Private ruling: Connected entity and Commissioner's discretion
Published: October 2014
Ruling period: 1 July 2013 to 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the Commissioner exercise his discretion pursuant to subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to exclude the taxpayer from being a connected entity of Company A? | A1: Yes.

Relevant facts and circumstances: The taxpayer is a company. The late individual owned 100% of the shares in the taxpayer. The taxpayer owned 100% of the shares issued in Company A. The taxpayer later sold 20% of Company A's shareholding to a third party in their own right. The third party is an employee of Company A. The sale of the 20% shareholding was subject to an option agreement which allowed the third party to acquire a further 31% of Company A shares in the event of the death of the individual. The individual died. Upon the death of the individual, the third party exercised their option and acquired 31% of the shares in Company A. In accordance with the individual's will, the shares in the taxpayer were bequeathed and transferred to X family members of the individual. At the date of death, the directors of the taxpayer were changed to appoint the X family members. One family member is a director of Company A however neither of the X family members are involved in the day to day running of Company A or its business operations. The third party does the running of Company A. The third party is the managing director of Company A. The third party controls, manages and conducts the business operated by Company A. The third party is not a related party to the X family members. The taxpayer owns at least 40% but less than 50% of Company A. All the ordinary shares have the same voting rights.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 328-125.

Reasons for decision: Summary: The term 'connected with' is defined in subsection 995-1(1) of the ITAA 1997 as: an entity is connected with you in the circumstances described in section 328-125. Subsection 328-125(1) of the ITAA 1997 states that an entity is connected with another entity if: (a) either entity controls the other entity in a way described in this section, or (b) both entities are controlled in a way described in this section by the same third entity. Subsection 328-125(2) of the ITAA 1997 states that 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 - own, or have the right to acquire the 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 - own, or have the right to acquire the ownership of, equity interests 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. However, the Commissioner may determine that an entity does not control another entity. Subsection 328-125(6) of the ITAA 1997 states: If the control percentage referred to in subsection (2) or (4) is a 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 is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates. The term 'affiliate' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 328-130. Subsection 328-130(1) of the ITAA 1997 states that an individual or a company is an affiliate of yours if the individual or company acts or could reasonably be expected to act, in accordance with your directions or wishes, on in concert with you, in relation to the affairs of the business of the individual or company. Subsection 328-130(2) of the ITAA 1997 states that however, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share. A partner in a partnership would not be an affiliate of another partner merely because the first partner acts or could reasonably be expected to act, in accordance with the directions or wishes of the second partner or in concert with the second partner, in relation to the affairs to the partnership. Directors of the same company, or the company and a director of that company would be in a similar position. In your case, the taxpayer has 49% of the shares in Company A. All the ordinary shares in Company A have the same voting rights. As a result, the taxpayer satisfy the requirement in paragraph 328-152(2)(b) of the ITAA 1997 as the taxpayer owns at least 40% of the voting power in Company A. However, the Commissioner may determine that the taxpayer does not control Company A as the taxpayer's control percentage is at least 40% but less than 50% and that the taxpayer does not control Company A if the Commissioner thinks that Company A is controlled by an entity other than, or by entities that do not include the taxpayer or any of their affiliates. In your case, the taxpayer has 49% shares in Company A. The third party owns and has control over 51% of the shares in Company A. The third party is the managing director and controls, manages and conducts the business operated by Company A. The two family members who are directors and shareholders of the taxpayer are not involved in the day to day running of the business conducted by Company A. Based on this information, it is considered that the third party would control Company A as a result of their ownership of shares as well as being the managing director conducting the business operated by Company A. The two family members do not appear to be involved in the day to day running of the business conducted by Company A. Therefore, the Commissioner is satisfied that Company A is not controlled by the taxpayer but instead controlled by the third party who effectively has a control percentage of greater than 50% through their shareholdings. Accordingly, the Commissioner will determine that under subsection 328-125(6) of the ITAA 1997 that the taxpayer does not control Company A.