Private ruling: Income Tax: small business entity
Published: July 2011
Ruling period: 1 July 2009 to 30 June 2010
Date scheme commenced: 1 July 2009

Ruling: Q1: Does the taxpayer satisfy the $2 million aggregated turnover test under Subdivision 328-C of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No.

Relevant facts and circumstances: In 2009, you acquired business capital assets. You seek a Ruling from the Commissioner as to whether you are entitled to be classified as a small business entity as provided for by ITAA 1997 and therefore entitled to claim the investment allowance at the rate of 50% of the value of the capital assets. You state that you specifically require a Ruling to determine if the control percentage of your ownership structure will enable the Commissioner to exercise his discretion to allow you to be treated as a small business entity and therefore entitled to a 50% investment allowance claim. Your sales turnover for the year ended 30 June 2009 was approximately $600,000. The sales turnover for the year ended 30 June 2010 was more than $600,000. You have a related entity. When the related entity's sales turnover is added to your sales turnover, the aggregated turnover for the year ended 30 June 2009 and for the year ended 30 June 2010 is in excess of $2,000,000. The ownership structure of the business is as follows: - 25 ordinary shares held by X Pty Ltd - dividend, capital and voting rights - 25 ordinary shares held by Y Pty Ltd - dividend, capital and voting rights - 50 ordinary shares held by Z - dividend, capital and voting rights - 2 class E shares held by X Pty Ltd - dividend rights only - 2 class F shares held by Y Pty Ltd - dividend rights only You state that the shares held in the company by Z Pty Ltd are held privately by unrelated parties. Z Pty Ltd is controlled by entities that do not include the taxpayer or its affiliates. The day to day management of the taxpayer is performed by the directors and shareholders of X Pty Ltd. The directors and shareholders of Z Pty Ltd are not involved in the day to day operations of the business and are only passive investors in the business. Z Pty Ltd plays no part in the strategic decision making of the taxpayer and is not involved in the day to day operations or strategic decision making of the taxpayer.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subdivision 328 - C, | Income Tax Assessment Act 1997 section 328-110, | Income Tax Assessment Act 1997 subparagraph 328-110(1)(b)(i), | Income Tax Assessment Act 1997 subparagraph 328-110(1)(b)(ii), | Income Tax Assessment Act 1997 subsection 328-110(2) , | Income Tax Assessment Act 1997 subsection 328-110(3), | Income Tax Assessment Act 1997 subsection 328-110(4) , | Income Tax Assessment Act 1997 section 328-115, | Income Tax Assessment Act 1997 subsection 328-115(2), | Income Tax Assessment Act 1997 subsection 328-115(3), | Income Tax Assessment Act 1997 section 328-120, | Income Tax Assessment Act 1997 section 328-125 , | Income Tax Assessment Act 1997 subsection 328-125(1), | Income Tax Assessment Act 1997 paragraph 328-125(2)(b) and | Income Tax Assessment Act 1997 section 328-125(6).

Reasons for decision: Summary: Taxpayer does not satisfy the $2 million aggregated turnover test under Subdivision 328-C of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 328-110 of the ITAA 1997 defines "small business entity". To qualify as a small business entity for an income year, you must carry on business in that year and satisfy the $2 million aggregated turnover test. There are several ways you may satisfy the $2 million aggregated turnover test. These are: (i) subparagraph 328-110(1)(b)(i) of the ITAA 1997 - you carried on business in the previous year and the aggregated turnover for the previous year was less than $2 million; (ii) subparagraph 328-110(1)(b)(ii) and subsection 328-110(2) of the ITAA 1997 - your aggregated turnover for the year you are seeking to be a small business entity i.e. the current year, worked out as at the first day of the current year is likely to be less than $2 million. However, subsection 328-110(3) of the ITAA 1997 provides an exception to this in that you cannot qualify as a small business entity under this provision if your aggregated turnover in each of the two previous years was $2 million or more; (iii) subsection 328-110(4) of the ITAA 1997 - your aggregated turnover for the current year worked out as at the end of the current year is less than $2 million. "Aggregated turnover" is defined by section 328-115 of the ITAA 1997. Aggregated turnover for an income year is the sum of your relevant annual turnovers for the year and certain related entities of yours (excluding certain amounts as provided for in subsection 328-115(3) of the ITAA 1997). The relevant annual turnovers as per subsection 328-115(2) are: (a) your annual turnover for the income year; (b) the annual turnover for the income year of any entity that is connected with you at any time during the year; and (c) the annual turnover for the income year of any entity that is an affiliate of you at any time during the income year. Broadly, your annual turnover is the total of the ordinary income derived by you in the income year in the ordinary course of carrying on a business (section 328-120 of the ITAA 1997). Turnover means your gross income and not your net profit. You calculate your aggregate turnover by including the turnover of other entities that need to be aggregated with it. The aggregation rules use the concepts of "connected with", which is based on control, and "affiliates". Subsection 328-125(1) of the ITAA 1997 states that an entity is connected with another entity if either entity controls the other entity in the way described in section 328-125 or both entities are controlled in that way by the same third entity. "Affiliate" is described in section 328-130 of the ITAA 1997. An individual or company is an affiliate of yours if the individual or affiliate acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company. Paragraph 328-125(2)(b) of the ITAA 1997 states that an entity (the first entity) controls another entity that is a company if the first entity, its affiliates or the first entity together with its affiliates beneficially own or have the right to acquire the beneficial ownership of, equity interests in the company that carry between them the right to exercise or control the exercise of at least 40% of the voting power in the company. However, where an entity has a legal ownership of the interests in the other entity but not the beneficial ownership of those interests, the entity will not be regarded as controlling the entity. From the facts provided by you, Z Pty Ltd has a 50 percentage control of you as they have a 50 per cent control of the dividend, capital and voting rights. Therefore, Z Pty Ltd directly controls you as per paragraph 328-125(2)(b) of the ITAA 1997. In the circumstances, Z Pty Ltd is an entity that is connected with you. As stated earlier, in calculating your aggregated turnover, the annual turnover of your connected entities would need to be taken into account. As your aggregated turnover for the years 2009 and 2010 was not less than $2 million, you do not satisfy subparagraph 328-110(1)(b)(i) of the ITAA 1997. On this basis, you do not satisfy the small business entity test. Subsection 328-125(6) of the ITAA 1997 states that if the control percentage is at least 40% but less than 50%, the Commissioner may determine that an entity (the first entity) does not control the other entity if the Commissioner thinks that the other entity is controlled by an entity or entities other than the first entity or its affiliates. However, in your case the Commissioner is not empowered to exercise his discretion under subsection 328-125(6) of the ITAA 1997 to enable you to be treated as a small business entity as Z Pty Ltd's control percentage is not less than 50%.

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