To access certain small business concessions including temporary full expensing, small business CGT concessions, shorter review periods and FBT exemptions, entities such as sole traders, partnerships, companies and trusts must have an aggregated turnover threshold of under $10m. Essentially, an entity’s (ie test entity’s) aggregated turnover is its annual turnover, plus the annual turnovers of any business entities that are affiliated or connected to it.
Whether or not entities are connected is determined based on the concept of control. Where an entity (ie the first entity) has a control percentage of at least 40% but less than 50% in the test entity, the Commissioner of Taxation has discretion to determine that the first entity does not control the test entity. To make that determination, the Commissioner must “think” that the test entity is controlled by a third entity, or entities, that does not include the first entity or any of its affiliates.
The statutory condition for exercising the Commissioner’s discretion requires that the Commissioner positively conclude that there is actual control of the test entity by a third entity or entities. It is not sufficient to merely show that the first entity does not have actual control of the test entity.
Prior to the COVID-19 pandemic, the aggregated turnover threshold for being a small business entity (SBE) was less than $2m. Since then, however, the legislation has been changed to include businesses with aggregated turnovers of less than $10m. Due to this increase in threshold the issue of connected entities have taken on a new significance, leading the ATO to release a Taxation Determination to provide guidance on two specific issues of control.
The first issue the ATO has considered is the relevance of who has responsibility for managing day-to-day business. It notes that while the sole or primary responsibility for day-to-day management of the affairs of the test entity is not immaterial, it does not itself constitute control for the purposes of the Commissioner’s discretion. According to the ATO, this is because the nature of control in the statutory context is typically associated with ownership of a business entity or entitlements to income and capital of the entity, as well as participation in decision-making on key matters.
The second issue considered by the ATO is that applicants for the Commissioner’s discretion suggesting that their control percentage is between 40% and 50% should be disregarded because the remaining holders of interests in the test entity will together necessarily control the entity, irrespective of their relationship to each other. The determination clearly states that the ATO will not accept as correct that an entity’s control percentage between 40% and 50% should be disregarded. While the ATO may look beyond a single third entity for relevant control, the discretion will not be exercised merely on the basis of identifying a group of unrelated entities that, when individual control percentages are aggregated, holds interests in the test entity amounting to a control percentage of more than 50%.
In order to form a view that a group of third entities controls the test entity, the ATO would need to form a view that the group has agreed to operate, and does operate, as a single controlling “mind” when it comes to decision-making. The conclusion that there is a single controlling mind is more readily reached in circumstances if the group consists of associated entities in terms of common ownership or close familial relationships – a mere alignment of purpose (eg shareholders wanting to maximise profits) on certain issues will not be sufficient.