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An entity refers to a distinct body, like a body corporate, partnership, unincorporated body, an individual or trustee. Notably, the way in which you structure your company may impact your obligations under the Corporations Act 2001 (Cth). For example, setting up or acquiring a new company may have unexpected consequences. Hence, it is essential to understand the impact of a company being considered a ‘controlled entity’. This article will explain what a controlled entity is and the practical impact this has on your company’s governance.
What Is a Controlled Entity?
A company will control a second company if it can determine the outcome of decisions about the second company’s financial and operating policies. In this instance, the second company will be a controlled entity.
There are certain situations where your company will become a controlled entity. If that is the case, it may be subject to new or additional obligations. These situations include if:
- you are setting up a new company;
- another entity is acquiring your existing company;
- the shareholders in your company are changing; or
- you are restructuring your company group.
Likewise, depending on the size of the controlling entity and where they are based, your company may need to prepare and lodge audited financial reports and a directors’ report with the Australian Securities and Investment Commission (ASIC).
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For Example
Emily is running a successful fashion label in Melbourne (Studio Pty Ltd). A company based in New York (Big Shop Inc) approached Emily to sell her company.
Big Shop Inc is looking to expand its brands into Australia and see Studio Pty Ltd as the perfect company to help achieve this. Studio Pty Ltd is still fairly small, and Emily happily sells her company for a nice profit and stays on as the Australian director.
Studio Pty Ltd must now prepare and lodge an audited financial report and a directors’ report with ASIC. This is unless the company notifies ASIC and applies for relief from its new reporting obligations.
As the Australian director, Emily is now responsible for obtaining this relief from ASIC. In addition, she will be responsible for ensuring that Studio Pty Ltd lodges all necessary documents with ASIC each financial year. Therefore, it is important to remain diligent as to what entity is controlling a company and the added obligations that this may bring.
Is a Company a Controlled Entity?
To understand how control works in practice, we will look at the relationship between X Pty Ltd and Y Pty Ltd. The key factor in determining whether X Pty Ltd has control over Y Pty Ltd is the concept of capacity.
Capacity
In determining whether X Pty Ltd has the capacity to control Y Pty Ltd, consider the following:
It is essential to understand that this is not determined by X Pty Ltd being the holding company, but rather by the influence that is exerted by X Pty Ltd on Y Pty Ltd.
Joint Capacity
If multiple companies govern a single entity, this may impact whether the governed entity is actually a controlled entity.
Legal Obligation
The last key point to consider is whether there is a legal obligation by X Pty Ltd to control Y Pty Ltd.
Importantly, when assessing whether a company is a controlled entity, a director must consider:
- capacity;
- joint capacity; and
- legal obligations.
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Corporate Governance With a Controlled Entity
The controlling company or a group of companies will typically use a controlled entity as a tool to achieve their goals. From the example above, it is common that foreign companies will acquire or set up Australian companies to expand their business into Australia.
Accordingly, as a director in a group of companies is looking to set up or acquire a controlled entity, it is crucial to understand that this may impose:
- financial obligations;
- increased regulatory requirements; and
- additional compliance measures for the controlled entity in the group.
Therefore, preparing sophisticated financial reports may be overly burdensome for a controlled entity. Consider whether setting a new entity is the right decision. Alternatively, investigate whether ASIC can grant relief for the controlled entities reporting obligations.
Key Takeaways
When structuring your group, performing an acquisition or selling your company, it is important to understand the obligations this may trigger for a controlled entity. The following are key considerations regarding controlled entities:
- controlled entities may have additional reporting obligations to ASIC;
- a controlled entity is determined by capacity, joint capacity and legal obligations; and
- restructures and acquisitions can both cause a company to become a controlled entity.
For more information on your corporate governance obligations, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
Frequently Asked Questions
A company will control a second company if it can determine the outcome of decisions about the second company’s financial and operating policies. In this instance, the second company will be a controlled entity.
The law surrounding controlled entities can apply to small, medium or large companies. Depending on the size of the controlling entity, your company may need to prepare and lodge audited financial reports and a directors’ report with ASIC.
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