House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 11 - Control and ownership tests for the general value shifting regime and affected owners

Outline of chapter

11.1 This chapter explains the various control and common ownership tests which apply to determine whether an entity is (or entities are) covered by the value shifting rules, and also which interest holders (referred to as affected owners) are potentially affected. The amendments explained in this chapter are contained in Schedule 15 to this bill.

11.2 It explains the different tests for control and common ownership, and who is an affected owner for the purposes of the DVS and IVS rules in Divisions 725 and 727, and the key concepts relevant in applying these tests. Different tests apply for the purposes of Division 723, and these are discussed in Chapter 9.

11.3 Controllers and their associates (and sometimes associates of associates) may be affected owners where the control tests are met. Where the common ownership tests are met, then common owners and their associates may be impacted. The common ownership tests apply only to closely-held entities. Active participants may also be affected owners where the control or common ownership tests are satisfied, but this is only the case where the entities are closely-held.

Context of reform

11.4 The current income tax law prescribes consequences for value shifts that occur in a limited number of circumstances, and only for value shifts where the interests in a company are involved.

11.5 Robust anti-value shifting rules are needed to support the integrity of the tax system by ensuring that the value of interests in companies and trusts cannot be manipulated to generate tax advantages.

11.6 In contrast with the current law, the range of entities that may be affected by the GVSR has been expanded. However, the rules are limited to entities that control entities involved in the value shifting scheme, those who commonly-own entities so involved, those who actively participate in the scheme, or those who have a particular relationship to the controlling entity or common owners.

11.7 These tests save compliance costs for entities that are not in any way involved in the value shifting scheme.

Summary of new law

11.8. Not all entities that own interests affected by a direct or indirect value shift are within the scope of the new rules. There are only consequences for affected owners.

Direct value shift

11.9 A direct value shift only has consequences where a controlling entity test is satisfied, and then only for the controller, its associates (and associates of associates in some cases), and for any active participants in the value shift if the controlled entity is closely-held. Refer to paragraphs 11.12 to 11.32 for further details.

Indirect value shift

11.10 An indirect value shift has consequences only if the losing and gaining entity satisfy an ultimate controller test or, if both are closely-held, a common ownership test. An affected owner may be a controller, common-owner, losing entity, gaining entity, and certain other entities related to these entities (including associates). An active participant in the scheme (if both losing and gaining entities are closely-held) can also be an affected owner. Refer to paragraphs 11.33 to 11.141 for further details.

Detailed explanation of new law

11.11 Who is an affected owner will depend upon whether the DVS or IVS rules are being applied. [Schedule 15, item 25, definition of affected owner in subsection 995-1(1) of the ITAA 1997]

Who are affected owners for a direct value shift?

11.12 The DVS rules only apply to affected owners of up or down interests. [Schedule 15, item 1, paragraph 725-50(1)(d)]

11.13An up interest is an equity or loan interest that increases in market value, or is issued at a discount to market value. A down interest is an equity or loan interest that decreases in market value [Schedule 15, item 1, section 725-155] . Diagram 11.1 demonstrates when there may be affected owners for a direct value shift.

11.14 Working out whether an entity is an affected owner is a 3 step process:

•

firstly, determine whether the controlling entity test in section 725-55 is satisfied (i.e. did an entity control the target entity at some time during the period of the value shifting scheme);

•

secondly, determine whether the entity holds an interest that has decreased in market value (called a down interest), or increased in market value or was issued to it at a discount (each called an up interest); and

•

thirdly, apply the affected owner tests in either section 725-80 (for down interest holders) or section 725-85 (for up interest holders) to that interest holder.

Step 1: Is the controlling entity test satisfied?

Controlling entity test

11.15 The controlling entity test is satisfied if an entity controls (for value shifting purposes) the target entity at some time during the period when the scheme is entered into and ending when it has been carried out (the scheme period) [Schedule 15, item 1, section 725-55] . It is not necessary for the control relationship to exist over the entire scheme period.

11.16 The rules in Subdivision 727-E set out who is a controller of an entity for value shifting purposes. There are different tests for companies, fixed trusts and non-fixed trusts. These are explained in paragraphs 11.93 to 11.114.

Step 2: Ownership of an up interest or a down interest

11.17 An entity must work out if it owns an up interest or a down interest at the time of the interests increase or decrease in market value (or is issued an up interest at a discount). An entity must own an interest at this time to be an affected owner. For a detailed discussion of the meaning of up interests and down interests refer to Chapter 8.

Step 3: Range of affected owners depends on whether interest goes up or down in value

11.18 The rules for determining whether an owner is an affected owner vary depending on whether the affected interest is an up interest or a down interest. There are some tests that are common to both sections 725-80 (about down interests) and 725-85 (about up interests) and some that apply only in relation to up interests.

11.19 There can never be an affected owner of an up interest in an entity unless there is at least one affected owner of a down interest. [Schedule 15, item 1, paragraph 725-85(a)]

Controller or an associate

11.20 The controller of the target company or trust referred to in step 1 who also satisfies step 2 will always be an affected owner of an up or down interest in the entity. [Schedule 15, item 1, paragraphs 725-80(a) and 725-85(c)]

11.21 The controller of an entity is properly within the scope of the DVS rules because by virtue of the control, it is in a position to shape the transactions that give rise to the value shift.

11.22 Similarly, an entity that was an associate of a controller at some time during or after the scheme period, is also an affected owner of an up interest or a down interest. This requirement will be satisfied even if the controlling entity is not a controller at the time the relevant association is established. In the absence of applying the rules to associates, a related party could reap the benefits of the value shifting scheme instead of the controller and thereby avoid the DVS rules. [Schedule 15, item 1, paragraphs 725-80(b) and 725-85(d) and (e)]

11.23 The concept of associate is well known in the income tax law and takes its meaning from section 318 of the ITAA 1936. The tests for who is an associate is wider than that of control and looks at the relationship between entities.

11.24 If there is more than one controller during the scheme period then each of them (together with their associates) will be affected owners if they own a down interest or an up interest at the relevant time (see step 2).

Active participants or direct facilitators

11.25 A holder of an up or down interest who actively participates or directly facilitates the entering into or carrying out of the scheme under which the value shift occurs, is also an affected owner [Schedule 15, item 1, paragraphs 725-80(c), 725-85(f) and 725-65(2)] . The kinds of acts or omissions that could amount to active participation or direct facilitation are discussed in paragraphs 11.115 to 11.141.

11.26 It is a further requirement that at some time during the scheme period the target entity was closely-held. A closely-held entity is one that has fewer than 300 members or beneficiaries (as applicable).

11.27 In some circumstances, an entity is treated as having fewer than 300 members or beneficiaries (as applicable) [Schedule 15, item 1, subsection 725-65(3)] . Direct and indirect interests must be taken into account in applying these conditions.

11.28 A company is taken to have less than 300 members if there are up to 20 individuals who between them own shares in that company for their own benefit. Those shares must carry rights to at least 75% of the companys income or capital, or voting power. These are the same conditions as set out in subsection 124-810(3) of the ITAA 1997 (in the scrip for scrip CGT roll-over provisions).

11.29 Similarly, a fixed trust is taken to have less than 300 beneficiaries if there are up to 20 individuals who between them own fixed interests in that trust for their own benefit. Those fixed entitlements must carry rights to at least 75% of the trusts income or capital, or voting on activities of the trust. This is set out in subsection 124-810(4) of the ITAA 1997 (in the scrip for scrip CGT roll-over provisions).

11.30 Furthermore, a company or fixed trust is treated as having less than 300 members or beneficiaries where it is reasonable to conclude that rights attaching to interests in that entity could be varied so that ownership become concentrated. The matters relevant to this conclusion are set out in subsection 124-810(5) of the ITAA 1997 (in the scrip for scrip CGT roll-over provisions).

11.31 A non-fixed trust is always taken to have less than 300 beneficiaries [Schedule 15, item 1, subsection 725-65(4)] . This treatment overcomes the problem at general law concerning the nature of the interest held by a discretionary object. Such a beneficiary does not have an interest in the trust income or capital until the trustee declares an entitlement.

Additional affected owners (up interests only): associate of an associate of a controller

11.32 An entity will also be an affected owner of an up interest if:

•

an associate of the controller, at some time during or after the scheme period, is an affected owner of a down interest; and

•

the entity is an associate of that associate at some time during that time.

[Schedule 15, item 1, paragraph 725-85(e)]

The down interest holder and up interest holders 1 and 2 are members of the target entity. The controller varies rights that results in some interests increasing in value and others decreasing in value, that is, a direct value shift.

Up interest holder 1 is an affected owner for the DVS rules under paragraph 725-85(e). It is an associate of a down interest holder who is an associate of the controller.

However, up interest holder 2 is not an affected owner for the direct value shifting rules because it has no relationship with the controller or its associates, nor did it actively participate in the scheme.

Who are affected owners for an indirect value shift?

11.33 Division 727 applies to an indirect value shift that arises from economic benefits being provided by one entity (the losing entity) to another (the gaining entity) in connection with a scheme. This nexus is satisfied if:

•

the benefit is provided under the scheme; or

•

the providing of the benefit is reasonably attributable to an act or omission under the scheme by any entity.

[Schedule 15, item 1, section 727-160]

11.34 Although the range of entities that can cause an economic benefit to be provided in connection with a scheme is quite large, there are only consequences if the entities are controlled (or commonly-owned, if both entities are closely-held) and there are only consequences for an affected owner of certain equity or loan interests in the losing entity or the gaining entity.

11.35 The rationale underlying the control and common ownership tests and the tests for who is an affected owner under the IVS rules is that the rules should impact on an entity that can (on an associate-inclusive basis) control or shape the events that give rise to the indirect value shift or to make some contribution towards this end.

11.36 Furthermore, the IVS rules impact on interests in entities not involved directly in the unequal flow of economic benefits. Consequently, entities owning interests in affected owners may themselves be affected owners.

Are there affected owners for an indirect value shift?

11.37 Diagram 11.2 demonstrates whether there are affected owners for an indirect value shift.

11.38 Working out who is an affected owner in an indirect value shift is a 2 step process:

•

firstly, determine whether one or both of the following tests is satisfied:

-

the ultimate controller test [Schedule 15, item 1, section 727-105] ; and/or

-

the common ownership nexus test [Schedule 15, item 1, section 727-110] ; and

•

secondly, apply section 727-530 to determine the affected owners.

The ultimate controller case

Step 1: Is the ultimate controller test satisfied?

11.39 The ultimate controller test is satisfied if, at a time during the IVS period, the losing entity or the gaining entity control each other or the losing entity and the gaining entity have the same ultimate controller. The test is also satisfied if, at some time during that period, the ultimate controller of the losing entity is the same as the ultimate controller of the gaining entity at a different time. [Schedule 15, item 1, section 727-105]

Example 11.2

Smith Co is the ultimate controller of losing entity James Co at one point in time during the IVS period. Smith Co is the ultimate controller of gaining entity Jones Co at another point in time during the IVS period. The ultimate controller test is satisfied for both James Co and Jones Co.

11.40 This test applies to companies and trusts that are widely or closely-held.

11.41 An entity is an ultimate controller of a company or trust if it controls that company or trust, provided there is no other entity that is an ultimate controller of both [Schedule 15, item 1, section 727-350] . Control refers to control (for value shifting purposes) as set out in Subdivision 727-E. The concept of control is discussed in paragraphs 11.89 to 11.114.

Step 2: Determining the affected owners

11.42 Where the gaining and losing entities have the same ultimate controller at any time between immediately before the entering into of a scheme and the IVS time ( IVS period ), then the following entities will be affected owners:

•

an ultimate controller;

•

any intermediate controller;

•

the losing entity and gaining entity; and

•

an entity that is an associate of the above entities at any time after the commencement of the scheme.

[Schedule 15, item 1, subsection 727-530(1), items 1, 3 and 4 in the table]

11.43 An intermediate controller is an entity that at some time during the IVS period controls either the losing entity or the gaining entity, and is itself controlled by another entity that is an ultimate controller of both the losing and gaining entities. [Schedule 15, item 1, subsection 727- 530(2)]

Example 11.3

This is an example of how an intermediate controller and its associate come within the scope of the IVS rules.

Discovery Co and Hartog Plate Co have not dealt at arms length in relation to the provision of benefits under a scheme and an indirect value shift has resulted.

At the time of the value shift, Batavia Trust is an ultimate controller of both Discovery Co (which it controls after taking into account direct and indirect interests) and Hartog Plate Co (in which it has a 65% direct interest).

Associates of Batavia Trust that hold interests in either the losing entity (Discovery Co) or gaining entity (Hartog Plate Co) are affected owners for IVS purposes. Consequently, the beneficiaries of Batavia Trust are affected owners.

Endeavour Co is an intermediate controller of Discovery Co and therefore an affected owner. Captain Cook Co is an associate of Endeavour Co and therefore an affected owner in respect of its interest in the gaining entity.

The common ownership case

Step 1: Is the common ownership nexus test satisfied?

11.44 The common ownership nexus test cannot apply if at all times during the IVS period the gaining entity or the losing entity has 300 or more members [Schedule 15, item 1, paragraph 727-110(1)(a)] . Both entities must be closely-held at some time during the IVS period for the common ownership nexus test to be satisfied.

11.45 In some cases an entity will be treated as if it does not have 300 or more members [Schedule 15, item 1, subsection 727-110(2)] . For a discussion about when an entity will be regarded as having less that 300 members refer to paragraphs 11.28 to 11.31.

11.46 The test also requires that within the IVS period the losing entity and the gaining entity have a common ownership nexus. [Schedule 15, item 1, paragraph 727-110(1)(b)]

Meaning of common ownership nexus

11.47 The table in section 727-400 sets out the conditions that must be met before 2 entities can be said to have a common ownership nexus. That table has 5 items that deal with combinations of companies, fixed trusts and non-fixed trusts for which common ownership might be examined in applying the IVS rules. These 5 combinations are discussed in paragraphs 11.53 to 11.72. [Schedule 15, item 1, section 727-400]

11.48 The table deals only with these combinations of entities because only companies, fixed trusts and non-fixed trusts can be losing entities under the IVS rules and, although gaining entities can be entities other than companies or trusts, the test is limited to these entities.

11.49 The common ownership nexus examines who holds particular rights, that are incidental to the ownership, of 2 entities. Where the same ultimate owners (on an associate-inclusive basis) hold such rights in excess of certain thresholds, the 2 entities are taken to satisfy the common ownership nexus. Cases where a single ultimate owner holds the relevant rights, or where the 2 entities are non-fixed trusts, are covered by the ultimate controller test. An ultimate owner is an entity referred to in subsection 149-15(3) of the ITAA 1997. It includes individuals, certain governments and companies whose constitutions prevent them from making any distribution to members.

11.50 The kinds of rights or features that are examined in determining whether 2 entities have common owners differ according to the nature of the entities that are being tested. These features are set out in Table 11.1.

11.51 In tracing ownership, and some rights which are a proxy for ownership, it is necessary to take into account interests and rights that are held both directly and indirectly. This will involve tracing through interposed entities. [Schedule 15, item 1, subsection 727-415(2)]

11.52 Furthermore, it should be noted that in tracing ownership, some interests (e.g. finance shares) are excluded, and that the interests of 2 or more ultimate owners may be aggregated in some circumstances [Schedule 15, item 1, subsections 727-405(5) and 727-415(4)] . These are discussed in paragraphs 11.74 to 11.80.

Combination 1 - both entities are companies

11.53 Two companies have a common ownership nexus if, during the IVS period, the same ultimate owners have ultimate stakes totalling 80% or more in each company. The ultimate stakes in each company need not be held at the same time during the IVS period [Schedule 15, item 1, section 727-400, item 1 in the table] . The profile of the percentage of ultimate stakes held by the ultimate owners is also relevant to whether a common ownership nexus exists (see paragraphs 11.55 to 11.58). An ultimate owner has an ultimate stake in a company to the extent (expressed as a percentage) they control the voting power, or hold rights to dividends or rights to capital distributions in the company [Schedule 15, item 1, section 727-405] .

11.54 The ultimate stake of an affected owner is determined on an associate-inclusive basis. This is discussed in paragraphs 11.75 to 11.78.

11.55 Ultimate stakes of 80% or more in a company need to be established for one of the 3 rights. It will not be met, for instance, where one ultimate owner has 40% of the rights to dividends and another has 45% of the rights to capital distributions. Similarly, commonality must be established as between similar rights in each company. For example, 2 companies do not necessarily have a common ownership nexus where the same ultimate owners hold 80% of the voting power in one, and 80% of the rights to dividends in the other.

11.56 If the requirement that the same ultimate owners have ultimate stakes totalling 80% or more in each company is met, there is a further condition that must be satisfied before there will be a common ownership nexus. The condition is met if one of 3 situations exist. [Schedule 15, item 1, subsection 727-400(2)]

11.57 The 3 ways the condition can be met are:

•

one of the ultimate owners has ultimate stakes of at least 40% in each company [Schedule 15, item 1, subsection 727-400(3)] ;

•

each ultimate owner holds the same percentage of ultimate stakes in each company [Schedule 15, item 1, subsection 727-400(4)] ; or

•

16 or fewer ultimate owners have the ultimate stakes that satisfy the 80% or more ultimate stakes requirement [Schedule 15, item 1, subsection 727-400(5)] .

11.58 The first and last items in paragraph 11.57 can apply where each ultimate owner does not hold the same percentage of ultimate stakes in each company. Both of these items will be met in many cases.

11.59 The 40% or more item in paragraph 11.57 can apply where an ultimate owner has a significant interest in both companies and the remaining ownership is widely-held (more than 15 other entities). The last item will cover such situations as where 2 individuals have 20% ultimate stakes in one company and 25% in the other, and another 2 individuals have 25% ultimate stakes in the two companies.

11.60 It is necessary to trace through direct and indirect holdings in working out who are the ultimate owners of each company.

11.61 A consequence of looking at voting power and rights to dividends and capital distributions is that 2 companies could potentially have 3 sets of ultimate owners.

Example 11.4: Common owners of 2 companies - simple case

Mika Dolls Pty Ltd and Vonny Pty Ltd provide each other with economic benefits in a non-arms length dealing. They are a gaining entity and a losing entity respectively.

Tom, Jessica and Emmalee are joint shareholders in Mika Dolls Pty Ltd. They hold voting and distribution rights of 20%, 35% and 45% respectively.

Tom, Jessica, Emmalee and Sam are joint shareholders in Vonny Pty Ltd. They hold voting power of 20%, 20%, 40% and 20% respectively. However, rights to distributions are held in proportions of 5%, 5%, 5% and 85%.

Mika Pty Ltd and Vonny Pty Ltd have a common ownership nexus because the same entities (Tom, Jessica and Emmalee) hold at least 80% of the voting power in each company. Emmalees holdings meet the requirement that one owner have a 40% or greater interest in both companies. In this case, the 16 or fewer entities item is also met.

This is so even though the test is not met in relation to rights to dividends and capital distributions.

Applying item 2 of affected owners table in subsection 727-530(1), Tom, Jessica and Emmalee are affected owners of Mika Dolls Pty Ltd. They are owners of primary equity interests in a gaining entity.

Similarly, Tom, Jessica and Emmalee are affected owners of Vonny Pty Ltd, and are owners of primary equity interests in a losing entity.

Example 11.5: Affected owners of 2 companies - more complex case

Lusitania Co and Gandolf Co are gaining and losing entities respectively in an indirect value shift. They have the following ownership structures.

Lusitania Co and Gandolf Co have a common ownership nexus with Bernie and Andrew as ultimate owners. After tracing interests through interposed entities, Bernie and Andrew hold 100% of the interests in Lusitania Co, and 80% of the interests in Gandolf Co.

As a result, Bernie and Andrew are affected owners under the common ownership nexus test.

The entities through which the indirect interests that Bernie and Andrew hold are traced (Nero Co, Anita Co, Caesar Trust and Jobba Co) will also be affected owners under the common ownership nexus test.

(Note: Bernie satisfies the ultimate controller test. Practically, the common ownership test is therefore only relevant for Andrew.)

The same principles apply where combinations 2 to 4 of losing and gaining entities are found.

Combination 2 - both entities are fixed trusts

11.62 Two fixed trusts have a common ownership nexus if the same ultimate owners hold ultimate stakes, consisting of the rights to receive distributions of income or capital, totalling at least 80% in each fixed trust. [Schedule 15, item 1, section 727-400, item 2 in the table and section 727-410]

11.63 Commonality needs to be established for only one of these rights, and not for both. However, commonality must be established as between similar rights. For example, 2 fixed trusts do not necessarily have a common ownership nexus where 2 ultimate owners hold 80% of the rights to income in one, and 80% of the rights to capital in the other.

11.64 The principles regarding commonality, associate-inclusive basis and profile of holdings discussed in paragraphs 11.53 to 11.58 also apply here.

Example 11.6

Wormy Trust and Scoob Trust are fixed trusts. They provide each other with unequal economic benefits in a non-arms length dealing.

Sue, Len and Siobhan are beneficiaries in Wormy Trust. They hold rights to income and capital in the shares of 60%, 25% and 15% respectively.

Len and Siobhan are also beneficiaries in the Scoob Trust, holding rights to capital and a share of the income in proportions of 50% each.

Wormy Trust and Scoob Trust do not have a common ownership nexus because the same entities (Len and Siobhan) do not hold at least 80% of the rights to income or capital in each fixed trust.

11.65 It is necessary to trace through direct and indirect holdings in working out who are the ultimate owners of each fixed trust. [Schedule 15, item 1, subsection 727-415(2)]

Combination 3 - company and fixed trust

11.66 A company and fixed trust have a common ownership nexus if the same ultimate owners have ultimate stakes totalling at least 80% in the company and the fixed trust. Again, the principles regarding commonality, associate-inclusive basis and profile of holdings discussed in paragraphs 11.53 to 11.58 also apply here. [Schedule 15, item 1, section 727-400, item 3 in the table]

11.67 It is necessary to trace through direct and indirect holdings in working out who are the ultimate owners of the company or fixed trust. [Schedule 15, item 1, subsection 727-415(2)]

Combination 4 - company and non-fixed trust

11.68 A company and non-fixed trust have a common ownership nexus if the same ultimate owners:

•

have ultimate stakes of at least an 80% in the company; and

•

control the non-fixed trust (for value shifting purposes).

[Schedule 15, item 1, section 727-400, item 4 in the table]

11.69 Whether an ultimate owner controls a non-fixed trust is worked out by applying the tests in section 727-365 (discussed in paragraphs 11.105 to 11.111). The principles regarding the associate-inclusive basis of these tests (discussed in paragraph 11.54) also apply here.

11.70 It is necessary to trace through direct and indirect holdings in working out who are the ultimate owners of the company or a controller of the non-fixed trust. [Schedule 15, item 1, subsection 727-415(2)]

Example 11.7: Affected owners of a company and non-fixed trust under common ownership

Alicia is the sole capital beneficiary (not being a fixed entitlement) in Gandolf Discretionary Trust. Jack is the trustee of the trust.

After tracing through direct and indirect interests, it can be determined that Lusitania Co and Gandolf Discretionary Trust have a common ownership nexus with Jack and Alicia being ultimate owners. This means that Alicia and Jack are affected owners. Alicias associate Liam is also an affected owner because he is an ultimate owner as a result of applying subsection 727-415(4).

Furthermore, Stoney Co is an affected owner because it has been necessary to trace Alicias and Jacks ownership rights through it.

The income beneficiaries of Gandolf Discretionary Trust are not affected owners because they are not ultimate owners, nor are they associates of Alicia, Jack or Stoney Co (affected owners because of the common ownership nexus), nor has it been necessary to trace through their interests.

(Note: Alicia and Liam satisfy the ultimate controller test. Practically, the common ownership test is therefore only relevant for Jack.)

Combination 5 - fixed trust and non-fixed trust

11.71 A fixed trust and non-fixed trust have a common ownership nexus if the same ultimate owners:

•

have ultimate stakes totalling at least 80% in the fixed trust; and

•

control the non-fixed trust (for value shifting purposes).

[Schedule 15, item 1, section 727-400, item 5 in the table]

11.72 It is necessary to trace through direct and indirect holdings in working out who are the ultimate owners of the fixed trust or a controller of the non-fixed trust [Schedule 15, item 1, subsection 727-415(2)] . The principles regarding the associate-inclusive basis of these tests (discussed in paragraph 11.54) also apply here.

Other matters relevant to tracing interests for the common ownership nexus test

Ownership or rights held jointly

11.73 If ownership or other particular rights in a company or trust are held by 2 or more entities jointly or in common, each entity is treated as holding a proportion of the ownership or rights, worked out on a reasonable basis. The total of the proportions for any particular ownership interest or right cannot exceed one. [Schedule 15, item 1, subsection 727-415(3)]

Ownership or rights held by associate

11.74 The common ownership nexus requires the ultimate owners to be identified, rather than taking the more limited approach of looking to who is the immediate and direct owner of any particular interest, or rights in respect of an interest in an entity.

11.75 The ownership or other particular rights in a company or trust that are ultimately held by associates of an ultimate owner, who are themselves ultimate owners, may be treated as being held by the ultimate owner. This is for the purpose of working out if the ultimate owner and other ultimate owners have ultimate stakes that result in a common ownership nexus for two entities. This rule can apply separately to each ultimate owner who has associates. [Schedule 15, item 1, subsections 727-415(4) and (5)]

11.76 The effect of this rule is to aggregate the ownership or particular rights held ultimately by an ultimate owner (directly and indirectly) with those held by associate ultimate owners. This prevents the common ownership nexus test from being avoided by splitting rights amongst associates. For example, where one ultimate owner has an ultimate stake of 90% in one company and an associated ultimate owner has an 80% ultimate stake in the other company.

11.77 The policy is for the common ownership nexus test to reflect the fact that an ultimate owner and associates are sufficiently related that they can be seen as a single economic agent.

11.78 The operation of the aggregation rule is illustrated in Example 11.8.

Example 11.8: Operation of the aggregation rule

Continued from Example 5.6 (Wormy Trust).

Assume that Sue and Len are associates.

The attribution rule in subsection 727-415(4) operates so that Len is taken to hold an 85% interest in the rights to income and capital of Wormy Trust. As in Example 5.6, Len and Siobhan are, together, ultimate owners (as to 100%) of Scoob Trust.

Consequently, Wormy Trust and Scoob Trust have a common ownership nexus. As a result of the attribution rule, Len and Siobhan together are ultimate owners with ownership rights greater than 80% in respect of each fixed trust. The 40% or greater, and 16 or fewer, items of the additional condition are also met. Len and Siobhan will be affected owners.

The attribution rule also applies so that Sue is taken to hold an 85% interest in the rights to income and capital of Wormy trust, and a 50% interest to the rights to income and capital of Scoob Trust. Again, Wormy Trust and Scoob Trust have a common ownership nexus. Sue and Siobhan together are ultimate owners with ownership rights greater than 80% in respect of each fixed trust. The 40% or greater, and 16 or fewer, items of the additional condition are also met. Sue will be an affected owner.

Exclusions

Finance shares are ignored

11.79 Finance shares are ignored for the purposes of tracing ownership in a company. A finance share is a share whose dividends are more akin to the payment of interest on a loan, rather than a true sharing in the risks and rewards of the activities of the company. [Schedule 15, item 1, subsection 727-405(5)]

11.80 Whether a dividend can reasonably be regarded as being equivalent to interest on a loan, requires an objective consideration of:

•

the way in which the amount of the dividends are worked out;

•

the conditions that apply to the payment, for example, whether payments are cumulative or not; and

•

any other relevant matters.

[Schedule 15, item 1, paragraphs 727-405(5)(a) to (c)]

Step 2: Determining the affected owners

11.81 The first set of affected owners (because the common ownership nexus test is satisfied) is each ultimate owner in the gaining and losing entity, the ownership interests of which have been taken into account in order to establish that the common ownership nexus has been satisfied at any time in the IVS period. Any entity through which these ownership interests have been traced is also an affected owner, as are the losing entity and gaining entity. [Schedule 15, item 1, subsection 727- 530(1), paragraphs (a) and (b) of item 2 and 3 in the table]

11.82 The second set of affected owners where the common ownership nexus applies is any entity that, at any time after the scheme was entered into, is an associate of one of the affected owners mentioned in the preceding paragraph. [Schedule 15, item 1, subsection 727- 530(1), item 4 in the table]

11.83 The reason that these owners are subject to the IVS rules is that a high degree of common ownership between closely-held entities gives rise to a significant risk that the provision of economic benefits under a scheme is by way of the direction of another entity or entities, or at least is tacitly approved or encouraged by them.

11.84 In this way, the common ownership nexus test shares some of the elements that underpin the ultimate controller test, and can be seen as a supplement to that test.

Active participants

11.85 An active participant in a scheme may be an affected owner if the ultimate controller test is satisfied and the losing and gaining entities are closely-held at some time in the IVS period, or the common ownership nexus test applies. [Schedule 15, item 1, subsection 727-530(1), item 5 in the table]

11.86 An entity is an active participant in a scheme if the entity has actively participated in or directly facilitated the entering into of the scheme or at some time during the IVS period actively participated in or directly facilitated the carrying out of the scheme [Schedule 15, item 1, paragraph 727- 530(3)(b)] . The kinds of acts or omissions that could amount to active participation or direct facilitation are discussed in paragraphs 11.115 to 11.141.

11.87 An entity is not an active participant if it did not own an equity or loan interest in the losing or gaining entity, or an indirect equity or loan interest in either of those entities at some time during the IVS period. [Schedule 15, item 1, paragraph 727- 530(3)(c)]

11.88 The losing or gaining entity cannot be an active participant. [Schedule 15, item 1, paragraph 727- 530(3)(d)]

When does one entity control another (for value shifting purposes)?

11.89 The circumstances in which one entity can be said to control another are set out in Subdivision 727-E of this bill. This Subdivision sets out an exclusive code for control (for value shifting purposes). [Schedule 15, item 1, section 727-375]

11.90 However, these tests share characteristics of control tests drawn from other areas in the existing income tax law, for example, provisions dealing with CFCs (Part X of the ITAA 1936), thin capitalisation (Division 16F of the ITAA 1936), trust losses (Schedule 1F to the ITAA 1936) and share value shifting (Division 140 of the ITAA 1997).

11.91 There are separate control tests for companies, fixed trusts and non-fixed trusts. These tests cater for the particular characteristics of each entity.

11.92 In applying the percentage stake tests referred to in paragraphs 11.94 and 11.95, double counting of direct and indirect interests is prevented [Schedule 15, item 1, section 727-370] . This is discussed in paragraphs 11.112 to 11.114.

When does an entity control a company?

11.93 There are 3 tests for control of a company, which are similar to those which apply in the CFC provisions. They are the:

•

50% stake test;

•

40% stake test; or

•

actual control test.

[Schedule 15, item 1, section 727-355]

50% stake test

11.94 An entity controls a company if, alone or together with its associates, it has at least 50% of voting, dividend or capital rights in the company, either directly or indirectly. [Schedule 15, item 1, subsection 727-355(1)]

40% stake test

11.95 An entity (the test entity) also controls a company if, alone or together with its associates, it has at least 40% of voting, dividend or capital rights in the company, either directly or indirectly. However, a 40% or more stake is not enough to establish control if there is another entity that alone, or with its associates (other than the test entity and its associates), in fact controls the company. [Schedule 15, item 1, subsection 727-355(2)]

Actual control test

11.96 An entity also controls a company if, alone or together with associates, it actually controls the company. Control here takes on its ordinary meaning, and this test recognises that there are some circumstances in which control can exist in the absence of the tracing tests being satisfied. For example, an entity may own a 30% interest in a company whose board of directors is accustomed to acting upon that entitys instructions. Such an entity controls the company for value shifting purposes. [Schedule 15, item 1, subsection 727-355(3)]

When does an entity control a fixed trust?

11.97 A fixed trust is a trust in which entities have fixed entitlements to all of the income and capital of the trust [Schedule 15, item 40, definition of fixed trust in subsection 995-1(1) of the ITAA 1997] . Generally, an entity has a fixed entitlement if it is a beneficiary with a vested and indefeasible interest in a share of the income or capital of the trust. Fixed entitlement takes on the same meaning as in the trust loss rules in Division 272 of Schedule 1F to the ITAA 1936.

11.98 There are a number of tests for determining control of a fixed trust. These are:

•

the 40% stake test; and

•

tests that reflect an entitys position to control the trust.

[Schedule 15, item 1, section 727-360]

40% stake test

11.99 An entity controls a fixed trust if, alone or together with associates, the entity has the right to receive (either directly or indirectly through one or more interposed entities) at least 40% of any distribution of income or capital of the trust (that could be made) to members of the trust. [Schedule 15, item 1, subsection 727-360(1)]

Other tests

Tests based on control of the trust income or capital

11.100 An entity also controls a fixed trust if the entity, or an associate (relevant entity):

•

either alone or together with associates, has the power to obtain the beneficial enjoyment of the trusts income or capital;

•

can control in any way at all, the application of trust income or capital; or

•

can under a scheme, gain that enjoyment or control.

[Schedule 15, item 1, paragraphs 727-360(2)(a) to (c)]

Trustee tests

11.101 A relevant entity controls a fixed trust if it can remove or appoint a trustee of the trust. [Schedule 15, item 1, paragraph 727-360(2)(e)]

11.102 A relevant entity also controls a fixed trust if a trustee is accustomed, or under an obligation, or might reasonably be expected to act in accordance with that entitys directions, instructions or wishes. [Schedule 15, item 1, paragraph 727-360(2)(d)]

11.103 Whether a trustee is accustomed or might reasonably be expected to act in accordance with the directions, instructions or wishes of another is determined having regard to all the circumstances of the case. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions, instructions or wishes would not prevent the examination of the actual circumstances to determine whether an entity controls the trust.

11.104 Some factors which might be considered include:

•

the way in which the trustee has acted in the past;

•

the relationship between the entities and the trustee;

•

the amount of any property or services transferred to the trust by the entities; and

•

any arrangement or understanding between the entities and a settlor or persons who have benefited under the trust in the past.

When does an entity control a non-fixed trust?

11.105 A non-fixed trust is a trust that is not a fixed trust [Schedule 15, item 62, definition of non-fixed trust in subsection 995-1(1) of the ITAA 1997] . Basically, if there is any discretion as to which beneficiaries will receive a share of the income or capital of the trust, that trust will be a non-fixed trust. Trusts that have both fixed and non-fixed elements (hybrid trusts) are non-fixed trusts.

11.106 There are 2 categories of tests for control of a non-fixed trust. These tests look to:

•

the relationship between the entity and the trustee; or

•

who can control or benefit from the trusts income or capital.

[Schedule 15, item 1, section 727-365]

Trustee tests

11.107 An entity controls a non-fixed trust if it (or an associate) is a trustee of the trust, or can remove or appoint a trustee of the trust (either alone or together with associates). [Schedule 15, item 1, paragraphs 727-365(1)(a) and (b)]

11.108 An entity also controls a non-fixed trust in situations where the trustee is:

•

accustomed to act;

•

is under some formal or informal obligation to act; or

•

might reasonably be expected to act,

in accordance with the entitys directions, instructions or wishes [Schedule 15, item 1, paragraph 727-365(1)(c)] . This applies whether or not the directions, instructions or wishes are those of the entity alone, or of the entity and any other entity [Schedule 15, item 1, subparagraphs 727-365(1)(c)(i) and (ii)] .

11.109 This extends to situations where those directions, instructions or wishes are of an associate of the entity, or of an associate and any other entity [Schedule 15, item 1, subparagraph 727-365(1)(c)(ii)] . In this case, the relationship of the associate and the trustee will be enough to satisfy the control test.

Tests based on control of the trust income or capital

11.110 An entity also controls a non-fixed trust if the entity, either alone or together with associates, has the power to obtain the beneficial enjoyment of trust income or capital, or can control in any way at all, the application of trust income or capital, or can under a scheme, gain that enjoyment or control. [Schedule 15, item 1, subsection 727-365(2)]

11.111 An entity also controls a non-fixed trust if it, or any of its associates, can benefit under the trust (other than because of a fixed entitlement to income or capital of the trust). This test focuses on the capacity of an entity, or an associate, to receive capital or income of a trust. For example, any entity that is an object of a discretionary trust will be taken to control the non-fixed trust. An entity will also have the required control if it, or it and its associates, have a right to receive 40% or more of any distribution of trust income or capital. [Schedule 15, item 1, subsection 727-365(3)]

How are interests traced when applying the stake tests?

11.112 The stake tests measure control in terms of percentages. Any capacity to exercise voting power, or other entitlement that an entity may have, must take into account both direct and indirect interests. This requires the entity to trace through interests held in interposed entities, where those entities have a direct or indirect interest in the relevant entity.

11.113 Section 727-370 provides that where a direct and indirect interest gives rise to the same percentage being counted twice, the indirect interest is to be ignored.

11.114 This rule applies in working out the amount of voting power an entity (alone or with associates) has or can control, and its interest in any rights to receive dividends or capital from a company, or distributions of income or capital from a trust.

Active participation and direct facilitation

How are these concepts relevant to the value shifting measures?

11.115 An entity that has actively participated in, or directly facilitated, the entering into or carrying out of a scheme, may be subject to the value shifting provisions because:

•

the entity is an affected owner of an interest in the entity that is the target entity for the direct value shift [Schedule 15, item 1, paragraphs 725-80(c) and 85(f)] ; or

•

the entity is an affected owner of an interest (direct or indirect) in the entity that is involved in the indirect value shift [Schedule 15, item 1, subsection 727- 530(1), item 5 in the table] .

11.116 An entity may actively participate or directly facilitate a scheme under which the value shift occurs, even if it does not satisfy any of the control tests (for value shifting purposes) as set out in Subdivision 727-E.

11.117 It is recognised that it is easier to implement a value shifting scheme in the absence of control where the entity is closely-held. Consequently, the active participant tests only apply if the target entity, or losing entity and gaining entity, have fewer than 300 members.

When does an entity actively participate in a scheme?

11.118 Active participation is not a term of art and takes on its ordinary and natural meaning. It is a term of limitation because mere participation in the scheme is not enough, there must be active participation. Consequently, not all forms of involvement in a scheme will amount to active participation.

11.119 Whether an entity has actively participated in or directly facilitated a scheme is a question of fact to be decided having regard to all of the circumstances. Whilst an exhaustive list of all circumstances that satisfy this test cannot be made, some guidance can be given.

11.120 The Macquarie Dictionary defines active as in a state of action , in actual progress or motion and capable of exerting influence . Participate means to take or have a part or share, as with others .

11.121 There is no requirement for the participation to involve other entities, although often it will. This is because participation must be interpreted in the context of the scheme. Scheme is defined broadly in the ITAA 1997 and includes a unilateral course of action. Consequently, an entity can participate in a scheme by acting alone.

11.122 Active participation can involve the doing of some act that is capable of exerting an influence over the scheme from which the value shift arises. The participation must take place in connection with the scheme; there is no need to show that there is a nexus between the acts or conduct that make up the active participation and the value shift.

11.123 Furthermore, the importance of the act to the success or effect of the scheme, whether great or slight, is not a relevant consideration.

11.124 Generally, the existence of a common purpose or agreement between parties to a scheme will result in the active participation test being satisfied. However, this is not a prerequisite.

11.125 Typically, actions such as voting for a value shift proposal, or arranging for economic benefits to be provided under a scheme, will be actions that amount to active participation in the scheme. These are actions that promote the performance of the scheme.

Example 11.9

Lachlan, Helen and Emmalee are shareholders and directors in The Shack Pty Ltd, a closely-held company with 3 members. Emmalee holds only a 10% interest, but under the Articles, must consent to all changes in the capital structure of The Shack Pty Ltd.

Lachlan and Helen, as directors, prepare and pass the resolutions for the variation of share rights as between the shares, affecting the market value of all interests. Emmalee gives her consent.

Emmalee has actively participated in a scheme under which a direct value shift has arisen. The giving of consent is sufficient to amount to active participation.

11.126 It is not necessary to point to any single act that the entity has done, and which has resulted in a value shift, in order to show that it has actively participated in the scheme. For example, the value shifting provisions will apply where an entity encourages or counsels others to embark upon the scheme that results in the value shift. This encouragement may comprise the taking of preparatory action that sets the scheme in motion, or the exerting of any kind of pressure upon others to implement the scheme.

11.127 In these circumstances, the policy of the law is to apply the value shifting provisions because it cannot be said that the entity is merely a fortuitous recipient of the benefits of the value shift without any involvement.

Active compared with passive

11.128 The word active is used in contradistinction with passive . The Macquarie Dictionary defines passive as not acting with open or positive action , being acted upon or the object of action by another.

11.129 An entity can participate, or become involved, in a scheme even if it does not engage in some positive action, or is subjected to the actions undertaken by another. However, if an entity has done no more than received the benefit of the value shift, then it cannot be said that it has actively participated in the scheme.

Knowledge requirements

11.130 The concept of active participation requires there to be a degree of knowledge of the scheme. An entity cannot be said to actively participate in a scheme where it does not have some appreciation of the consequences of its participation in the context of the scheme. This is consistent with the position that entities that have acted inadvertently are intended to be brought within the value shifting measures.

11.131 The degree of knowledge required is at least some awareness of the existence of the scheme. There is no need for the entity to be fully aware of each and every step of the scheme, nor of its precise nature. Neither is there any requirement for a common agreement between the entity and others that have entered into or carried out the scheme.

11.132 Knowledge of the scheme will not of itself result in an entity coming within the scope of the value shifting rules. There must be some conduct amounting to participation in the scheme (for direct value shifting) or the provision of economic benefits (for indirect value shifting) or direct facilitation. However, simply observing the scheme unfold or merely acquiescing is not enough to bring an entity into the value shifting provisions.

What amounts to direct facilitation?

11.133 The words direct facilitation expand the types of conduct that attract the value shifting provisions. There are many ways in which an entity might help bring about, or facilitate, a value shift. Some of these ways will amount to active participation, but direct facilitation is a wider concept than this.

11.134 Direct facilitation is a wider concept than active participation in 2 significant ways:

•

an entity may facilitate a scheme through an act or omission; and

•

an entity that facilitates a scheme need not be a party to the scheme.

11.135 As with active participation, the entity doing the facilitation must have some knowledge or awareness of the scheme.

Acts or omissions

11.136 An entity can facilitate the entering into or carrying out of a scheme by an act or omission. Facilitation occurs when that act or omission helps forward the scheme, or makes it easier or less difficult for the scheme to be entered into, or carried out.

11.137 A failure to act can facilitate a scheme where the entity is under a specific duty to act, or may exercise a right, but refrains from doing so. For example, a shareholder may be aware of a breach of the Corporations Act 2001 , or a beneficiary of a breach of trust, that occurs in the course of a value shifting scheme but is content to ignore it. Such inactivity constitutes a departure from simply observing the scheme, and brings the entity closer to being a participant in the scheme.

11.138 Direct facilitation is a conduct based test. It looks at what was done by an entity, or what that entity failed to do, and evaluates the significance of the act or omission in light of the scheme as a whole. It connotes a lower degree of involvement in the scheme to that of an entity that actively participates in a scheme.

11.139 The casual link that is required between the act or omission and the promotion of the scheme is a direct one. It is not enough for the act or omission of the entity to have made it easier for the scheme to be implemented in some remote, roundabout or insignificant way. The effect must be such that it can be said that the act or omission has contributed directly and immediately to the progression of the scheme.

Example 11.10

Suz and Kathy are the only shareholders in Nic Pty Ltd. Suz holds both pre-CGT and post-CGT interests, that together amount to only 25% of the voting power in Nic Pty Ltd, with Kathy holding the other 75%. Suz has a right of veto in respect of most matters.

Kathy proposes a scheme that will shift value between the pre-CGT and post-CGT interests owned by Suz. The resolution is passed after a vote is held. Suz abstains, and fails to exercise her veto.

Suz is potentially caught within the scope of the DVS rules because her failure to exercise the veto has directly assisted the successful implementation of the scheme. Here, although Suz has not done anything, that omission amounts to active participation in, or direct facilitation of, the scheme.

11.140 An entity that has directly facilitated the scheme may not be a party to the scheme, whereas an active participant will invariably be a party to the scheme. It follows from this that, as with active participants, there need not be an agreement or common purpose as between the entity facilitating and others involved in the scheme.

11.141 Whether an act or omission has directly facilitated a scheme is a question of fact that is to be determined having regard to all of the circumstances.

Consequential amendments

11.142 There are consequential amendments. A discussion of these is included in Chapter 12.