Private ruling: Small business capital gains tax concessions
Date of advice: 14 February 2017
Published: April 2017
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

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 individual A and B did not control, and are not connected with the relevant entities? | A1: No.

Relevant facts and circumstances: Individual A and B practice in their field of specialty and have been married for many years. Individuals A and B sold an asset in the 2015-16 financial year. The Family Trust is controlled by individual A and B. The Family Trust owns more than 40% but less than 50% of the units in a relevant entity. Individual A and B together hold more than 40% but less than 50% of the shares in a relevant entity. A business agreement exists which covers all of the relevant entities. The business agreement states that each partner will have equal voting rights regardless of the percentage of ownership of the underlying structure. The business agreement is an employment agreement, unitholders agreement, share and unit sale agreement and shareholders agreement between five individuals including individual A and B. The business agreement outlines additional management duties. This role is being fulfilled by individual A and B. No partner can assert control over the relevant entities in the sense that each partner has equal voting rights regardless of the percentage of ownership of the underlying structure.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 328-125 | Income Tax Assessment Act 1997 paragraph 328-125(2)(a) | Income Tax Assessment Act 1997 paragraph 328-125(2)(b)

Reasons for decision: Summary: Connected entity is defined under section 328-125 of the ITAA 1997. An entity is connected with or controls a partnership, company or trust (except a discretionary trust) if it or its affiliate (or all of them together): ● owns or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of - any distribution of income or capital by the other entity, or - if the other entity is a partnership, the net income of the partnership, or ● if the other entity is a company, owns, or has the right to acquire ownership of, equity interests in the company that give at least 40% of the voting power in the company. Indirect control of an entity The control tests for the connected with rules are designed to look through business structures that include interposed entities. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity. Commissioner’s discretion If your control percentage in a company 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 affiliate). Application to your circumstances In this case both individual A and B are connected with the relevant entities as defined in section 328-125 of the ITAA 1997. As discussed above, for the Commissioner to consider the discretion he must be satisfied that the relevant entities are controlled by a ‘third entity’. In the application for private ruling it was indicated that ‘no partner controls the relevant entities’. Therefore the Commissioner is unable to exercise the discretion in subsection 328-125(6) of the ITAA 1997. Further, given the information provided in the business agreement and the fact that individual A and B take on the responsibility of ‘managing partner’ we cannot accept that they do not control the relevant entities.