Private ruling: CGT – Small Business Concessions – Control - Commissioner’s discretion
Date of advice: 13 November 2017
Published: April 2018
Ruling period: Income year ended 30 June 2017
Date scheme commenced: 1 July 2016.

Ruling: Q1: Will the Commissioner exercise his discretion under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that Company Z does not control Company A? | A1: Yes.

Relevant facts and circumstances: Company A is an Australian Proprietary Company, limited by shares. The directors of Company A are Persons A and B. An agreement (the Agreement) was executed between Company A Group and Company A (collectively known as the Company A Companies) and Person X for the transfer of XX% of Company A’s shares from which the following information has been sourced: ● The Company A Companies are 100% owned by Company B, for the benefit of a trust; ● Company A Group is the owner of intellectual property that it licences to Company A; ● Person X was referred to the Company A companies as a possible investment partner; ● The Agreement between the Company A Companies and Person X is binding on all parties until such time as both parties agree in writing to amend or replace the Agreement; ● Person X will be an investment partner and is to provide $XXX,XXX working capital to the Company A Companies which will be used primarily to develop the technology in relation to that particular investment concept; ● Upon the deposit of cleared funds into the account of Company A, Person X will be issued with XX% equity of the Company A Companies, in anticipation of value being created once the technology is built, and upon the concept being proven; ● Person A will be entitled to be issued with the XX% equity in the Company A Companies, upon their initial investment and acceptance of the Agreement; and ● The only current class of shares in the Company A Companies are ordinary shares, with Person X’s equity being in the form of ordinary shares. ● The day to day decisions of the Company A Companies are made by its management which consists of Persons A and B as the directors of the Company A Companies, with certain decisions being made by the shareholders. After a period of time the parties agreed to transfer a further X% shares in Company A to Person X for an additional investment. On 1 July 2017, the shares in Company A were held by the following shareholders: Name of shareholder Percentage of shares held Company B, for the benefit of the trust XX% Company Z XX% Company B has issued ordinary shares which are beneficially held by Persons A and B. Company Z has a share capital of ordinary shares held by the following shareholders: Name of shareholder Number of shares held Person X (beneficially held) XX Company Y (beneficially held) XX All of the shares issued in Company A carry the same voting rights. No affiliate relationship exists between Company Y and/or Person X and Company A and/or Company B. Person A and/or Person B are not affiliates of either Company Z and/or Person X.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 328-125. | Income Tax Assessment Act 1997 Subsection 328-125(1). | Income Tax Assessment Act 1997 Subsection 328-125(2). | Income Tax Assessment Act 1997 Subsection 328-125(6). | Income Tax Assessment Act 1997 Section 328-130.

Reasons for decision: Summary: Summary The Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Company Z does not control, and is not connected with, Company A. Detailed reasoning | Detailed Reasoning - Connected with an entity: The meaning of a connected entity is defined under section 328-125 of the ITAA 1997 which states as follows: An entity is connected with another entity if: (a) either entity controls the other entity in the way described in this section; or (b) both entities are controlled in a way described in this section by the same third entity. | Detailed Reasoning - Direct control of a company: Subsection 328-125(2) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own: ● interests in the company that give them the right to receive at least 40% (the control percentage) of any distribution of income or capital; or ● equity interests in the company that carry between them the right to exercise at least 40% (the control percentage) of the voting power in the company. An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you (section 328-130 of the ITAA 1997). A trust, partnership or superannuation fund cannot be an affiliate. | Detailed Reasoning - Commissioner may determine that an entity does not control another entity: If an entity's control percentage (as referred to in subsection 328-125(2) of the ITAA 1997) in an entity (‘the other entity’) is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 that the first entity does not control the other entity if the Commissioner thinks that the other entity is controlled by a third entity (other than an affiliate of the first entity). For the Commissioner to be able to consider the exercise of the discretion in subsection 328-125(6) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage of at least 40% of the other entity. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account. The third entity must control the other entity in the way described in subsection 328-125(2) of the ITAA 1997. Unless the conditions of subsection 328-125(2) of the ITAA 1997 are met the Commissioner cannot determine that the first entity does not control the other entity. If there was a third entity with a control percentage of 40% or more it would then be necessary to consider additional factors such as who is responsible for the day-to-day and strategic running of the other entity to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least 40% may control the other entity if such responsibilities are shared. In this case, for the Commissioner to consider the exercise of the discretion contained in subsection 328-125(6) of the ITAA 1997 there would need to be a single, identifiable third entity that would have a control percentage (including the interests of its affiliates) of more than 40%. | Detailed Reasoning - Application to your circumstances: In this case, Company B owns XX% of Company A’s shares and Company Z owns the remaining XX% of Company A’s shares. Persons A and B are the directors and equal shareholders of Company B and are also the directors of Company A. The Agreement outlines that the day to day decisions of the Company A Companies are made by its management which consists of Persons A and B as the directors of the Company A Companies, with certain decisions being made by the shareholders. Company A’s shares are ordinary shares which entitled its shareholders to voting rights based on the percentage of their ownership. Therefore Company B has XX% of the voting rights and Company Z has XX% of the voting rights. There is no affiliate relationship between Person X and/or Company Z and Company B and/or Company A and/or Person A and/or Person B. Given the information provided we accept that Company A is controlled by Company B, being the major shareholder whose directors are Persons A and B, who are also directors of the Company A Group. Therefore, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 and determine that Company Z does not control, and is not connected with, Company A.