It’s been a while since my last post because, well let’s face it – there are more enjoyable ways to spend your free time than writing about tax. However, this week I had the opportunity to advise two separate clients on the small business CGT concessions and figured I would take it as a sign that I should finally continue my series on small business CGT concessions. Today’s post will be about connected entities.
When applying the aggregated turnover test (and similarly when applying the maximum net asset value test as we shall see in a future blog post) a connected entity’s turnover is taken into account. That is, when determining if aggregated turnover of a taxpayer is $2m or less, it is necessary to count the turnover of its connected entities. To do this it will obviously be necessary to first identity which entities are connected.
One entity is connected with another entity if either entity controls the other entity or both entities are controlled by the same third entity. When thinking about connected entities key number to remember is 40% because control will generally occur if the control percentage is 40% or more. However, the Commissioner does have the power to determine that control does not exist if the percentage is between 40 and 50% (say because another entity owns 50-60%). Remember also that control can be direct or indirect such as where an entity directly controls a second entity and this second entity directly controls a third.
There are different rules for establishing control for different types of entities so I will consider each separately;
A shareholder will have a 40% control percentage where, together with its affiliates (more on that in my next post) it beneficially owns shares that have the right to at least 40% of any dividends paid, any distributions of capital or voting power.
A unit holder will have a 40% control percentage where, together with its affiliates it beneficially owns units that have the right to at least 40% of any distributions of income or distributions of capital. Unlike companies there is no equivalent voting power test.
There are two ways an entity can control a discretionary trust.
The first way is by influencing a trustee – where the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates or the entity acting together with its affiliates (deep breath). Some of the factors to consider when determining this include
How the trustee has acted in the past
The relationship between the entity and trustee
The amount of any property or services transferred to the trust by the entity and
Any arrangement or understanding between the entity and any person who has benefited under the trust in the past
This test seems to have some strange consequences. On a strict reading, this rule seems to suggest that a sole director of a corporate trustee would be connected but not an individual acting in their own right as trustee. If the corporate trustee has two directors and decisions are made by them jointly neither one of them will control the trustee. Finally, according to the Commissioner, an appointor will control a discretionary trust, even if it has no day-to-day involvement.
The other way to determine control of a discretionary trust is to look at the pattern of distributions in the previous four income years (excluding the current year in question). A beneficiary controls a discretionary trust in an income year if at least 40% of the trust’s income or capital is paid/applied for the benefit of it and/or its affiliates.
Some things to note include;
According to new rules which apply to CGT events on or after 27 June 2011, if a trust is unable to establish a beneficiary-controller because it is unable make a distribution, the trustee may nominate up to 4 beneficiaries as controllers. This would occur where the trust had a tax loss or no net income and the trustee did not make a distribution of income or capital for that year.
It is income or capital but these are considered separately. If a beneficiary receives 35% of each they will not control the trust but a beneficiary who receives 40% of one and 0% of the other will.
Exempt entities and deductible gift recipients (e.g. charities) cannot be treated as controlling, regardless of the percentage of distributions made to them.
Even though a partnership is not a separate legal entity, it can be a connected entity. A partner will be connected with a partnership if he/she/it is entitled to receive at least 40% of the income or net income of the partnership or at least 40% of distributions of capital
These would probably be considered under the discretionary trust rules.
Although a super fund is a type of trust, the Commissioner’s view is that it will not be connected with any of its members or trustee. This opens up opportunities to reduce your net assets by contributing funds or assets into a super fund. Of course the contribution rules will need to be considered before doing this.
In my next post I’ll write about affiliates.