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  • Guarantees

    Division 7A can apply to arrangements that involve a private company indirectly distributing money to a shareholder or an associate of a shareholder by guaranteeing a loan that an interposed private company or other entity makes to the shareholder or their associate. This can include more complex arrangements that involve a guarantee and loans or payments through a chain of entities.

    How a deemed dividend arises

    Several provisions within Division 7A deem dividends to occur through the use of guarantees in the same way as if the private company had made a payment directly to the target entity. Essentially, this is where:

    1. A private company guarantees a loan made by an interposed entity.
    2. A reasonable person would conclude that the private company gave the guarantee solely or mainly as part of an arrangement involving a payment or loan to the target entity.
    3. Either:
      1. As a result of the guarantee, the private company has a liability (other than a contingent liability) to make a payment to the interposed entity, or
      2. An interposed private company makes a payment or loan to the target entity (there can be more than one interposed entity).
       

    For these purposes, it does not matter:

    • whether the interposed private company made the payment or loan to the target entity before, after or at the same time as the first interposed entity received the guarantee from the private company
    • whether or not the interposed private company paid or lent the target entity the same amount as the private company guaranteed, or
    • whether or not a present liability ever arose under the guarantee.

    Amount of the deemed dividend

    The Division 7A provisions involving guarantees draw a distinction between a situation where an interposed private company makes a payment or loan to a target entity, and where other types of entities are used.

    Where there is an interposed private company that makes a payment to a target entity, then the amount of the deemed dividend is based on:

    • the amount of the loan the private company guaranteed
    • the amount the interposed private company paid to the target entity
    • less: any arm's length consideration payable to the target entity by the private company or any of the interposed entities

    For example, the amount the interposed private company paid the target entity might include an amount payable to the target entity for goods or services provided.

    • less an adjustment for the distributable surplus (of the interposed private company) and other dividends that company is taken to pay that income year.
    • The amount of reduction (if any) is equal to the distributable surplus of the interposed private company that made the payment or loan to the target entity less any dividends that company is taken to pay under Division 7A during that income year (apart from as a result of the payment or loan in question).

    Repayments made by the target entity to the interposed private company are not taken into account in working out how much the private company is taken to pay the target entity.

    The private company is taken to have made the payment to the target entity at the same time the interposed private company makes the payment or loan to the target entity.

    On the other hand, if the arrangement does not involve an interposed private company directly making a payment to a target entity, then the amount of the deemed dividend is based on:

    • the amount the private company is liable to pay under the guarantee to the interposed entity as a result of a default on the loan by the target entity
    • the amount the interposed entity loaned the target entity
    • less: any arm's length consideration payable to the target entity by the private company or the interposed entity.

    Example 6

    Epsilon Pty Ltd guarantees a loan of $600,000 that its subsidiary Delta Pty Ltd makes to Sam, a majority shareholder of Epsilon Pty Ltd on 12 May 2015. The guarantee is part of an arrangement involving the loan by Delta Pty Ltd to Sam. There is no written agreement outlining the terms of the loan. For the 2014-15 income year, Epsilon Pty Ltd has a distributable surplus of $1,000,000 and Delta Pty Ltd has a nil distributable surplus.

    Epsilon Pty Ltd is taken to pay a dividend to Sam because, as part of an arrangement, it guaranteed a loan that another private company (Delta Pty Ltd) made to Sam. Delta Pty Ltd is not taken to pay a dividend to Sam because its distributable surplus is nil (for further information, see Division 7A - Loans by private companies).

    Epsilon Pty Ltd is taken to pay Sam $600,000 on 12 May 2014, being the amount Delta Pty Ltd loaned Sam less Delta Pty Ltd's distributable surplus (that is $600,000 less nil).

    On 30 June 2015, Epsilon Pty Ltd is taken to pay a dividend of $600,000 to Sam.

    Example 7

    On 10 June 2015, Z Pty Ltd, a wholly owned subsidiary of X Pty Ltd, borrows $150,000 from Megabank Ltd (a publicly listed financial institution). The loan is guaranteed by X Pty Ltd. The guarantee is part of an arrangement between X Pty Ltd and Z Pty Ltd involving a payment of $150,000 to Harold, a majority shareholder of X Pty Ltd. The payment of $150,000 is made to Harold on 10 June 2015.

    For the 2014-15 income year, the distributable surplus of X Pty Ltd is $250,000 and the distributable surplus of Z Pty Ltd is $25,000. Z Pty Ltd is not taken to pay any other dividends under Division 7A during that income year. This example is shown below.

    X Pty Ltd guarantees a loan made by a publicly listed financial institution (Megabank Ltd) to X Pty Ltd's subsidiary Z Pty Ltd which pays the funds to X Pty Ltd's shareholder Harold. It is reasonable to conclude an arrangement was made to produce this effect. X Pty Ltd is taken to pay a dividend to Harold (the payment amount reduced by Z Pty Ltd's distributable surplus).

    All four of the conditions are satisfied for X Pty Ltd to be taken to make a payment to Harold (the target entity). X Pty Ltd is taken to pay Harold $125,000, being the amount Z Pty Ltd paid Harold less Z Pty Ltd's distributable surplus (that is $150,000 - $25,000).

    On 30 June 2015 X Pty Ltd is taken to pay a dividend of $125,000 to Harold.

    Z Pty Ltd has made a payment directly to Harold that is treated as a dividend (see Division 7A - payments by private companies). That dividend arises because Harold is an associate of a shareholder of Z Pty Ltd. The amount treated as a dividend to Harold is $25,000 (that is the dividend is reduced to Z Pty Ltd's distributable surplus of $25,000). This assumes that Z Pty Ltd is not taken to pay any other dividends under Division 7A during that income year.

    Example 8

    On 15 August 2014, Mary takes out a bank loan of $80,000. The loan is guaranteed by PQR Pty Ltd, of which Mary is a shareholder. The bank is not a private company. The guarantee is part of an arrangement involving a loan to Mary. After repaying $10,000, Mary defaults on the loan on 30 May 2015 and the bank exercises the guarantee.

    PQR Pty Ltd is taken to make a payment to Mary equal to the amount it is liable to pay under the guarantee

    The amount PQR Pty Ltd is taken to pay Mary is the amount it is liable to pay the bank under the guarantee, which is $70,000.

    On 30 June 2015, PQR Pty Ltd is taken to pay a dividend of $70,000 to Mary, subject to PQR Pty Ltd's distributable surplus.

    End of example

    Avoiding a deemed dividend

    Written loan agreement

    A private company will not be taken to make a payment to the target entity if the private company and the target entity enter into a written loan agreement in respect of the debt, and that written loan agreement meets the minimum interest rate and maximum term criteria for a complying loan (see Division 7A – loans by private companies).

    Hardship

    A private company is not taken to pay a dividend in relation to arrangements where the private company has a present liability to an interposed entity as a result of the default of a target entity if we are satisfied that:

    • the target entity would suffer undue hardship as a result of the deemed dividend
    • the target entity had the capacity to repay the loan when the it entered into the loan.
    • Apply to us in writing, addressing the above points, if you consider you will suffer undue hardship if an amount is treated as a dividend.

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      Last modified: 08 Feb 2017QC 51189