Guidance paper: Negative Control and the application of Division 6C

Transcription

1 2 September 2015 Guidance paper: Negative Control and the application of Division 6C QUALIFICATION THIS DOCUMENT IS A DRAFT. IT SHOULD NOT BE TAKEN AS AN INDICATION OF ANY SETTLED ATO VIEW, NOR SHOULD IT BE TAKEN TO REPRESENT THAT THE ATO WILL ISSUE A FINAL POSITION IN THIS FORM.

2 Table of Contents Introduction...3 Background...4 Past ATO Guidance...7 Feedback from stakeholders...7 Appendix 1 Simplified privatisation structure Appendix 2 Negative control clauses and implications PAGE 2

3 Introduction This draft guidance paper is part of the ATO Privatisation and Infrastructure project (the Project Team) initiative in consulting and providing guidance on issues of relevance to the infrastructure industry. This paper concerns the implications of security holder veto rights from the perspective of control under the Public Trading Trust regime of Division 6C to the Income Tax Assessment Act 1936 (abbreviated to ITAA 1936 herein). The paper sets out the ATO s position regarding veto rights constituting negative control for the purposes of Division 6C. Feedback from several members of the Australian legal and accounting community have been summarised and an analysis provided. PAGE 3

4 Background Infrastructure and privatisation project initiative In January 2015, the Project Team initiated a public consultation whereby interested parties were invited to provide feedback in respect of a particular tax issue relating to the anticipated privatisation of a number of government businesses, and infrastructure investment more generally. The issue of when a power of veto can constitute negative control for the purposes of section 102N of Division 6C of the ITAA 1936 was commonly raised as an area of uncertainty. The public was invited to provide their views on examples of clauses that are commonly found in shareholder agreements, constitutions or similar documents and an outline on why those clauses support, or fail to support, the existence of control over the affairs and operations of the trading business. The consultation was closed for submissions on 17 April 2015 and the Project Team had received written feedback from the following parties: KPMG on 27 February 2015 PriceWaterhouseCoopers 2 March 2015 Deloitte 2 March 2015 Ernst & Young 12 March 2015 Law Council of Australia 28 Aril 2015 Negative control issue in privatisations The typical privatisation structure which is central in the current issue is provided in Appendix 1. The critical question raised by industry is whether one or more of the Investor Trusts in the structure controlled or was able to control the trading business being conducted by Operating Entity for the purposes of paragraph 102N(1)(b) of the ITAA The consequences to an Investor Trust of meeting the control test in section 102N are that: the trust will be a public trading trust (if the trust is also a public unit trust) under section 102R of the ITAA 1936; and the trust cannot qualify as a managed investment trust under section of Subdivision 12-H of Schedule 1 to the Taxation Administration Act Paragraph 102N(1)(b) provides that: For the purposes of this Division, 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: (a). (b) 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. Generally, the question of control arises not by virtue of the level of ownership (each Investor Trust generally owns less than 40% of the Operating Entity), but because of the existence of a power of veto in various constituent documents and other agreements which may be exercised by an investor or an entity acting on behalf of the investor (for example, a director of Operating Entity appointed by the investor). They are referred to as a power of veto because they allow the investor (or person acting on behalf of the investor) to prevent or block a decision being made by the Operating Entity on a particular topic. There are a range of different types and sources of these veto powers. Broadly they relate to matters concerning Investor Trust s investment in Operating Entity and matters related to the running of Operating Entity. They generally require the approval of a super-majority of investors or persons acting on behalf of the investors. They tend to be in respect of, or a mixture of: PAGE 4

5 (a) the actual business functions and activities of the trading business of Operating Entity, or (b) the governance and management of its business or structure (e.g. board membership, dividend policy). The key question is if, and when, the existence of such veto powers will be considered sufficient to give the investor trusts control of Operating Entity. Section 102N of the ITAA 1936 Historically under the classical system of taxation, business activities were tax advantaged by utilising trusts in preference to companies, as tax was levied on both companies and company distributions to shareholders. Trust arrangements, on the other hand, were not subject to the same dual layer of taxation. The introduction of dividend imputation, removed some, but not all, of the tax advantages arising through the use of trusts. Division 6C was introduced in 1985 and was intended to stem the increasing use of trusts to avoid the company tax arrangements. Specifically, the intention was to ensure that certain public unit trusts were not used to conduct trading business normally undertaken by companies, thereby escaping company tax by exploiting the flow-through nature of trust taxation. The Division operates by subjecting public unit trusts that are public trading trusts to taxation in a modified way. The modifications, very broadly, equate the taxation of the trust to that of a company. The trust is assessed at a corporate tax rate on the net income and presently entitled beneficiaries are treated equivalently to shareholders in receipt of dividends. However, provided unit trusts limit their investments to essentially passive investments - defined as eligible investment business in section 102M of Division 6C - they can preserve their trust taxation status. The E.M. to Taxation Laws Amendment Bill (No. 4) 1985 explained the application of the Division as follows: Division 6C will apply to unit trusts that are public unit trusts and operate a trade or business, other than a business that consists of investing in land or an interest in land for rental purposes, or of investing or trading in equities or securities, or a combination of these activities. Paragraph 102N(1)(b) provides that 102N(1) For the purposes of this Division, 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: (a) ; or (b) 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 (emphasis added). A trading business is defined in section 102M to mean any business that does not consist wholly of eligible investment business. In terms of paragraph 102N(1)(b), the E.M. to Taxation Laws Amendment Bill (No. 4) 1985 described the intention of the provision as follows: Paragraph (b) of section 102N is a safeguarding provision against arrangements to circumvent the operation of Division 6C by having activities that would constitute a trading business of a public unit trust carried on by an associated entity. By taking income from the associate in the PAGE 5

6 form of eligible investment income, the trust could otherwise ensure that the relevant trust did not qualify as a trading business and so avoid the operation of Division 6C. Section 102N will apply in relation to an entire year of income if at any time during the year the trustee satisfies the condition in 102N(1)(b). The use of the past tense of controlled or was able to control indicates that the test is able to be applied on a look back basis at the end of an income year having regards to the circumstances that arose during the year. In light of this context, it can be observed that the test requires three key elements to be satisfied. 1. Controlled or was able to control, directly or indirectly This element of the test looks not only at whether the trustee actually controlled the relevant affairs and operations but whether the trustee was able to control such matters in the relevant period. The test, therefore, contemplates that an entity other than the trustee may have control at a particular time but nevertheless requires consideration as to whether the trustee had the ability to control such matters, despite not having exercised it. There reference to directly or indirectly recognises that the ability to control can exist through an interest in a subsidiary or relationship with an interposed entity that may legally control of the person carrying on the trading business. 2. The affairs or operations of another person This element of the test looks to control of or ability to control the affairs or operations of another person rather than control of the person themselves. Consistent with the purpose of the provision, the test is applicable to arrangements where there is practical or de facto control of such matters. Depending on the relevant facts and circumstances, control or the ability to control these matters may be separate to the legal ability to control the person, through voting rights. 3. In respect of the carrying on of a trading business Consistent with the purpose of the provision targeting arrangements to circumvent the eligible investment business rules by having activities that would constitute a trading business being carried out by associate, the relevant affairs and operations of the person to which the provision is directed are those that go to the trading business actually being carried on. Whether the affairs and operations subject to the trustee s control go to the trading business being carried on will be a matter of fact in each circumstance. PAGE 6

7 Past ATO Guidance The ATO has previously released two interpretive decisions which provide that a trustee s power of veto can be sufficient to give the trustee control of a trading business for the purposes of section 102N ATO ID 2011/11 Trading trust: meaning of control and affairs and operations of another person and ATO ID 2003/162 Public Trading trust: meaning of control. As part of this consultation process, the Project Team was asked to review the interpretive position reached in the ATO ID s in light of feedback from stakeholders and to provide further guidance to industry on if, and when, a power of veto will be considered to provide negative control of a trading business. Feedback from stakeholders This section will discuss the various arguments put forth by the community and our opinion of agreement and disagreement. Contention 1: Control refers to de-facto rather than legal control Some submissions indicated that the context and wording of 102N indicated that phrase controlled or able to control should not be interpreted as being limited to the strict legal tests of control based on majority shareholding. It should be capable of applying to de facto control. ATO response We agree with this position. As the terms control or controlled are not defined for the purposes of Division 6C, they must be construed according to their natural meaning having regard to the context and legislative purpose of section 102N. As explained in Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue context refers very broadly to encompass the existing state of the law, the mischief the law is designed to overcome and the objects of the legislation. The plain meaning of control as defined in the Australian Oxford Dictionary (2004) is: Control noun 1. the power of directing, command: under the control of. 2. the power of restraining, especially self-restraint. 3. a means of restraint; a check. 4. transitive verb (controlled controlling) 1. have control or command of; dominate. 2. exert control over; regulate. 3. hold in check; restrain: told him to control himself. PAGE 7

8 4.. This plain meaning has to be read in light of the purpose of section 102N being a safeguarding provision to avoid arrangements to circumvent Division 6C and the broader objects of Division in seeking to ensure that trust taxation is limited to public unit trusts that carry on activities that constitute eligible investment business. It also has to be read in light of the surrounding words paragraph 102N(1)(b) as shaped by this element of context. There is an established case law principle that where a provision in a revenue statute refers to control of a company, it should be taken to be a reference to a member of a company that has sufficient shareholding to give a total of more than 50% votes at a general meeting of the company. 1 However, this principle is not applicable to paragraph 102N(1)(b). Rather than enquiring as to whether a company is controlled by the trustee the plain words of the statute ask whether the trustee controls or is able to control, directly or indirectly, the affairs or operations of a person. The EM makes it clear that what section 102N is targeting is control or the ability to control the activities that would constitute a trading business of an entity. In defining what activities the section is concerned with, the legislature has used the terminology affairs or operations in respect to the carrying on of a trading business by that person. In ATO ID 2011/11 it was concluded that: the term affairs is not defined in the Tax Act. On ordinary concepts, the affairs of a person includes their business and internal affairs 2 and in the context of a company, Winn J in R v Board of Trade, ex parte St Martin Preserving Co Ltd 3 said: the phrase affairs of the company comprises all its business affairs, interests or transactions, all its investment or other property interests, all its profits and losses, and its goodwill. The term operations, on the other hand, is explained in the singular in the Australian Oxford Dictionary as (i) an action, or process or method of working or operating; (ii) an active process, a discharge of a function; and (iii) a piece of work, especially one in series. It would seem then that the word operations has a narrower meaning than affairs and would sit more comfortably as a reference to the day to day business. In the case of a company, case law has drawn a distinction between control of the business of a company (encompassing its affairs and operations) and control of a company as summarised by Stephen, Mason and Wilson JJ in FCT v Commonwealth Aluminium Corporation Ltd (1980) 143 CLR 646 at , who said: It is idle to suggest that it is the shareholders who ordinarily control the business and the business activities of a company. Their participation is generally limited to the receipt of annual accounts and reports of directors, the approval of these accounts and reports and to the election of directors at the general meeting. Important decisions, whether involving questions of policy or not, are invariably taken by the directors who are ultimately responsible to the company in general meeting for the conduct of the business operations. The 1 See for example Mendes v Commissioner of Probate Duties (Vic) (1967) 122 CLR 152 ( Mendes ) and WP Keighery Pty Ltd v Federal Commissioner of Taxation (1957) 100 CLR 66 2 Re National Foods Ltd (Nos 1 and 2) (2005) 54 ACSR 80 at [55]. 3 R v Board of Trade, ex parte St Martin Preserving Co Ltd [1964] 2 All ER 561 at 568 PAGE 8

9 shareholders, through their power to control the company in general meeting and perhaps through their power to elect directors, may be said to 'control' the company, but as a general rule they do not exercise de facto control of the company's business. Of course, there will be cases in which the evidence establishes that some shareholders or outsiders do exercise de facto control of the business and possibly there may be cases in which shareholders exercise control of the business at general meetings. In asking whether the trustee controlled or had the ability to control the activities of a person which constitute their affairs or operations in respect of trading business carried on by that person, it is apparent that parliament intended that control be given a broad meaning which encompasses de facto control of these aspects of the trading business as well as legal control. An interpretation which limited the meaning of control to strictly legal corporate control would unjustifiably restrict the natural meaning of the word as supported by the statutory context of section 102N. This position is consistent with the position outlined in ATO ID 2011/11 where it was stated: Given that paragraph 102N(1)(b) of the ITAA 1936 is a safeguarding provision, the concept of 'control' and its variants which determine the provision's application should be given the wide meaning which accords with its intention and not be constrained by conventional notions of corporate control. Contention 2: Control must be positive and active Some submissions argued that a power of veto can never amount to control because veto powers are negative powers that provide no active control over a business. They submit that a line of revenue cases including Mendes and Federal Commissioner of Taxation v West Australian Tanner s & Fellmongers Ltd (1945) 70 CLR 623 (West Australian Tanners) support the position that control (or the ability to control) must be positive and active for the purpose of section 102N. ATO ID 2011/11 makes no reference to these decisions. Some submissions argued that the phrase able to control did not indicate that a broader interpretation of control than referred to in the case law concerning control of a company was warranted. Rather, it was suggested that the in order to give section 102N its intended effect, there must be a nexus between the ability to negatively control and actual control. Having the ability to control still requires that once the ability is exercised, actual control occurs. Submissions also argued that the decision in Re The News Corporation Ltd (1987) 15 FCR 227 (News Corporation) should not be given the weight of authority as given by the ATO because the decision was in relation to a markedly different and non-revenue statute (namely the Broadcasting and Television Act 1942). ATO response We disagree with this position. As explained above, because the term control is not defined for the purposes of Division 6C, it must be construed according to its natural meaning having regard to its context and the legislative purpose served by paragraph 102N(1)(b). The plain meaning of the word control as supported by context encompasses a power to restrain. There is nothing in the decisions in Mendes or West Australian Tanners which would lead to the conclusion that this natural meaning should be constrained in the context of 102N. In Mendes, two shareholders of a company (the deceased and the deceased son) had control of certain matters by virtue of the rights attaching to the different class shareholdings, The court was required to determine whether the company was controlled by the deceased for the purposes of paragraph 7(2)(b) of the Probate Duty Act 1962 (Vic) which provided that, for the purposes of paragraph 7(1)(d), shares issued at any time by a company which was controlled by the deceased to PAGE 9

10 another person, otherwise than for a full consideration in money or money's worth, were deemed to have been property the subject matter of a gift by the deceased. The court concluded that the company was not so controlled but rather that the shareholders had control only in respect of those certain matters. Divided control was not sufficient for the purposes of the section in question. Kitto J stated that 4 : The deeming provisions of s. 7 (2) (b) are expressed to apply, not where a company was partially controlled by the deceased, or was controlled by him in respect of most topics, or in respect of the most important topics or those of most common occurrence, or even all topics that might relate to the ordinary operation of the company as a going concern, but where it was controlled by the deceased - controlled by the voting rights of the deceased in no less than the whole of the possible agenda of a general meeting - controlled because the company in general meeting could pass no resolution against his opposition and must pass any resolution he should support, not perhaps as a special resolution and so achieve a particular legal result, but at least as an ordinary resolution. To interpret the provision in this sense is, of course, to leave outside its operation many cases in which the deceased had a preponderance of voting power in respect of so significant a range of matters that it might have been considered to be as surely in accord with the general idea of s. 7 (1) (d) to deem him to have controlled the company as to deem one whose preponderance of voting power extends to every matter within the competence of the general meeting. However, in coming to this conclusion, Kitto J placed particular emphasis on the statutory context and the plain reading of the section requiring control of the company itself rather than affairs of the company. In particular, his Honour held that 5 : The task of identifying the concept which the Act adopts when it refers to a "company which was controlled by the deceased", is, I think, not difficult when these considerations are borne in mind. The concept has to do in the first case with the general likelihood that the pecuniary advantage which the "donee" received by the issue to him of the new shares for less than their value was at the expense, mainly if not altogether, of the deceased. In the second case the description relates to the voting power which the deceased had and continued to have by virtue of his shares; for only by reason of a preponderance of his votes over all others that may be cast at a general meeting could one person's shareholding be regarded as qualifying, in a practical sense, the full possession and enjoyment of the shareholdings of others. The context therefore suggests strongly that what sub-s. (2) (b) means by the company having been controlled by the deceased is that the deceased's shareholding carried with it the power to out-vote all opposition in the company. To say this is of course to use the expression "the company", and to read sub-s. (2) (b) as using it, in its strict sense as meaning the corporation aggregate itself as distinguished from the board of directors which acts for it in the management of its affairs. The board binds the company by what it does within the authority which the articles of association confer upon it, but its decisions are decisions made for the company, not by it. Only the decisions of the company in general meeting are decisions of the company; and this is true however wide may be the powers of the board and however few and limited the powers of the general meeting. When, therefore, a statute makes the fact that "the company" was controlled by a deceased person a critical fact in respect of duty upon the estate of the deceased the prima facie meaning must be that the company in general meeting was controlled by the deceased in the only way in which it could be so controlled, namely by the aggregation in the hands of the deceased of shares carrying a majority of the votes that might be cast upon a poll. This is the conclusion to which I think one would come upon a study of sub-s. (2) (b) in the context in which it stands and without the aid of decisions upon other and different enactments. The reasons above given involve the rejection of one of the appellant's contentions, namely that control of the company, in this context, is to be decided by CLR 152 at CLR 152 at 160 PAGE 10

11 assessing the degree of ascendency which the deceased possessed in the general government of the company's affairs by the board as well as by the general meeting. I think the contention should be rejected as departing from the language of the statute by substituting "the affairs of the company", or some similar expression, for "the company". I think it should be rejected also as disregarding the nature and apparent object of the provision for the purposes of which sub-s. (2) (b) is enacted. And finally I think it should be rejected as being inconsistent with cases decided upon comparable enactments. (emphasis added) West Australian Tanners concerned the application of former subsection 103(1) of the ITAA 1936 and whether the company in question was a private company being a company which is under control of not more than seven persons. The Commissioner approached the section by aggregating the seven largest shareholders interests and given this amounted to a majority interest, concluded that the company was a private company. The High Court rejected the Commissioner s argument and agreed with the reasoning in Mendes that in the context of the section, the word control was to be construed as meaning there could only be singular control by 7 or fewer persons. As here there could be several groups of seven shareholders possessing majority shareholding when aggregated, no such control was said to exist. In contrast to the provision referred to in Mendes and West Australian Tanners, the interpretation of 102N does not ask whether the trustee had control, or was able to control a company. Rather the express language of the statute looks to control or the ability to control the affairs or operations of a person. As noted above, revenue case law distinguishes between control of the affairs and operations of a company and control of the company itself. The quote from Mendes above demonstrates this distinction and this was confirmed in Federal Commissioner of Taxation v Commonwealth Aluminium Corp Ltd (1980) 143 CLR 646 (Commonwealth Aluminium). Barwick CJ noted at that: There is no validity, in my opinion, in the proposition that, because, due to the shareholding, the non-resident companies had the capacity if they chose to exercise it to control a general meeting of the taxpayer, therefore they did in fact control its business in the tax years in question. Further, it is important to distinguish between control of the business and the control of a general meeting of shareholders. Whilst through the latter the business might possibly be controlled, it does not in the least follow that the control of a general meeting necessarily involved or resulted in fact in the control of the company's business. In News Corporation, Beaumont J summed up the various authorities as such 6 :.for the purposes of the revenue laws a member of a company who holds enough shares to give a majority of votes at a general meeting has "control" of the company. "That is the general rule. Control in that sense means the capacity to carry an ordinary resolution at a general meeting." See also Kolotex Hosiery (Australia) Pty. Ltd. v. The Commissioner of Taxation of the Commonwealth of Australia (1973) 130 CLR 64 per Mason J. at pp 77-8; (1975) 132 CLR 535 per Gibbs J. at pp On the other hand, in The Commissioner of Taxation of the Commonwealth of Australia v. Commonwealth Aluminium Corporation Limited (1980) 143 CLR 646, the meaning of "control" of a business by non-residents for the purposes of s.136(a) of the Income Tax Assessment Act 1936 was seen to be different. Stephen, Mason and Wilson JJ. said (at pp ) that shareholders, through their power to control the company in general meeting and perhaps through their power to elect directors, may be said to "control" the company, "but as a general rule they do not exercise de facto control of the company's business." Authorities such as Mendes were distinguished as being concerned with the different question of control of the company rather than its business (at p.660). The term person is not defined but consistent with the definition in section 6(1) it would be expected to encompass a legal person including a company. The reference to person rather than company is 6 Re The News Corporation Ltd (1987) 15 FCR 227 at 252 PAGE 11

12 consistent with the purpose of the provision in targeting arrangements where activities that would constitute a trading business are carried on by another entity. Such activities need not only be carried on by a company, in particular, given the entire Division is aimed at trusts carrying on trading business, it stands to reason that 102N would have to be broad enough to cover trading activities undertaken by a trustee in respect of another trust estate. If parliament intended to limit the control in section 102N to the same type of control of a company, as referred to in Mendes and West Australian Tanners, the reference to the ability to control the affairs or operations of a person would be unnecessary. Additionally, it is worth emphasising that parliament has chosen to differentiate between control of the affairs or operations of a person. Clearly it was within the contemplation of parliament that there could be scenarios where the facts were such that a trustee had control or the ability to control only the affairs or operations with respect to the trading business being carried on and yet such control be considered sufficient to engage the section. An interpretation of control within 102N that equated it to singular control of a company as found in Mendes would not give effect to that intention. Able to control Given what we have outlined above about the meaning of control in the context of the provision, we do not consider that in order to give section 102N its intended effect, there must be a nexus between the ability to control and actual control of a company as it is understood in cases such as Mendes and West Australian Tanners. The phrase able to control again has to be read in context as shaped by the purpose of the section. Again, what is being looked at here is the ability to control the affairs or operations of a person that go to the trading business being carried on. However, in order to be consistent with the purpose of the provision, we agree that the ability to control has to be more than a remote or hypothetical possibility. The Court explained in News Corporation when an entity would be in a position to control the company and discussed the distinction between a power being presently excisable versus being contingent, by reference to whether the exercise of the power relied on external factors being fulfilled or was incapable of exercise by the entity. 7 A power could be presently exercisable at a relevant time even if it had not been exercised. We consider that able to control the affairs or operations of a person in respect of the trading business being carried on means an ability which, based on the facts was or is presently exercisable even if it has not been exercised. News Corporation In regards to the decision in News Corporation referred to in ATO ID 2011/11, it is acknowledged that the broader statutory context is different to that of section 102N. The issue in News Corporation was whether a foreign person was in a position to exercise control of the company holding the licence. However, News Corporation confirmed that the ordinary meaning of control encompasses a power to constrain and that a power of veto, being a power to constrain can amount to control in the ordinary sense. Hence the statement from Bowen CJ that 8 : The second argument advanced by counsel for both groups of applicants was that, even if control of the board of directors be relevant, TNCL's power was only to appoint half of the board of NTHL and did not put it in a position to exercise control of that company. It was argued that a power of veto does not constitute control in the relevant sense. Control, it was said, exists only where there is a power to get one's own will. I do not agree that the concept of control is so limited. The Oxford English Dictionary defines "control" as "to exercise restraint or direction". A power to veto is a power to restrain, and 7 Re The News Corporation Ltd (1987) 15 FCR 227 at Re The News Corporation Ltd (1987) 15 FCR 227 at 243 PAGE 12

13 hence to control. This view of control accords, in general, with the view of the concept recently taken by the New South Wales Court of Appeal in North Sydney Brick & Tile Co. Ltd. v. Darvall (1986) 4 ACLC 539 at p 545 ; See also Re Kornblum's Furnishings Ltd (1982) VR 123 at pp ; and Re Herald and Weekly Times Ltd; T.V.W. Enterprises Pty Limited v. Queensland Press Ltd (1983) 7 ACLR 821 at p 838. Chief Justice Bowen concluded that a broad interpretation of the term control of a company better served the object and purpose of the act even if such an application would give rise to difficult questions of fact. In the case of 102N, an interpretation of control which required only active and positive control of a company does not accord with the language, object and purpose of the provision. A broader notion of control is consistent with an anti-avoidance provision that is situated in a Division of the act which is concerned with limiting the type of activities that can be undertaken by a trustee. It is reasonable to conclude that parliament would have intended a provision which was broad in scope and capable of applying to contrived arrangements by targeting the substance of the control rights rather than limiting it to strict legal tests of control. Contention 3: Control being a singular concept Some submissions argued that that control is a singular concept such that where more than one investor is able to exercise the power of veto then no one investor will have negative control for the purposes of section 102N. The argument relies on the same line of authorities including Mendes and West Australian Tanners which conclude that there can only be one controller of a company. ATO response We disagree with this position. As discussed above, paragraph 102N(1)(b) is not concerned with the concept of control of a company as explained in those cases. Additionally, in enquiring into where the trustee controlled or was able to control the relevant matters the paragraph specifically contemplates that in certain factual scenarios, there will already be a legal controller and despite this, the trustee may yet be able to control the affairs or operations of a person. There may well be factual scenarios, particularly where the investors are related parties, where shared negative control rights over matters that go to the affairs or operations of a trading business confer the ability to control that paragraph 102N(1)(b) was designed to overcome. However, the ATO acknowledges that in cases where there are shared negative control rights between unrelated investors, there may be more of a presumption that such rights are in the nature of protective minority interest holder rights rather than the type of control rights to which the paragraph was directed. Whether this is the case, however, will be a question of fact in each case. Contention 4: Veto rights relating to affairs or operations of an entity, other than those relating specifically to the carrying on of the trading business, should not impact upon Division 6C control We agree with this statement and acknowledge that this is something that was not clear on the face of ATO ID 2011/11. We also acknowledge that on the face of ATO ID 2011/11 it was difficult to discern when a matter would be considered to go the trading business being carried on. Accordingly, we have set out below some examples of veto rights which we consider would and would not go to the trading business being carried on and others where it would depend on the particular facts of the arrangement. The following table provides a summary of common shareholder clauses and how we believe they fall under the negative control spectrum. A more detailed explanation is provided in Appendix 2. PAGE 13

14 PAGE 14

15 Does negative control arise from a shareholder s veto rights? Likely Potentially Board members New investments Changes to Constitution Management Arrangements Management Business Plan / Annual Budgets Entry into business contracts Divestments Capital expenditure New indebtedness Termination or changes of Security holders Agreement Material change in business Delegations Operating expenditure Loans Dispute resolution and deadlock Guarantees Litigation Matters Related party contracts Entry into Lease Distributions Policy Capital structure Variation of security rights Initial Public Offering Entry into a Partnership or Joint Venture Transfer of securities Creation of new Group Entity Change of Trustee Regulatory Approvals Hedging Transactions Pension / Superannuation Winding up of the Entity Administration Third Party Advisors Annual Accounts Tax Registered Office Name of group Entities PAGE 15

16 Appendix 1 Simplified privatisation structure Investor Trusts separate trust for each investor) Land Trust ys Access (Iand+ fixtures)\ Access Fees Operating Entity (chattels) Long Term Lease Operating Revenue State Lessor Co Customers PAGE 16

17 Appendix 2 Negative control clauses and implications Negative control clauses either require that certain decision by approved by a super majority of the board of the directors or require a special resolution by a supermajority of shareholders. Whether a specific clause requires board or shareholder approval varies from case to case. Investor Agreements can have multiple tiers of approval requirements for the same activity depending in materiality. For example capital expenditure of more than $5 million that is not contemplated in the approved annual budget may require approval of two thirds of the board directors, whereas a new investment of more than $50 million will require approval by 80% of shareholders. Investor Agreements can also be structured such that minority investors will have different veto rights depending on their ownership level. For example an agreement could provide for both 75% shareholder reserved matters and 90% shareholder reserved matters. A minority investor with 30% shareholding will have veto power over both 75% shareholder reserved matters and 90% shareholder reserved matters, whereas a minority investor with 15% shareholding would only be able to exercise negative control over the 90% shareholder reserved matters. If only 75% shareholder reserved matters go to the carrying on of the trading business, then only the 30% investor would be able to exercise negative control for the purposes of section 102N. Clause type Clause control coverage Does negative control arise? Explanation Board members The appointment and removal of Board members (including the independent chairperson) Changes to the size of the board Change to any compensation to members of the Board Changes to directors professional liability insurance Likely Depending on the management structure of the entity, the Board members may have authority to makes decision regarding most of the day-to-day operating decision in respect of the business carried out by the entity. The power of appointment over a Board members who have veto powers in relation to operational matters will be an important consideration to establishing negative control Management Arrangements Appointment and removal of the CEO (and CFO) of the Company. The appointment or termination of any employee with a salary above [$250,000] or whose redundancy would cost over [$350,000] Likely Depending on the management structure of the entity, the CEO (or equivalent) would generally have authority to makes decision regarding most of the day-today operating decision in respect of the business carried out by the entity. The power of appointment over an entities CEO would be an important consideration to establishing negative control Where the senior employees have a high level of authority over the carrying on the trading business than as per appointment and removal of CEO it PAGE 17

18 Management Business Plan / Annual Budgets Implementation of, and amendments to, the Management Incentive Plan. Any approval or amendment of strategic and annual operating plans, including the annually revised Business Plans. Likely would be an important consideration. To the extent that members of senior management have high level of authority regarding the day to day operation of the business, and it is likely that the structure of the management incentive plan is likely to influence those decision, then veto of implementation or amendment of the incentive plan could contribute to establishing negative control The business plan is a key input into planning the carrying on of the trading business. As such a veto over the establishment or amendment over business plans would be highly influential in establishing negative control. Entry into business contracts Entry into, amendment or termination of any arrangement, contract or transaction with an aggregate value greater than [$20 million], including entry into, amendment or termination any financing debt facilities, guarantees, indemnities or hedging agreements where the amount of those facilities is in excess of [$20 million], Likely Entering into, variation and termination of business contract is fundamental aspect of carrying on a business. The power of veto over the ability of an entity to enter into contract would generally represent control in respect of carrying on business by that entity. Operating expenditure Ordering of any goods and services in excess of [5%] or those approved by the Budget Likely A veto power in relation to this activity would directly impact the operational activities of the underlying business, depending upon the actual goods/services in question and their importance to the operational activities. New investments Entity entering into or exiting any project or transaction (including any acquisition, disposal, investment, divestment, joint venture, partnership, indebtedness of any kind, redemption or early payment of loan capital) which has a value or consideration value greater than [$10 million], including any variation to any existing project or Possible fact dependent Negative control may arise depending on the materiality of the threshold, and the frequency at which decisions regarding new investments are made. Where the threshold is low and decisions to which the veto power relates are made frequently, then such veto power would contribute to a conclusion that the veto power gives rise to negative control. PAGE 18

19 transaction. Divestments Entity exiting from any project or divestment of any kind which has a value or consideration value greater than [$10 million], including any variation to any existing project or transaction. Possible fact dependent Negative control may arise depending on the materiality of the threshold, and the frequency at which decisions regarding divestments are made. Where the threshold is low and decisions to which the veto power relates are made frequently, then such a veto power would contribute to a conclusion that the veto power gives rise to negative control. Capital expenditure Approval for capital expenditure projects over [$10 million]. Possible fact dependent Depend on the materially of the threshold, and the frequency at which decisions regarding capital expenditure are made. Where decisions to which the veto relates are made frequently, then such a veto power would contribute to a conclusion that the veto power gives rise to control over trading activities New indebtedness Entity entering into any indebtedness of any kind, redemption or early payment of loan capital which has a value or consideration value greater than [$10 million]. Possible fact dependent Decisions regarding to enter new indebtedness would generally relate to the capital structure of an entity rather than the carrying on of a trading business. However, where the threshold is sufficiently low that decisions that relate to the working capital of the entity, such that the purchasing of goods or services on credit are likely to be within the veto power, then it would be regarded that the power of veto over new indebtedness would go toward establishing control over the carrying on of a trading business Loans Granting any loan or advance, or giving credit other than in the ordinary course of the business over [$20 million] Possible fact dependent The granting of loans would generally be an extraordinary event outside the dayto-day operation of carrying on a business. However, where the loans are granted / refinanced by the entity frequently and/or the loan/interest income is material to the overall business of the entity (e.g. intra-staple loans by the Property Trust), then veto power over granting of such a loan could go towards establishing negative control. Guarantees Giving any guarantee or indemnity to any person other than in the ordinary Possible fact As per granting of loans. PAGE 19

20 course of business. dependent Litigation Matters Starting, defending or settling any material legal proceedings or dispute over a certain threshold other than debt collection in the ordinary course of business over [$10 million] Possible fact dependent Depends on the materiality threshold. Related party contracts Entry into a contract with a related party for over [$50 million] Entering into any transaction with any security holder, or members of the security holders group or any director or officer holder of the security holder group Possible fact dependent Depends on frequency and materiality of related party dealings. Where an entity deals almost exclusively with related parties, then veto rights over contracts with related parties would likely result in control in respect of the carrying on business by that entity. Where the related party dealings are infrequent and immaterial, then the veto rights would generally not be regarded as going to establishing control over trading activities. Entry into Lease Entry into a lease (or other similar arrangements) requiring annual rental payments in excess of [$1 million] that are not approved by the budget Possible fact dependent Depends on frequency and materiality of leasing arrangements entered into party dealings. Changes to Constitution Any amendment to the constituent documents of the Company. The protection to veto a change to a company s constitution does not generally impact on the trading business. The constitution is in relation to the overall governance of a company. Termination or changes of Security holders Agreement Decision to terminate or change Security holders Agreement Security holders Agreement relates to overall governance. Termination of or changes to this agreement, of itself, does not impact the operational activities of the underlying business. Material change in business Material change in business. Material changes to business carried by an entity would be generally infrequent and by definition outside of ordinary course of carrying on a trading business. As such it would generally not be relevant establish negative control. Delegations Setting and implementing appropriate delegated authorities to the officers of the Group, including granting non transactional The veto right over creation and implementation of delegations by itself does not give control over the exercise of those delegations. PAGE 20

21 specific power of Attorney. Dispute resolution and deadlock If any disputes or deadlocks arise at the Board level and are not able to be resolved, these disputes will be referred to Security holders This relates to overall governance of the entity. This process, of itself, does not concern the decisions regarding the conduct of the trading business. Distributions Policy The establishment of or any change to the distribution policy of the Company. Decisions regarding the allocation of profits are separate to that of the carrying on of a trading business, would therefore generally not be relevant for establishing negative control Capital structure Any change in capital structure, including any issue of a new class of securities, reclassification of existing securities, buyback, redemption, purchase or cancellation of any securities or reduction of share capital in the Company other than on a pro rata basis to all existing Security holders. The decisions regarding the capital structure do not relate to the trading business but rather relates to the overall equity and funding structure of the company. Variation of security rights Changes in the rights attaching to any securities issued in the Company. Decisions regarding the variation of security rights are an investor protection and should not impact the trading business but rather relates to the equity structure of the company. This decision does not directly impact the day to day operations and management of a business. Initial Public Offering A decision to proceed with investigating and preparing for an initial public offer of Securities, or a listing of the business, on a recognised stock exchange, and the ultimate decision to proceed with the IPO. The decision regarding an IPO of a company does not have any direct bearing over the day to day management of a trading business. Rather, it relates to the capital structure of the company. Entry into a Partnership or Joint Venture The entry by any group member into a partnership, joint venture or restructure, other than internal restructure that will not crystallise a material liability. The entry by any group member into a partnership, joint venture or restructure will generally go to the capital structure of the business, or the commencement of new business being carried. Such a veto right would not give control over control of the business currently being carried on. Transfer of Any decision by the parent company to transfer any or The Transfer or disposal on securities in subsidy a new group entity does not PAGE 21