Focus: Positive guidance on negative control?
18 September 2015
In brief: Draft guidance targeting the infrastructure industry, particularly in the context of stapled property trust and operating company structures frequently used in infrastructure projects, has been released. Partner Charles Armitage (view CV), Managing Associate Judith Taylor and Lawyer David Lewis report.
- De facto control
- Negative control
- Shared negative control rights
- Whether veto rights specifically relate to trading businesses
- The future of the draft Guidance Paper
How does it affect you?
- Interested parties will be disappointed that the draft Guidance Paper largely reiterates arguments already put forward by the Commissioner in ATO ID 2011/11. The Commissioner has sought the views of interested parties, summarised them and then largely rejected them all. The Commissioner does not appear to have changed his position substantively.
- While the draft Guidance Paper does purport to provide some additional clarification as to which particular 'veto rights' exercisable by a trustee the Commissioner thinks will be indicative of 'negative control', it is unlikely, in its current form, to improve certainty or clarity for trustees.
- In any event, there is a qualification on the front of the draft Guidance Paper to the effect that this paper may not be an indication of any settled view of the Commissioner.
The Commissioner released a draft Guidance Paper entitled 'Negative Control and the application of Division 6C' on 2 September 2015. The paper is a response to submissions received by the Commissioner from the Law Council of Australia, and other interested parties, on the interpretation of the control tests in Division 6C of the Income Tax Assessment Act 1936 (Cth), which operates to tax certain 'trading trusts' like companies. The issue of what constitutes control in this context has been of particular interest in recent years, in the context of certain infrastructure projects that use a traditional stapled property trust and operating company structure, and investments made by managed investment funds.
The draft Guidance Paper purports to clarify the circumstances in which a trustee will be taken to 'control' the affairs or operations of another person regarding the carrying on by that other person of a trading business.
Interested parties had hoped that the Commissioner would reconsider the views he expressed in ATO ID 2011/11 regarding veto rights giving rise to 'negative control' for the purposes of Division 6C. However, the Guidance Paper effectively responds to a number of contentions put forward by such interested parties, and, in most cases, disagrees with them.
The draft Guidance Paper does purport to provide some additional clarification as to which particular 'veto rights' exercisable by a trustee the Commissioner would consider indicative of control over the carrying on of a trading business, along with the relative weights that the Commissioner might give to those 'veto rights'. However, the real benefit to the infrastructure industry of the additional information appears limited.
Section 102N(1)(b) provides that a unit trust is a trading trust in relation to a year of income if, at any time during the year of income, the trustee:
controlled, or was able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a trading business.
Consistent with the Commissioner's views to date, the draft Guidance Paper states that 'control' in this context is a broad notion of de facto control, rather than strict legal control.
The Commissioner takes the view (as originally expressed in ATO ID 2011/11) that 'control' in this context includes the ability to restrain a person's activities, such as through powers of veto.
In the draft Guidance Paper, the Commissioner concedes that the trustee's ability to exercise its power would need to be more than a 'remote or hypothetical possibility', and that the trustee's power would need to be 'presently exercisable even if it has not been exercised'.
Again drawing from ATO ID 2011/11, the draft Guidance Paper states that a trustee may, through its ability to exercise veto rights, have sufficient control over a person's carrying on of a trading business, even if other entities have the same rights to restrain the person's carrying on of the trading business.
However, if there are 'shared negative control rights' exercisable by several investors, this might be regarded as a legitimate protection of minority interests where the trustee and other investors are unrelated parties. In this situation, the trustee would not necessarily be considered to have control. However, if the investors who, together, were able to exercise the negative control rights were related parties, the position would be different and the trustee might be considered to have control.
The draft Guidance Paper also acknowledges that a trustee may have veto rights relating to the affairs or operations of a person carrying on a trading business but where those veto rights do not specifically relate to the carrying on of the trading business. It concedes that ATO ID 2011/11 was unclear on this point and that such veto rights would not give the trustee the requisite level of control to engage the provision.
The draft Guidance Paper then provides an extensive appendix, which is an attempt to classify different kinds of veto rights according to whether they are 'likely', 'potential – fact dependent' or 'unlikely' to give rise to the inference that the holder of the veto right controls the carrying on of a trading business by another person.
However, the draft Guidance Paper does not discuss how these factors are to be applied. For example, would the presence of one 'likely' factor mean that there is negative control? Or should countervailing factors be balanced against each other, as some of the language used in the appendix tends to suggest?
The factors considered in the draft Guidance Paper are as follows.
These types of veto rights are considered to be 'likely' to give rise to an inference of control of the carrying on of a trading business, as they would tend to give a trustee control over the key personnel, plans or resources available to conduct the trading business at a high level:
- board members – changes to composition, size, remuneration and insurance;
- management arrangements – changes to CEO, CFO and other senior employees;
- approval of management plan and budgets;
- entry into business contracts exceeding particular values; and
- approval of operating expenditure above a threshold outside of budget.
Potential – fact dependent
The draft Guidance Paper identifies that these types of veto rights are 'potential – fact dependent' to give rise to an inference of control of the carrying on of a trading business, and are more likely to do so if the relevant monetary thresholds are low and the decisions to which the veto power relates are required to be made frequently:
- making new investments;
- engaging in divestments;
- capital expenditure;
- taking on new indebtedness;
- granting loans;
- giving guarantees;
- starting, defending or settling legal disputes;
- entry into related party contracts; and
- entry into leases.
These types of veto rights are considered 'unlikely' to give rise to an inference of control of the carrying on of a trading business, because they generally relate to the capital structure and other arrangements as between holders of securities in the person carrying on the trading business, or they relate to conduct outside the ordinary course of the business:
- changes to the constitution;
- changes to security holders agreements;
- material change in business;
- delegations of authority;
- resolution of disputes arising within the board;
- changes to distribution policy;
- changes to capital structure;
- variation of security rights;
- engaging in an initial public offering;
- entry into a partnership or joint venture;
- transfer of securities;
- creation of new entities;
- change of trustee;
- complying with regulatory requirements;
- entry into hedging or other derivative arrangements;
- establishment of a pension or superannuation scheme;
- decision to wind up the person carrying on the trading business;
- appointment of an administrator;
- appointment of third party advisers;
- approval of accounts;
- filing tax returns and making tax elections;
- changes to registered office; and
- changes to names.
The cover sheet of the Guidance Paper states that the document is a draft and should not be taken as an indication of any settled view of the Commissioner, nor should it be taken to represent the Commissioner will issue a final position in this form. However, how the Commissioner intends to progress the paper remains a mystery. There is no invitation for submissions in response to the draft Guidance Paper, despite there being square brackets around thresholds listed in the appendix, suggesting that the Commissioner expects further input.
There is also no indication of what status the Commissioner intends the Guidance Paper to have when it is finalised. The Guidance Paper is not legally binding on the Commissioner.
We would strongly encourage a concerted push by relevant industry bodies to initiate further engagement with the Commissioner, with a view to achieving a shift in the Commissioner's views and providing some certainty for taxpayers in the context of real transactions. Without a coordinated and proactive reaction by the industry bodies, it seems likely the Commissioner will either leave the Guidance Paper in draft form indefinitely or finalise it without any meaningful improvement.
- Charles ArmitagePartner,
Ph: +61 2 9230 4756
- Judith TaylorSenior Tax Counsel,
Ph: +61 2 9230 4856
- Martin FryPartner, Practice Leader, Tax,
Ph: +61 3 9613 8610
- Marc KempPartner, Sector Leader, Funds,
Ph: +61 2 9230 4991
- Penny NikoloudisPartner,
Ph: +61 3 9613 8816
- Geoff SandersPartner,
Ph: +61 3 9613 8673
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