Private ruling: CGT - SBC - connected entities
Published: April 2014
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

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 you do not control X? | A1: No | Q2: Will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that you do not control Y? | A2: No | Q3: Will the Commissioner exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that you do not control Z? | A3: No

Relevant facts and circumstances: You are a shareholder in X, Y and Z. You hold more than 40% but less than 50% of the total shares on issue for X, Y and Z. Each of the remaining shareholders in X, Y and Z hold less than 40% of the total shares on issue. The remaining shareholders are not connected entities (as defined in section 328-125 of the ITAA 1997). X, Y and Z have the same directors and as per the shareholders agreement, each director is appointed as a representative of each of the shareholders. The directors are not related to each other and are not otherwise affiliated. The shareholder's agreement provides each director with one equal vote in relation to the meetings and resolutions of the directors. The shareholder's agreement requires the unanimous resolution of all shareholders for certain matters to proceed. It is proposed to restructure X, Y and Z so that the shareholders' interests are held through one holding company. The shareholders intend to sell their respective shares in the three companies to the new holding company at market value.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 328-125 | 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: 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: The Commissioner's discretion, as set out in subsection 328-125(6) of the ITAA 1997 states the following: If the control percentage referred to in subsection (2) or (4) is at least 40%, but less than 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks that the other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its *affiliates. The Advanced Guide to Capital Gains Tax Concessions for Small Business 2012-2013 NAT 3359 ( Advanced Guide ) discusses the application of the discretion contained in subsection 328-125(6) of the ITAA 1997. The Advanced Guide provides that for the Commissioner to be able to consider 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 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 by a third entity, the Commissioner cannot determine that the first entity does not control the company. 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 company 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 company if such responsibilities are shared. | Detailed Reasoning - Application to your circumstances: In this case, the remaining shareholders each less than a 40% interest in x, Y and Z. The definition of 'affiliate' in section 328-130 of the ITAA 1997 prevents a trust from being an affiliate. Accordingly, the interests of the other shareholders could not be aggregated to determine that there is a third entity that holds a control percentage of at least 40% in X, Y and Z. As there is no third entity that could be taken to control X, Y and Z in accordance with subsection 328-125(2) of the ITAA 1997, it is not necessary to consider additional factors such as which entity is responsible for the day to day and strategic running of the companies. Accordingly, the Commissioner will not exercise the discretion contained in subsection 328-125(6) of the ITAA 1997.