Private ruling: Control of a discretionary trust
Date of advice: 4 February 2021
Published: February 2022
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Does Mr X control the Trust for the purposes of subsection 328-125(4) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If the answer to Question 1 is 'yes', will the Commissioner exercise the discretion in subsection 328-125(6) of the ITAA 1997 to determine that Mr X does not control the Trust? | A2: Yes

Relevant facts and circumstances: The Trustee is a hybrid unit trust and is a discretionary trust for the purposes of section 328-125 of the ITAA 1997. The Trust carries on a business. The Trustee can only be removed if a resolution is passed by 67% of the Unitholders entitled to vote (in this case, the A class Unitholders). No Unitholder has the ability to unilaterally remove and appoint a new Trustee. Mr X and Mr Y hold one share each in the Trustee company and one share jointly (Mr Y is the first registered shareholder). Under the Articles of Association of the Trustee company, where shares are held jointly, the first registered shareholder will have the casting vote in respect of those shares. The implications of naming Mr Y as the first holder of shares was considered appropriate due to the fact that Mr Y manages the day to day operations of the business. Mr X and Mr Y are the directors of the Trustee company. Mr Y is the secretary of the Trustee company. There are two classes of Units on issue in the Trust: The Trust Deed defines the rights attached to the Units as: • A Class Units - means an undivided part or share in the Trust Fund, capital and income, with full voting rights attached thereto; • B Class Units - means an undivided part or share in the Trust Fund, capital and income, with no voting rights attached thereto; • C Class Units - has an entitlement to share in net income of the Trust only, has no entitlement to share in any other part of the Trust Fund, is not transferrable, has no voting rights attaching thereto and at all times, the par value attaching to it at the time of issue. Practically, the C Class Units were intended to allow a proportion of the Trust income to be distributed to entities associated with those persons (i.e., Mr X and Mr Y) who were actively engaged in running the business conducted by the Trust. The current Unitholders are: • Mr X - One A Class Unit; • Mr X and Mr Y - One A Class Unit held jointly; • Mr Y - One A Class Unit; and • Mr Y - One C Class Unit. During the 20XX, 20XX and 20XX income years, the income of the trust was distributed as follows: (a) the first $XXX to the C class Unitholder; and (b) the balance to the A class Unitholders in proportion to their Units. The $XXX distributed to Mr Y relates to his role in managing the day to day operations of the business. Day to day decisions in respect of the operation of the business conducted by the Trustee are made by three managers within the business, with the final decision determined by Mr Y.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 269-95(1) of Schedule 2F | Income Tax Assessment Act 1997 section 328-125 | subsection 328-125(4) | subsection 328-125(6)

Reasons for decision: Summary: Mr X does control the Trust for the purposes of subsection 328-125(4) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 328-125(4) of the ITAA 1997 provides that: | Detailed Reasoning - Direct control of a discretionary trust: (a) the trustee of the trust paid to, or applied for the benefit of: (i) the first entity; or (ii) any of the first entity's *affiliates; or (iii) the first entity and any of its affiliates; any of the income or capital of the trust; and (b) the percentage (the control percentage ) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year. Subsection 328-125(4) refers to amounts paid or applied by the Trustee of the Trust in the 4 income years before the relevant income year. The relevant income years are the income years ended 30 June 20XX, 30 June 20XX and 30 June 20XX (as per the Ruling Period). For the income year ended 30 June 20XX, the 4 income years are the income years ended: • June 20XX; • 30 June 20XX; • 30 June 20XX; and • 30 June 20XX. For the income year ended 30 June 20XX, the 4 income years are the income years ended: • 30 June 20XX; • 30 June 20XX; • 30 June 20XX; and • 30 June 20XX. For the income year ended 30 June 20XX, the 4 income years are the income years ended: • 30 June 20XX; • 30 June 20XX; • 30 June 20XX; and • 30 June 20XX. The Trustee of the Trust paid or applied income of the Trust for the benefit of Mr X in the amounts of 45% in the income year ended 30 June 20XX and 46% in the income year ended 30 June 20XX. Therefore, subsection 328-125(4) of the ITAA 1997 is satisfied in respect of the income years ended 30 June 20XX, 30 June 20XX and 30 June 20XX as the Trustee of the Trust paid or applied at least 40% of the income of the Trust. | Summary: The Commissioner will exercise the discretion in subsection 328-125(6) of the ITAA 1997 to determine that Mr X does not control the Trust. | Detailed Reasoning - The legislation: Subsection 328-125(6) of the ITAA 1997 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. In respect of subsection 328-125(6) of the ITAA 1997 the EM that accompanied the Tax Laws Amendment (Small Business) Bill 2007 relevantly provides: | Detailed Reasoning - The Commissioner's discretion: 2.59 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] 2.60 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. Example 2.10 Chandra owns a restaurant with a turnover of less than $2 million and has inherited his father's 42 per cent interest in a software company. The other 58 per cent of the software company is owned by the manager of the company, and Chandra has had no dealings with the manager whatsoever. The turnover of Chandra's restaurant will not be aggregated with the turnover of the software company if the Commissioner thinks that the software company is actually controlled by the other person with the 58 per cent interest. | Detailed Reasoning - Relevant matters to the discretion in subsection 328-125(6) of the ITAA 1997: The consideration of the exercise of the discretion in subsection 328-125(6) requires the Commissioner to refer to all the relevant facts and circumstances and to make an objective determination. The term 'control' is defined in the Macquarie Dictionary and includes: (i) To exercise restraint or director over; dominate; command. (ii) To hold in check; curb. Therefore, to determine whether the third entity controls the other entity in the ordinary sense of that term, all relevant facts and evidence will be considered to determine actual control. | Detailed Reasoning - Relevant facts and circumstances: In relation to the Trust we consider the relevant facts and circumstances for exercise of the discretion in subsection 328-125(6) of the ITAA 1997 to be: In relation to the Trustee company: • Power of Appointment of the Trustee the Trust Deed : The Trustee can only be removed if a resolution is passed by 67% of the Unitholders entitled to vote (in this case, the A class Unitholders). Given that Mr X and Mr Y each hold one A Class Unit and also hold one A Class Unit jointly, neither Mr X and Mr Y has the ability to unilaterally remove and appoint a new Trustee. • Shareholders in the Trustee company : Mr X and Mr Y each own 1 Ordinary share and jointly own 1 Ordinary share in the Trustee company. Under the Articles of Association of the Trustee company, where shares are held jointly, the first registered shareholder will have the casting vote in respect of those shares. Mr Y is the first registered shareholder of the share held jointly with Mr X. The implications of naming Mr Y as the first holder of shares was considered appropriate due to the fact that he manages the day to day operations of the business. • Directors of the Trustee company : Mr X and Mr Y are the directors of the Trustee company. In relation to the Units in the Trust: The current Unitholders are: • Mr X - One A Class Unit; • Mr X and Mr Y - One A Class Unit held jointly; • Mr Y - One A Class Unit; and • Mr Y - One C Class Unit. In relation to distributions of income and capital by the Trustee of the Trust: During the 20XX, 20XX and 20XX income years, the income of the trust was distributed as follows: • (a) the first $XXX to the C class unitholder; and • (b) the balance to the A class unitholders in proportion to their units. In relation to the management of the Trust: • The $XXX distributed to Mr Y relates to his role in managing the day to day operations of the business. • Day to day decisions in respect of the operation of the business conducted by the Trustee are made by three managers within the business, with the final decision determined by Mr Y. | Detailed Reasoning - Consideration of the exercise of the discretion in subsection 328-125(6) of the ITAA 1997: In relation to the relevant facts and circumstances it is considered that: • In Gutteridge and Commissioner of Taxation ([2013] AATA 947; 2013 ATC 10-347; (2013) 96 ATR 472) the AAT was required to consider the control of a discretionary trust in the context of subsection 328-125(3) of the ITAA 1997. In that regard, it was noted that it is necessary to undertake a critical assessment of the way in which the Trust is managed (reference was made to the decision of Gordon J in a parallel context Australian Securities and Investments Commission v Murdaca [2008] FCA 1399 at [11] as endorsed in a corporate law context in Buzzle Operations Pty Ltd (In Liq) v Apple Computer Australia Pty Ltd [2011] NSWCA 109 at 74[203] Young JA (with whom Hodgson and Whealy JJA agreed). • Mr Y has day to day management of the Trustee company; • Mr Y is recompensed for his management role by holding a Class C Unit that has entitled him to $XXX in each of the income years ended 30 June 20XX, 20XX and 20XX. • The implications of naming Mr Y as the first holder of shares in the Trustee company was both known and taken into account. As the first named shareholder, Mr Y will ultimately have the ability to exercise the voting rights attached to that share. In this regard, Mr Y effectively controls two-two thirds of the voting rights in the Trustee company and he ultimately controls the appointment of the directors. | Detailed Reasoning - Conclusion: As the Commissioner is satisfied that the Trust is controlled by Mr Y the Commissioner will exercise his discretion in subsection 328-125(6) of the ITAA 1997 to determine that Mr X does not control the Trust.