Private ruling: R&D tax incentive: interpretation of 'combination of exempt entities' and 'control'
Published: October 2012
Ruling period: The income year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: If two or more entities, being exempt entities within the meaning of section 995-1 (the exempt entities), who are not affiliates of one another, collectively hold a greater than 50% shareholding in Company A, will item 2 of the table in subsection 355-100(1) apply to Company A? | A1: Yes. Item 2 of the table in subsection 355-100(1) will apply to Company A. The exempt entities are a combination of exempt entities irrespective of their relationship, and collectively own a beneficial interest in Company A that carries a greater than 50% right to the distribution of income and capital, and a greater than 50% right to voting power. | Q2: If the two or more entities, being exempt entities within the meaning of section 995-1 (the exempt entities), collectively hold a greater than 50% shareholding in Company A, but have a less than 50% control over the Board of Company A in relation to the exercise of directors' voting power, will the exempt entities control Company A in a way described in section 328-125? | A2: Yes. While the exempt entities have a less than 50% control over the Board of Company A in relation to the exercise of directors' voting power, the exempt entities control Company A in a way described in section 328-125.

Relevant facts and circumstances: During the income year, the shareholders of Company A included a number of exempt entities. Individually, no single exempt entity had more than 50% shareholding in Company A. Together, the total shareholdings of the exempt entities exceeded 50%. The shares carried with them voting rights and rights to distributions of income or capital Company A incurred research and development expenditure during the income year and intends to claim the tax offset under section 355-100 of the ITAA 1997. Company A's constitution provides that there shall be a minimum of five and a maximum of ten directors. Company A's constitution provides for the exempt entities to collectively appoint up to four directors. However, two of those four directors must be independent of the exempt entities and Company A. At 30 June 2012, there were a certain number of board members. Several members were elected by the exempt entities collectively, with two directors elected by the exempt entities being independent of themselves and Company A.

Relevant legislative provisions: 355-100 of the Income Tax Assessment Act 1997 | 328-125 of the Income Tax Assessment Act 1997 | 328-130 of the Income Tax Assessment Act 1997 | Question 1

Reasons for decision: Detailed Reasoning - Reasons for decision: For the reasons discussed above in regards to Question 1, commencing under the heading Control in a way described in section 328-125 , the exempt entities combined shareholding carry with it the right to a greater then 50% entitlement to any distribution of income or capital, and a greater than 50% entitlement to voting power. Because of this, the exempt entities control Company A in a way described in section 328-125.

All subsequent legislative references are to the ITAA 1997 unless otherwise indicated. | Where an R&D entity has engaged in registered R&D activities and satisfied the requirements of Division 355, then subsection 355-100(1) allows the entity to claim the R&D tax offset at the rate specified in the table therein. | Item 2 of the table in subsection 355-100(1) provides that the rate utilised to calculate any entitlement to the R&D tax offset shall be 40% where: | an exempt entity, or combination of exempt entities, would control the R&D entity in a way described in section 328-125 (connected entities) if: | (a) references in section 328-125 to 40% were references to 50%; and | (b) subsection 328-125(6) were ignored | Broadly, a company will be controlled within the meaning of section 328-125 by another entity if that entity, its affiliates, or that entity together with its affiliates beneficially own, or have the right to beneficially own shares in the company which carry the right to at least 40% of: | · any distribution of income by the company; | · any distribution of capital by the company; or | · the voting power in the company. | Under section 328-125, a shareholder of a company will be aggregated with another shareholder if it is an affiliate of that other shareholder. The meaning of 'affiliate' is provided by section 328-130. The aggregation of shareholdings in section 328-125 therefore depends on a certain relationship between the shareholders. Multiple shareholders will be included in the test, provided there is one identified shareholder to which each other shareholder has the requisite relationship. | Item 2 in the table in subsection 355-100(1) adopts the control test in section 328-125 with some modification. First, the threshold is increased to 50%. Second, the requirement for control by an exempt entity is extended to include control by a combination of exempt entities. | The term 'combination of exempt entities' is not a defined term. | The High Court stated (per Hayne, Heydon, Crennan and Kiefel JJ) in Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (NT) 2009 ATC 20-134 at 47: | "…the task of statutory construction must begin with a consideration of the text itself. Historical considerations and extrinsic materials cannot be relied on to displace the clear meaning of the text. The language which has actually been employed in the text of legislation is the surest guide to legislative intention. The meaning of the text may require consideration of the context, which includes the general purpose and policy of a provision, in particular the mischief it is seeking to remedy." | In consideration of the text itself, The Concise Oxford Dictionary , 1987, rev. 7 th edn., Oxford University Press, Melbourne, defines combination as a: | "…combined state ( in combination with ); combined set of things or persons ….group of things chosen from a larger number without regard to their arrangement…" | This definition makes no reference to a relationship between the things combined, in doing so it suggests that combination should be interpreted as a singular state. A strict reading of the text using this definition indicates that once a set of entities are combined, further enquiry into the existence of any relationship is not required. | If Parliament had intended the words 'a combination of exempt entities' to require an exempt entity to be an affiliate of another exempt entity in order for the two to be combined, that objective would have been achieved by section 328-125 without the inclusion of those words in item 2 of the table in subsection 355-100(1). The inclusion of the words ' a combination of exempt entities ' evidences Parliament's intention that those words serve a purpose in giving effect to the provision. | The definition and ordinary interpretation of the words used supports the view that Parliament did not intend for there to be a requirement as to the relationship between the individual exempt entities which comprise the combination. | Therefore, exempt entities that are not affiliates of each other are collectively capable of being a combination of exempt entities under subsection 355-100(1). | The exempt entities with shareholdings in Company A will collectively be a combination of exempt entities under subsection 355-100(1), regardless of their relationship. | The exempt entities will control Company A within the meaning of section 328-125 if they beneficially own, or have the right to beneficially own shares in Company A which carry the right to at least 50% of: | 50% of any distribution of income | The dividend policy in Company A's constitution provides that ' the Company will aim in each Financial Year… to distribute no less than 75% of its remaining profits to the members pro rata based on the shares in the Company held by them ' (emphasis added). | Although this clause is non-mandatory, where a dividend is declared it is expected that the exempt entities will be entitled to a dividend payment in proportion to their individual shareholding. As the exempt entities collectively have a greater than 50% shareholding in Company A, they would be entitled to a greater than 50% distribution of income. | 50% of any distribution of capital | Company A's capitalisation of profits policy provides shareholders with an entitlement to capital distributions that is determined in an equivalent manner to their entitlement to dividends. That is, pro rata based on the shares in Company A which are held by them. | Company A's winding up policy provides that after debts, liabilities, and winding up costs are paid, the excess is to be divided among members in proportion to the shares which are held by them. As a result of their shareholding, the exempt entities collectively have a right to receive a greater than 50% entitlement the distribution of capital. | 50% of the voting power in the company | As at 30 June 2012, the exempt entities had unanimously elected four directors, accounting for 50% of the Board. The constitution requires two of the four directors to be independent of the exempt entities and Company A. | It is recognised that the constitution restricts the exempt entities at Board level, in terms of their representative voting power by requiring them to elect independent directors. However, when determining whether there is 'voting power' for the purposes of subsection 328-125(2)(b), it is the voting power of the shareholders, as opposed to Board members, which must be considered. | Company A's Shareholders Deed confers a number of decision making powers upon the shareholder body. These powers include the ability to change the: | · board composition, arrangements and chairperson; | · Chief Executive Officer; and | · the business plan and nature of business. | As a combination of exempt entities, they have a collective shareholding that carries with it a greater than 50% entitlement to exercise the voting power in relation to these matters. This gives the exempt entities a greater than 50% exercise of voting power when changing the board and constitution of the company, which ultimately results in an ability to control the directors of Company A who themselves are agents of company control. Therefore, the exempt entities' shareholding provides them with the required greater than 50% voting power in the company. | Although the exempt entities do not have a greater than 50% direct control over Company A via the Board's representative voting power, as a combination of exempt entities they have control over at least 50% of the voting power in Company A and control it in a way described in section 328-125. | The exempt entities are a combination of exempt entities for the purposes of subsection 355-100(1), irrelevant of their relationship. During the income year, their combined shareholdings carried with it the right to a greater than 50% entitlement to any distribution of income or capital, and a greater than 50% entitlement to voting power, and resulted in the exempt entities controlling Company A in a way described in section 328-125.