Private ruling: Income tax -Research and development -Entitlement to tax offset –Connected entities
Date of advice: 20 July 2017
Published: November 2017
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: For the purposes of calculating the aggregated turnover of The Rulee under section 328-115 to determine its entitlement to an Research & Development (R&D) tax offset under section 355-100(1), does The Other Entity control The Rulee under section 328-125? | A1: Yes | Q2: For the purposes of calculating the aggregated turnover of The Rulee under section 328-115 to determine its entitlement to an R&D tax offset under section 355-100(1), will the Commissioner exercise his discretion under subsection 328-125(6) to determine that The Other Entity does not control The Rulee? | A2: Yes | Q3: For the purposes of calculating the aggregated turnover of The Rulee under section 328-115 to determine its entitlement to an R&D tax offset under section 355-100(1), is The Other Entity an affiliate of The Rulee under section 328-130? | A3: No

Relevant facts and circumstances: The scheme that is the subject of this Ruling is described below. The description is based on the provided documents. Structure of The Rulee and The Holding Company The Rulee is an Australian resident company with 100% of its total ordinary shares held by The Holding Company. The Holding Company is an Australian resident company with its total ordinary shares held in the following proportions: ● more than 50% by Australian residents (ARS), and ● less than 50% by The Other Entity. These are the proportions in which rights to voting and receiving income and capital distributions are held. A quorum for a meeting of shareholders requires at least one representative of The Other Entity and the ARS. Each shareholder has one vote for each fully paid share they hold. The management of the Company vests in the Board. The Board is comprised of the ARS as directors, an individual appointed by The Other Entity (Other Appointed Director [OAD]) and another entity appointed by the Board as Chairman. Board Voting of The Holding Company The Board of The Holding Company does not report, and is not subject, to the board of The Other Entity and the boards are separately functioning with no directors common to both. Each director has one vote for voting on Board resolutions. The Chairman is entitled to a second or casting vote in matters where equal votes are cast. The Chairman has a longstanding association with the ARS and was a former shareholder in the Group (The Rulee and The Holding Company). The Chairman votes with the ARS on any matter considered by the Board. There have been no instances where the Chairman has voted against the ARS. All Board meetings have been held in Australia. The ARS set the agenda and run the Board meetings. The Other Entity appointed director’s involvement has been limited to asking questions about the financial information. The strategic direction, decision making and actions of The Holding Company and subsidiary entities, including The Rulee, are determined by the ARS prior to the Board meetings without the involvement of The Other Entity appointed director or the non-executive director. Day to day operations of The Rulee The decision making and management of the day to day operations, including administration, legal and finance functions of The Holding Company and The Rulee rests with the ARS who constitute the executive management team. The Other Entity has a passive involvement in the operations of The Rulee through The Holding Company with the position taken that any decision made by The Holding Company’s Board should be in the best interests of The Holding Company Group. The ARS are not required to act in accordance with the directions of The Other Entity. There are times when the ARS request support and assistance form The Other Entity’s staff on various matters but the ultimate decision making responsibility rests with the ARS in relation to any advice received from The Other Entity. As part of the day to day operations the executive management team (consisting of the ARS) ensures that The Holding Company is operated in accordance with business plan, developed by the executive management team, is followed. The ARS established their own Advisory Committee for the Group, which did not include The Other Entity or its representative. The ARS and The Holding Company’s finance manager are the only signatories on the Group’s bank accounts. There is no one from The Other Entity eligible to transact on the accounts. Relationship of the ARS The ARS are the sole directors of The Rulee. They jointly make the strategic decisions regarding the direction of the Group and have always acted in concert with each other. The Other Entity has no involvement in this regard. The Group’s direction ultimately rests with the ARS. The ARS have always voted together in relation to all decisions of the Group, in their capacities as directors and shareholders. The ARS are financially interdependent and manage their personal affairs jointly. Relationship between The Other Entity and the ARS There are no personal relationships, financial dependencies, common links or shared strategic decision making that exist between the parties that would indicate that the ARS could be expected to act in accordance with the directions or wishes of, or in concert with, The Other Entity; or that The Other Entity could be expected to act in accordance with the directions or wishes of, or in concert with, the ARS. Relationship between The Holding Company, The Rulee and The Other Entity The Shareholders’ Agreement is the only agreement which establishes the relationship between the Group and The Other Entity. Neither the Group nor the ARS own any shares in, or any rights to vote or receive any distributions of income or capital from, The Other Entity. All operational and R&D business matters of the Group are handled without any input from The Other Entity. The Group and The Other Entity do not undertake business dealings with each other. The Group and The Other Entity do not share common resources and do not operate together. In particular: ● They use different accounting systems. ● The Group is not dependent on The Other Entity for access to loans or guarantees. ● They do not share common banking facilities and are not signatories on each other’s accounts. ● There are no common flows of revenues. ● They purchased goods and services independently of each other. ● They maintain separate client bases. ● They have different employees. ● They operate from different locations. ● They do not seek to pursue business opportunities through each other. ● The Other Entity does not communicate or negotiate with suppliers, clients or other key external stakeholders on behalf of the Group. ● There are no financial dependencies between the two groups. ● There are no close personal relationships between any key employees, including Board members and directors, between The Other Entity and the Group. There are no common directors. ● The Group has no ownership interest in The Other Entity. The Group does not have any affiliates with, relationships or interest in, any entities that have an interest in The Other Entity. The Group does not have any other relationship with, or interests in entities, that have a connection with The Other Entity that would be covered by section 328-130 of the ITAA 1997. Relationship between the Other Appointed Director and the ARS There are no family or close personal relationships between these parties. No directors are common to both The Other Entity and The Holding Company. Relationship between Holding Company and The Other Entity Holding Company does not control, directly or indirectly, The Other Entity. Relationship between the Other Appointed Director and the ARS There are no circumstances that would indicate that either entity could be expected to act in accordance with the directions or wishes of, or in concert with, the other in relation to each other’s business. There are no other relationships between these parties other than the requirements outlined in the Shareholder’s Agreement.

Relevant legislative provisions: Income Tax Assessment Act 1997 , section 328-115 | Income Tax Assessment Act 1997 , section 328-125 | Income Tax Assessment Act 1997 , subsection 328-125(1) | Income Tax Assessment Act 1997 , paragraph 328-125(2)(b) | Income Tax Assessment Act 1997 , subsection 328-125(2) | Income Tax Assessment Act 1997 , subsection 328-125(6) | Income Tax Assessment Act 1997 , subsection 328-125(7) | Income Tax Assessment Act 1997 , section 328-130 | Income Tax Assessment Act 1997 , Division 355 | Income Tax Assessment Act 1997 , subsection 355-100(1)

Reasons for decision: Summary: While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. | Detailed Reasoning - Introduction: The Rulee intends to apply for an R&D tax offset under the R&D tax incentive in Division 355 for the year ended 30 June 2017. The rate of the tax offset and whether it is refundable depends primarily on the R&D entity’s aggregated turnover (section 355-100). Only eligible entities with an aggregated turnover of less than $20 million (and one or more exempt entities do not control more than 50 per cent of the entity), are entitled to a refundable tax offset equal to 43.5 per cent of its notional R&D deductions. Section 995-1 provides that the phrase 'aggregated turnover’ has the meaning given by section 328-115. Aggregated turnover is calculated on a 'group’ basis (section 328-115). In broad terms, it is the sum of the annual turnovers of all of the following, excluding any dealings between those entities: ● the R&D entity ● any entity connected with the R&D entity ● any entity that is an affiliate of the R&D entity. For the purposes of determining an entitlement to the R&D tax offset, The Rulee has sought a ruling on whether The Other Entity is connected with or an affiliate of The Rulee for the purposes of section 328-125, to establish whether the annual turnover of The Other Entity is included in the aggregated turnover of The Rulee. This ruling only addresses that question. However, it is important to note that in determining its entitlement to an R&D tax offset at the rate under item 1 of the table under subsection 355-100(1) of the ITAA 1997, The Rulee will still need to consider all the requirements of Division 355 – including whether the aggregated turnover of The Rulee includes the annual turnovers of entities other than The Other Entity. | Summary: The Other Entity controls The Rulee under sub section 328-125(2). | Detailed Reasoning - The relevant provisions: Under paragraph 328-115(2)(b) an entity’s aggregated turnover includes the annual turnover of any entity that is connected with the entity at any time during the income year, excluding related dealings between these entities. Subsection 328-125(1) provides that: | Detailed Reasoning - 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 is defined in subsection 328-125(2). Under paragraph 328-125(2)(b), 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). Under subsection 328-125(7), if an entity (the first entity) directly controls a second entity, and that second entity also controls (directly or indirectly) a third entity, the first entity is taken to control the third entity. | Detailed Reasoning - Application to your circumstances: The Other Entity(the first entity) has a control percentage of more than 40% in The Holding Company (the second entity) and therefore directly controls The Holding Company. With a control percentage of 100%, The Holding Company controls The Rulee (the third entity). Accordingly, under subsection 328-125(7), The Other Entity is taken to control The Rulee for the purposes of section 328-125. | Summary: The Commissioner has exercised his discretion under subsection 328-125(6) to determine that The Other Entity does not control The Rulee. | Detailed Reasoning - Detailed reasoning: The Commissioner’s discretion Subsection 328-125(6) provides that: 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. (emphasis added) While this subsection refers to 'control by entities’, it does not indicate that those entities must be affiliates. Referring to the Commissioner’s discretion in subsection 328-125(6), paragraph 2.60 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 states, 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 or entities has a control percentage of at least 40% may assist in determining whether the third entity or entities control the other entity, but it is not decisive. | Detailed Reasoning - Application to your circumstances: The Other Entity has a control percentage of less than 50% as worked out under subsection 328-125(2). However, as this control percentage is between 40% and 50%, the Commissioner may exercise his discretion under subsection 328-125(6) to determine that The Other Entity does not control The Holding Company if he is satisfied that The Holding Company is controlled by an entity other than, or by entities that do not include, The Other Entity or any of its affiliates. The ARS together carry between them the right to exercise, or control the exercise of, more than 50% of the voting power in the company. In determining the controlling entity/entities of The Holding Company, the Commissioner will also consider who is responsible for the strategic decision making on behalf of the company and the day to day running of the company. Strategic decision making in relation to The Holding Company The strategic direction, decision making and actions of The Holding Company and subsidiary entities is determined by the ARS, without involvement of The Other Entity or any entity controlled by The Other Entity. The ARS form the executive management team along with independent advisors who have no relationships with The Other Entity. Given this and the fact that the ARS hold more than 50% of the shareholder voting rotes, ultimate control of the strategic operations and decision making aspects of The Holding Company is held by the ARS. Day to Day Management In their role as executive managers, the ARS control the decision making and management of the day to day operations, including administration, legal and finance functions of The Holding Company and The Rulee. They do not act on the instructions of The Other Entity or their appointed director, nor do they report to them. Further, the ARS and The Holding Company’s finance manager are the only signatories on the Group’s bank accounts, and there is no one from The Other Entity eligible to transact on the accounts. The ARS fulfil the relevant administrative positions in relation to the day to day running of The Holding Company. The Other Entity has no part in this taking a passive stance and providing assistance infrequently only as required. Even in this case, the ultimate decision making responsibility rests with the ARS. | Detailed Reasoning - Conclusion: The strategic decision making and day to day running of The Holding Company are controlled by the ARS. The Commissioner is satisfied that the ARS control The Rulee (through their direct control of The Holding Company) and are not controlled by, nor affiliates of, The Other Entity and/or its affiliates. Therefore, the Commissioner will exercise his discretion under subsection 328-125(6) and determine that The Other Entity does not control The Rulee. | Summary: The Other Entity is not an affiliate of the Rulee under section 328-130. | Detailed Reasoning - The relevant provisions: Under paragraph 328-115(2)(c) an entity’s aggregated turnover includes the annual turnover of any entity that is an affiliate of the entity at any time during the income year, excluding related dealings between these entities. Meaning of affiliates Section 328-130 states the meaning of affiliate as follows: (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. Meaning of 'could reasonably be expected' The Full High Court, in FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344, held that the phrase 'might reasonably be expected’ requires more than a possibility. An entity, the first entity, 'could reasonably be expected’ to act in accordance with another entity’s, the second entity’s, wishes where the second entity has a relationship of control or influence over the first entity. Such a relationship can be evidenced by the entities’ behaviours and the presence of any influential relationships, such as: (a) family or other close personal relationships; (b) financial relationships and dependencies; and (c) relationships created through links such as common directors, partners or shareholders. Conversely, the entities’ behaviours, obligations to each other and external parties, and their own interests may evidence the lack of such a relationship. For a company, this relationship depends on whether the majority shareholders and/or directors of the company can reasonably be expected to act in accordance with another entity’s directions. Meaning of 'in concert’ 'In concert’ is not defined in the ITAA 1997, therefore it needs to be interpreted according to its ordinary meaning and in accordance with Subdivision 328-C. The Macquarie dictionary relevantly defines the phrase 'in concert’ to mean: 'in a coordinated or organised way; together’. This ordinary meaning suggests that the term 'in concert’ is used in the affiliate definition to describe an entities that cannot be seen as independent of each other because of the degree to which their business activities are combined or organised together. The term 'in concert' was considered in Excellar Pty Ltd v FC of T [2015] AATA 282; (2015) ATC 10-391; (2015) 98 ATR 965, in relation to the meaning of 'small business CGT affiliate’ in subsection 152-25. This provision has since been repealed; however the definition is broadly similar to section 328-130. In this case, Senior Member Lazanas (at paragraph 75) agreed with earlier authorities that 'show that a person, A, will be acting in concert with another person, B, if A engages in conduct (act or omission) in consequence of an agreement or understanding between A and B and the conduct is in pursuance of an objective or purpose which is common to both.’ Senior Member Lazanas said (at paragraph 76) that The meaning of the phrase "to act in concert with" has been held (in non-tax contexts) to mean "at least an understanding between the parties as to their common purpose or object: Adsteam Building Industries Pty Ltd v The Queensland Cement and Lime Co Ltd (No 4) [1985] 1 Qd R 127. Consistent with these views and the ordinary meaning of the phrase, an entity will be viewed as acting in concert with another entity where it and the other entity act together in pursuit of a common purpose or goal. In the context of the definition of affiliate in section 328-130, that purpose or goal must be in relation to the affairs of the business of the individual or company. In determining whether two entities are acting in concert for the purpose of the affiliate rules, paragraph 2.36 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007, which introduced the definition of 'affiliate’, states, 2.36 The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert: ● family or close personal relationships; ● financial relationships or dependencies; ● relationships created through links such as common directors, partners, or shareholders; ● the degree to which the entities consult with each other on business matters; or ● whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity. 2.37 None of these factors are determinative in their own right. | Detailed Reasoning - Application to your circumstances: Taking into account these factors, there is nothing in the facts provided which suggest that either entity will act in accordance with the other’s wishes or act in concert with each other. The Other Entity and the Rulee do not share employees, resources, facilities or services. There are no financial interdependencies between them. Their businesses are unrelated and operate independently of each other. The only relationship the entities have is that The Other Entity holds a substantial shareholding in The Holding Company. There are no other routes of control by one entity over the other and no routes of common control of both companies by any third parties. Thus, the Other Entity is not an affiliate of the Rulee under section 328-130.

Subject: Income tax -Research and development -Entitlement to tax offset –Connected entities: * Note: all legislative references refer to the Income Tax Assessment Act 1997 unless otherwise indicated. | Reasons for decision: These reasons for decision accompany the Notice of private ruling for the Rulee.