Private ruling: Controlling entity
Published: July 2014
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: 1. For the purposes of calculating the aggregated turnover of Company A under section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997) and accessing the research and development (45%) refundable tax offset provisions under section 355-100 of the ITAA 1997, will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that Company B does not directly control Company A for the purposes of section 328-125 of the ITAA 1997? | A4: Yes.

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: • your application for private ruling which we received late June 2014 Company A Pty Ltd is an Australian registered specialist company The company was incorporated in mid-July 2013. Structure of Company A The ownership of the company is as follows: • X, Chief Executive Officer, holds % share • Y, Chief Creative Officer, holds % share • Company B holds the remaining % share Corporate governance of Company A The company's Board of Directors is currently made up of two nominee directors, X and Y. The Board meets four times per year. Company B in entitled, but not obliged, to appoint a nominee director to the company's Board of Directors. As at 30 June 2014, Company B had not exercised its right to appoint a director to the Board. The board meets four times per year with no nominee director appointment from Company B. Voting power and board meetings of Company A The voting power of the directors is determined by the proportion of equity held by their respective shareholdings. X and Y hold a combined voting power of % to continue to exercise their control over the company. X and Y regularly hold meetings to discuss the business functions as well as to make longer term strategic decision as to the direction of the company. At these meetings, no representative from Company B is in attendance. Strategic decision making in relation to Company A X and Y have, and continue to hold weekly meetings in order to discuss projects and day to day operations, as well as monthly meetings in order to discuss budgeting. X, as CEO, is accustomed to making strategic business decisions, and has continued to do so without input from Company B. Examples of X's strategic decision making includes the decision to undertake new projects, Company A budgeting, staff hires and major purchases. These decisions are made without the input of Company B or Y. Day to day management and running Company A This is undertaken by X and Y at Company A's offices without the input of Company B which is based in elsewhere. The day to day finance and administrative functions of Company A are fulfilled entirely by Company A personnel, in particular X. As CEO, X prepares business plans and budgets of Company A and consolidates the results into the financial accounts of Company A. In relation to products, the CEO and CCO are key in tendering for and winning new work, as well as facilitating the flow of development. Relationship between Company A and Company B Company B exerts no influence or control over Company A. Company A is not required to seek approval from Company B for business functions, nor is it required to provide Company B with updates to its business operations or financial performance. Intellectual property Company A maintains ownership of the core intellectual property derived in undertaking its operations, including ownership of any future intellectual property developed. Company B did not acquire any rights to intellectual property, including any future rights, as part of its share. Ownership of Company B Company B is 100% owned by its founder and Chief Executive Officer. Separation of Company A and Company B No financial relationships and dependencies exist between Company A and Company B. No relationships created through links such as common directors, partners or shareholders. There is no consultation between Company A and Company B on business matters. Both entities conduct their business affairs independently in all regards. There is no formal agreement or formal relationship between the entities dictating how the parties are to act in relation to each other. There are no common employees providing services across both Company A and Company B. Both entities maintain out of different business premises, in different states. Both entities maintain different bank accounts.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 328-115, | Income Tax Assessment Act 1997 Section 328-125 and | Income Tax Assessment Act 1997 Section 328-130.

Reasons for decision: Summary: 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: Paragraph 328-125(2)(b) 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 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 % of the voting power in the company. In this case, Company B currently holds a percentage of the shares in Company A. In accordance with subsection 325-125(2) of the ITAA 1997, Company B controls the company | Detailed Reasoning - Commissioner may determine that an entity does not control another entity: If an entity's control percentage in a company is at least % 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 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 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 % of the company. 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 company 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 company. If there was a third entity with a control percentage of % 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 company to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least % may control the company 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 be a single, identifiable third entity that would have a control percentage (including the interests of its affiliates) in the company of more than %. Neither of the two remaining shareholders in Company A holds a control percentage of % or more in their own right. Accordingly, we must consider if an affiliate relationship exists between the remaining shareholders. | Detailed Reasoning - Affiliates: 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 (subsection 328-130(1) of the ITAA 1997). The Advanced guide to capital gains tax concessions for small business 2011-12 (NAT 3359), provides a number of relevant factors that may support a finding that a person is an affiliate of a taxpayer in accordance with subsection 328-130(1) of the ITAA 1997: • the existence of a close family relationship between the parties • 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, and • the actions of the parties. However, subsection 328-130(2) of the ITAA 1997 points out that an individual or company is not your affiliate merely because of the nature of the business relationship. For example, companies and trusts are not affiliates of their directors and trustees respectively and vice versa, merely because of the positions held. In this case, the two directors of Company A hold the remaining %+ ownership in the company, in equal shares. There is no close family relationship between them and, as joint directors of the company; there is some formality to their relationship. However, while their business relationship is based on common financial interests in the company, there is evidence to show that one director/shareholder has control of the overall day to day running of the business and the other director/shareholder acts or could be reasonably expected to act in accordance with his/her directions. Commissioner is satisfied that Company A is not controlled by Company B but is instead controlled by a one of the directors/shareholders of Company A with a control percentage including the interests of his/her affiliate, the other director/shareholder. Accordingly, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997. | Detailed Reasoning - Aggregate turnover: Under subsection 328-115(2) of the ITAA 1997, your aggregated turnover includes your annual turnover, the annual turnover of any entity connected with you at any time during the year, and the annual turnover of any entity that is an affiliate of yours during the income year. | Detailed Reasoning - Connected entity: As discussed above, an entity is connected with you if the entity controls the company (section 328-125 of the ITAA 1997). An entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own 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 % of the voting power in the company. As concluded in the discussion above, the Commissioner is satisfied that the company is not controlled by Company B but is instead controlled by one of the directors/shareholders with a control percentage, including the interests of his/her affiliate, the other director/shareholder. | Detailed Reasoning - Affiliate: Under subsection 328-130(1) of the ITAA 1997, 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. However, a person is not your affiliate merely because of the nature of a business relationship you and the person share. Companies are not affiliates of their directors, and vice versa, merely because of the positions held. There is nothing to suggest that Company B acts or could be reasonably expected to act in accordance with Company A's directions or in concert with Company A in relation to their business affairs. Therefore, Company B is not considered to be connected with Company A or an affiliate of Company A for the purposes of calculating Company A's aggregated turnover.

2. For the same purpose as Question 1, in terms of subsection 328-125(6) of the ITAA 1997 will the Commissioner determine that Company B does not indirectly control Company A via an affiliate relationship in accordance with section 328-130 of the ITAA 1997? | 3. For the purposes of calculating the aggregated turnover of Company A under section 328-115 of the ITAA 1997, will the Commissioner determine that Company B is not an affiliate of Company A under section 328-130 of the ITAA 1997? | 4. For the purposes of determining control of Company A under section 328-125 of the ITAA 1997, will the commissioner determine that Y is an affiliate of X under section 328-130 of the ITAA 1997, and therefore X has ultimate control by virtue of his direct ownership and affiliate relationship with Y?