not gained a motion cannot be passed.

You have also stated Individual B would customarily be chairman of the meeting. In accordance with the Constitution the chairman is not self-appointed, rather it is appointed by the members or directors of the relevant meeting. This means a majority again would need to be reached by all parties.

There is no evidence of a written binding agreement between the other shareholders that they would act in concert with Individual B. Nor is there any evidence of coercion Individual B was able to exercise over the relevant parties. In the absence of such evidence the Commissioner cannot accept that Individual B on their own could exert control of decision making for Company A or Trust A.

The 'control' of Company A and Trust A is inextricably linked through the Stapling Deed. One cannot control Company A without also controlling Trust A and vice versa.

Based on the information provided we cannot accept that either Company A or Trust A was controlled by Individual B. Therefore, the Commissioner will not exercise the discretion under subsection 328-125(6) of the ITAA 1997.