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

Ruling: Q1: Will the Commissioner's discretion be exercised under subsection 328-125(6) of the ITAA 1997 to determine that you do not exercise control over Company X and that you are not connected with Company X for the purpose of the maximum net asset value test in section 152-15 of the ITAA 1997? | A1: Yes

Relevant facts and circumstances: You have held a 40% shareholding in Company X for a number of year. Company Y is the other shareholder in Company X, holding a 60% interest. You are considering selling your 40% interest in Company X to Company Y in the next two years. You have not entered into an agreement to sell your share, but have participated in preliminary discussions with Company Y. Company X has a turnover in excess of $2 million, and the value of its net assets is estimated to be less than $10 million. Monthly management meetings are held for Company X, as well as a quarterly board meeting. You are one party of Z which makes up the board of Company X. The CEO of Company Y also sits on the board. At board meetings all issues are generally discussed openly and amicably, however in the event of disagreement, the executives of Company Y make the decision. On several occasions when there has been disagreement, the executives of Company Y have decided on a course contrary to your wishes. You have had no power other than to accept the decisions of the board on these occasions.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 328-125 | Income Tax Assessment Act 1997 section 328-125(1) | Income Tax Assessment Act 1997 section 328-125(2) | Income Tax Assessment Act 1997 section 328-125(6) | Income Tax Assessment Act 1997 section 152-15

Reasons for decision: Detailed Reasoning - Detailed reasoning: 'Connected entity' is defined in section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997) as follows: 328-125(1) 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. 328-125(2) An entity (the first entity ) controls another entity if the first entity, its affiliates or the first entity together with its affiliates: (a) except if the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of: (i) any distribution of income by the other entity; or (ii) if the other entity is a partnership - the net income of the partnership; or (iii) any distribution of capital by the other entity; or (b) if the other entity is a company - beneficially own, or have the right to acquire the beneficial ownership of, equity interest 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 40% of the voting power in the company. In your circumstances, as you have a 40% shareholding in Company X, you are prima facie 'connected with' Company X. | Detailed Reasoning - Commissioner may determine that an entity does not control another entity: If your control percentage in a company is at least 40%, but less than 50%, the Commissioner may determine, under subsection 328-125(6) 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). For the Commissioner to make the determination under subsection 328-125(6) there must be a single, identifiable third entity that has a control percentage (including the interests of any small business CGT affiliates) of at least 40% of the company. It must control the company in the way described in subsection 328-125(2). Unless the conditions of subsection 328-125(2) are met the Commissioner cannot determine that you do not control the company. If there is a third entity with a control percentage of 40% or more it would then be necessary to consider additional factors such as which entity 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. In your situation, Company Y has a 60% shareholding. Based on the facts provided, Company Y has the controlling vote on the board, and has the power to make decisions which you do not agree with. In accordance with section 328-125(6) of the ITAA 1997, the Commissioner determines that you do not exercise control over Company X. This control is exercised by Company Y who has a shareholding of 60% and has the power to make majority decisions for Company X, which you do not agree with. Therefore, for the purpose of the maximum net asset value test, you are not connected with Company X.