Associates and affiliates – are they one and the same?

Across the provisions

The Income Tax Acts refer to the terms ‘associate’ and ‘affiliate’ in various provisions such as Division 7A, small business CGT concessions, R&D tax offset, early stage innovation company tax offset, thin capitalisation, control foreign entities rules to name a few. When considering who is an ‘associate’ and who is an ‘affiliate,’ practitioners should keep front of mind that these terms are not one and the same.

Associate – general concept

An ‘associate’ is defined in section 318 of the ITAA 1936 and is most commonly relevant to Division 7A. Each of the four subsections determines who is an ‘associate’ of a specific type of entity called the ‘primary entity’. For an individual, associates include relatives (as defined), spouse, partnership in which the individual is a partner, a trustee of a trust where the individual or their associates are able to benefit under the trust, and a company that is sufficiently influenced or where majority interest is held by the individual or their associates.

Associate rules for a trustee of a trust

For a trustee of a trust or a company, the rules are more complex. The associate rules for a trustee applies the concept of a “benefitting entity”, being an entity that benefits or is capable of benefitting under a trust either directly or indirectly through any interposed companies, partnerships or trusts; and is established by the terms of the trust deed. In other words, an associate of a trustee (and thus the trust) is:

• any entity that benefits or is capable of benefiting under the trust;
• if a natural person benefits under the trust, any entity that would be an associate of that individual under the associate rules for a naturel person;
• if a company benefits under the trust (whether directly or indirectly), any entity that is an associate of the company under the associate rules for a company.

A discretionary trust usually has a wide range of potential beneficiaries including natural persons, companies, other trusts etc. The broad definition of who is an associate of a trust will capture potential as well as default beneficiaries regardless of whether or not they have actually benefited from the trust through the power of appointment. For example, if discretionary trust (D2) is an object under the terms of discretionary trust (D1), all the discretionary objects under the trust deed of D2 will be taken to able to benefit from D1.

Where a trust has made a family trust election, the family group of beneficiaries will usually be much smaller than the same trust’s associates, resulting in a situation where a beneficiary who is outside the family group (and thus Family Trust Distribution Tax would apply to any distribution made to them) is still an associate of the trust.  An example of this could be a cousin of any test individual, as cousins are not members of the family group.

Associate for a company

When determining who is an associate of a primary entity that is a company there are two alternate tests. The first test is based on the concept of the primary entity being sufficiently influenced by another entity or the primary entity being able to sufficiently influence the other entity that is a company by having regard to whether the test entity is accustomed, or under an obligation or might reasonably be expected to act in accordance with the directions, instructions or wishes of the primary entity, its associates (or both). The High Court brought clarity to what “sufficiently influenced” meant in BHP Billiton Limited v Commissioner of Taxation [2020] HCA 5. The Court decreased the benchmark from “effective control” to a “requisite degree of contribution” between the directions and actions of the company and such entities. In considering the requirement to satisfy the “sufficiently influenced” test, the behaviours between the entities must be assessed.

The second alternate test is based on majority voting interest (i.e., more than 50%) being held by the primary entity or its associates (or both).

What if I get it wrong…

A common potential risk of getting the associate relationship wrong could include unintended Division 7A consequences. To illustrate consider the following:

A company (Company) lent monies to a unit trust (Unit Trust) on interest free terms. The shareholders of the company are three unrelated discretionary trusts. The unitholders of the Unit Trust are three self-managed superfunds. Individuals A, B and C are the sole member of their respective SMSFs (the unitholders of the Unit Trust) as well as being beneficiaries of their respective discretionary trusts (who are the shareholders of the Company).

Is the Unit Trust an associate of one or more shareholders of the Company?

On face value, it appears there does not exist any associate relationship. However, the author notes in edited private binding ruling PBR 1012639258252, the ATO adopts a look-through approach in identifying the entity that benefits or is capable of benefiting under a trust. That PBR involved an arrangement where a SMSF is the sole unitholder of a Unit Trust and the members of that SMSF, Individuals A and B are the shareholders of a private company. The conclusion drawn was that Individuals A and B stand to benefit or are capable of benefiting from the Unit Trust such that the Unit Trust is an associate of Individuals A and B. Presumably, such benefits arise from the Unit Trust deriving higher profits via the benefit of an interest-free loan and this additional profit will flow through the SMSFs to the individuals.  If the ATO approach is correct, then the Unit Trust in our example will be an associate of the respective individuals, and thus an associate of the respective discretionary trust shareholders such that Division 7A applies to the loan made by the Company. In this case getting the associate relationship wrong would lead to Division 7A exposure.

Affiliates – A matter of business

The meaning of ‘affiliate’ is narrower than that of an ‘associate.’ Only an individual or company that is carrying on a business can potentially be an affiliate of an entity provided the individual or company acts or could reasonably be expected to act in accordance, or in concert, with the entity, in relation to the affairs of that individual’s/company’s business.

TR 2002/6W whilst withdrawn, provides useful guidance for working out an affiliate relationship having regard to the following factors:

• family or close personal relationships;
• financial relationships or dependencies;
• connections through common partners, directors, or shareholders;
• degree of consultation between the parties;
• obligations to conduct business with one another.

To illustrate consider the following:

Company A and Company B have the same directors and shareholders. Company A manufactures pencils and Company B carries on a stationary supplies distribution business. Company A’s sole customer is Company B. As a result of Company A’s financial dependency on Company B, this factor alone may potentially cause Company A to qualify as an affiliate of Company B.

Note a spouse or child under 18 generally would not qualify as an affiliate of an individual based on their familial relationship. However, there is a deeming rule under the small business CGT concessions that could treat a spouse or a child under 18 to be an affiliate of an individual for the purposes of the active asset test. A detailed analysis of this deemed affiliate rule under s.152-47 ITAA 1997 is beyond this article, but practitioners should be mindful of the deeming provisions as this may impact the outcome of the other basic conditions such as the maximum net asset value test or the CGT small business entity test being satisfied.

Conclusion

As noted above the repercussions of not being able to correctly identify an associate or affiliate relationship could result in significant adverse income tax implications including Division 7A exposure and failing to qualify for, or inappropriately claiming access to the small business SBCGT concessions among others.

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