Private ruling: Exempting entities rule
Date of advice: 6 November 2017
Published: March 2018
Ruling period: 1 July 2017 – 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Is Company A an exempting entity under section 208-20 of the Income Tax Assessment Act 1997 ? | A1: No

Relevant facts and circumstances: Company A is an Australian resident company incorporated over 20 years ago. Company A has only issued ordinary shares. It has not issued nor planned to issue any other class of shares including, but not limited to, dividend access shares, preference shares and finance shares. Company A has not issued any options over its shares. Company A’s current shareholders and their respective interests are as below: Name Percentage Aus. resident Individual X 80% No Individual Y 13% No Individual Z 7% Yes Individual Z has always been an Australian resident. Individual Z has not issued an option, derivative or entered into any arrangement that would transfer the risks and opportunities in the 7% shareholding in ABC to another entity. There is no agreement or arrangement whereby Individual Z is not entitled to benefit from the shares held in Company A, nor to any compensation should Company A’s share price decrease. The shareholders and their interests in Company A have remained unchanged for over 20 years. Company A is the head entity of a tax consolidated group consisting of itself and 4 subsidiaries. All the subsidiaries have been wholly-owned by Company A since their incorporation.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 208-20

Reasons for decision: Summary: Summary : Company A is not an exempting entity for the purpose of section 208-20 of the ITAA 1997 as less than 95% of its accountable membership interests are owned by prescribed persons. | Detailed Reasoning - Detailed reasoning: Section 208-20 of the ITAA 1997 defines an exempting entity, stating: A corporate tax entity is an exempting entity at a particular time if, at that time, the entity is effectively owned by prescribed persons. Paragraph 208-40(4)(a) of the ITAA 1997 provides that an individual is a ‘prescribed person’ in relation to another corporate tax entity if the individual is a foreign resident. Section 208-25 of the ITAA 1997 states that: 208-25 Effective ownership of entity by prescribed persons 208-25(1) An entity is effectively owned by prescribed persons at a particular time if: (a) at that time: (i) not less than 95% of the accountable membership interests in the entity; or (ii) not less than 95% of the accountable partial interests in the entity; are held by, or held indirectly for the benefit of, prescribed persons; or (b) paragraph (a) does not apply but it would nevertheless be reasonable to conclude that, at that time, the risks involved in, and the opportunities resulting from, holding accountable membership interests, or accountable partial interests, in the entity that are not held by, or directly or indirectly for the benefit of, prescribed persons are substantially borne by, or substantially accrue to, prescribed persons. Accountable membership interests are defined in subsection 208-30(2) of the ITAA 1997 as those membership interests that are not excluded membership interests. Accountable partial interests are similarly defined in subsection 208-35(2) of the ITAA 1997 as those partial interests that are not excluded partial interests. An entity has a ‘partial interest’ in a corporate tax entity if it has an interest in a membership interest in the corporate tax entity (subsection 208-25(3) of the ITAA 1997). Excluded membership interests (or excluded partial interests) are those interests that, having regard to a number of factors listed in subsection 208-30(3) of the ITAA 1997 (or subsection 208-35(3) of the ITAA 1997 for partial interests) including the rights attaching to the interests and any arrangement in respect of those interests, it would be reasonable to conclude that the interest is not relevant in determining whether the entity is effectively owned by prescribed persons because holding the interest does not involve the holder bearing the risks, or result in the accrual to the holder of the opportunities, of ownership of the entity that ordinarily arise from, or ordinarily attach to, the holding of membership interests in the entity. In other words, an interest is excluded if, upon weighing the factors listed in subsection 208-30(3) of the ITAA 1997 (or subsection 208-35(3) of the ITAA 1997), it does not expose the holder of that interest to the risks and opportunities that ordinarily arise from share ownership. The risks and opportunities that ordinarily arise from share ownership are those that expose the holder of the interest to the performance of the company. Some of the indicia of share ownership include that the holder has a right to dividends in the event the company is profitable and the directors declare them, the holder has voting rights in proportion with his or her interest in the company and that the value of the shares broadly track the performance of the company (that is, the holder is exposed to capital risk). | Detailed Reasoning - Prescribed person – paragraph 208-40(4)(a) of the ITAA 1997: Individuals X and Y are ‘prescribed persons’ as they are foreign residents. | Detailed Reasoning - Effectively owned by prescribed persons – subsection 208-25(1) of the ITAA 1997: In this case, Company A has only issued ordinary shares and Individual Z does not hold the 7% interest in Company A for the benefit of prescribed persons, nor is there any arrangement or agreement that would affect the rights and entitlements of this interest. All the shareholders, therefore, participate to the same extent in the risks and opportunities of holding their membership interests in Company A and are exposed to the capital risk attached to their interests as well as benefit from voting and dividend rights proportionately to their shareholdings. As Individuals X and Y collectively own 93% of ABC’s ordinary shares, they hold 93% accountable membership interests in Company A. Subparagraph 208-25(1)(a)(i) of the ITAA 1997 is, therefore, not satisfied. Subparagraph 208-25(1)(a)(ii) of the ITAA 1997 is not relevant as no entity holds a partial interest in ABC. Paragraph 208-25(1)(a) of the ITAA 1997, therefore, does not apply. There are no options, derivatives or any arrangement over the 7% shareholding held by Individual Z. The risks and opportunities of holding these shares are borne by and accrued to Z and not to any prescribed persons. Paragraph 208-25(1)(b) of the ITAA 1997, therefore, does not apply. For a consolidated group, Subdivision 709-B of the ITAA 1997 modifies the operation of Division 208 of the ITAA 1997. Section 709-155 of the ITAA 1997 states that: 709-155(1) To determine whether a consolidated group is an exempting entity or former exempting entity, the tests in Division 208 are applied to the head company of the group. 709-155(2) However, there are some additional rules that can alter the way that Division 208 applies to a consolidated group. These are set out in sections 709-160 to 709-175. 709-155(3) In applying those rules to an entity that is a member of a consolidated group: (a) Division 208 is to be applied before those rules; and (b) that Division is to be applied just after the entity became a member of the group but, for a subsidiary member, it is to be applied on the assumption that the subsidiary was not a member of the group at that time. 709-155(4) Except as mentioned in paragraph (3)(b), Division 208 has no application to a subsidiary member of a consolidated group. When Subdivision 709-B of the ITAA 1997 modifies the operation of Division 208 of the ITAA 1997 for consolidated groups, Division 208 is applied to determine the status of the head company of the group (subsection 709-155(1)) and then to determine the status of the subsidiary member (subsection 709-155(2)). However, the status of the subsidiary member is determined on the assumption that the subsidiary was not actually a member of the group at the joining time (subsection 709-155(3)). Paragraph 709-155(3)(b) allows Division 208 to have application to a subsidiary member of a consolidated group at the joining time. Once the status of the subsidiary member has been determined as above, Division 208 of the ITAA 1997 does not operate in relation to the subsidiary (subsection 709-155(4) of the ITAA 1997). In this case, the subsidiaries were wholly owned by Company A at the time of their incorporation and joining the tax consolidated group. Accordingly, Company A is not an exempting entity for the purpose of section 208-20 of the ITAA 1997.