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  • Loans by private companies

    A private company may be taken to pay a dividend to an entity at the end of the company's income year, if it loans an amount to an entity during the year:

    • when the entity is a shareholder or an associate of a shareholder of the company, or
    • a reasonable person would conclude that the payment was made because the entity was a shareholder or an associate of a shareholder at some time.

    The total of all dividends a private company is taken to pay under Division 7A is limited to its distributable surplus for that income year.

    See also:

    Ensure loans comply with Division 7A

    Watch this video to learn about complying loans under Division 7A.

     

    Loans by other entities

    Closely-held corporate limited partnerships

    In general, the income tax law treats corporate limited partnerships as companies. For example, a reference to a share includes a reference to an interest in a corporate limited partnership. And a reference to a shareholder includes a reference to a partner in a corporate limited partnership. As of 1 July 2009, Division 7A applies to a closely-held corporate limited partnership in the same way it applies to a private company.

    See also:

    Trusts

    Division 7A applies to certain payments made by trustees to a shareholder or an associate of a shareholder of a private company where the company is presently entitled to an amount from the net income of the trust estate and the whole of that amount has not been paid by a specified date.

    However, the rules do not apply in all cases where there is an unpaid present entitlement.

    Interposed entities

    Division 7A applies to certain loans made by private companies to a shareholder or their associate through interposed entities.

    See also:

    Division 7A - payments and loans through interposed entities

    Meaning of 'Loan' under Division 7A

    Division 7A extends the meaning of 'loan' to include:

    • an advance of money
    • a provision of credit or any other form of financial accommodation
    • a payment for a shareholder or their associate, on their account, on their behalf, or at their request if they have an obligation to repay the amount; and
    • a transaction (whatever its terms or form) that is the same as a loan of money.

    A loan is made to an entity at the time the amount of the loan is paid to the entity by way of an ordinary loan, or any of the above is done in relation to the shareholder or their associate.

    If a private company makes one or more loans to a shareholder or their associate in an income year, it may be taken to make an amalgamated loan to that shareholder or associate.

    Example 1 – loan to a shareholder

    Terry Pty Ltd loans $20,000 to Ann, a shareholder of Terry Pty Ltd. The money is loaned to Ann on the basis that she pays it back when she can. The $20,000 is a loan from Terry Pty Ltd to Ann because it is an advance of money, and Division 7A may apply.

    End of example

    If a loan is made to an entity by way of a promissory note, it is a provision of credit or a form of financial accommodation, and Division 7A may apply.

    Example 2 – promissory note to a shareholder

    Lucas Pty Ltd provides $10,000 to Belinda, a shareholder of Lucas Pty Ltd, by way of a promissory note. The note places no obligation on Belinda to repay the amount. The $10,000 is a loan from Lucas Pty Ltd to Belinda because it is a form financial accommodation, and Division 7A may apply.

    End of example

    From 16 December 2009, if a private company beneficiary, in respect of an unpaid present entitlement, provides financial accommodation to the trustee of a trust, or enters into a transaction with the trustee of a trust, it will be taken to make a loan to the trustee of the trust for Division 7A purposes.

    See also:

    Loans that are treated as dividends

    A loan will be deemed to be a dividend by Division 7A if:

    • it is made to a shareholder or an associate of a shareholder
    • it is not fully repaid before the private company's lodgment day for the year when the loan is made. A private company's lodgment day is the earlier of the due date for lodgment, or the actual date of lodgment of the private company's income tax return for the income year
    • it is not excluded specifically by other sections of Division 7A

    Exclusions

    A loan is not treated as a dividend:

    • if it is made to another company (and they are not acting in the capacity of trustee)
    • if the payment would be included in the shareholder's or their associate's assessable income under a provision of the tax law (other than Division 7A)
    • if the payment would be excluded from the shareholder's or their associate's assessable income under a provision of the tax law
    • if it is made in the ordinary course of business and on the usual terms the private company applies to similar loans to entities at arm's length
    • if the loan has satisfied the minimum interest charge and maximum term requirement and is made or put under a written agreement before the private company's lodgment day
    • if it is a distribution made in the course of a liquidator winding-up a company
    • if it is made to purchase shares or rights under an employee share scheme
    • if it is an amalgamated loan in the year it is made and provided the required minimum yearly repayments are made in the following years
    • loans made before 4 December 1997 where no variation of terms or amounts have since been made
    • in instances where the required minimum yearly repayment has not been met as a result of circumstances beyond the shareholder's or their associate's control, the Commissioner can exercise his discretion to allow an amalgamated loan not to be treated as a dividend. The Commissioner will either
      • disregard the dividend if he is satisfied that treating the loan as a dividend would cause undue hardship, or
      • disregard the dividend if the shortfall is paid within a specified time.
       

    Converting payments to a loan

    Payments made can be converted to loans before the private company's lodgment day to avoid a dividend being deemed.

    For payments converted to loans, the private company is taken to have made a loan at the time the payment was made.

    Example 3 – payment converted to a loan before lodgment day

    In the 2016 income year, XYZ Pty Ltd pays the petrol expenses of a vehicle owned by shareholder Sally. Sally is under no express or implied obligation to repay the amount. Unless Sally converts the payment to a complying loan, the Division 7A provisions in respect of payments will apply.

    Sally and XYZ Pty Ltd agree to convert the payment into a loan before the private company's lodgment day. The Division 7A provisions relating to loans now apply.

    End of example

    See also:

    Varying the terms of a pre 1997 loan

    Loans made before 4 December 1997 generally will not be subject to Division 7A.

    However, where a loan is varied on or after 4 December 1997, either by extending the term of the loan or increasing the amount of the loan, the loan will be treated as if it were a new loan entered into on the day it is varied and therefore Division 7A may apply.

    Criteria of a complying loan agreement

    A loan that complies with the criteria set out in section 109N of the Income Tax Assessment Act 1936 is explicitly exempted from being deemed to be a dividend. The criterion are summarised below:

    Minimum interest rate

    The interest rate of the loan for each year after the year in which the loan was made must be greater than or equal to the benchmark interest rate for each year.

    The Division 7A - benchmark interest rates are published annually by the ATO.

    Maximum term

    The maximum term for a loan secured by a mortgage over real property is 25 years. The whole of the loan must be secured by a registered mortgage over the property. When the loan is first made, the market value of the property (less liabilities secured over the property in priority to the loan) must be at least 110% of the amount of the loan.

    The maximum term for any other loan is 7 years.

    Written agreements

    A loan which is made under a written agreement before the private company's lodgment date and meets the minimum interest rate and maximum term criteria, will not be treated as a dividend in the income year the loan is made.

    There is no prescribed form for the written agreement. However, as a minimum, the agreement should identify the parties, set out the essential terms of the loan (that is the amount and term of the loan, the requirement to repay and the interest rate payable) and be signed and dated by the parties.

    A written agreement can be drafted to cover loans which will be made to a shareholder or their associate for a number of income years in the future.

    Example 4 – loan put under written agreement before lodgment day

    During the 2016 income year, Frame Pty Ltd made an unsecured loan to Penelope, a shareholder of Frame Pty Ltd. The loan will not be treated as a dividend in the 2016 income year if it is put under a written agreement before the private company's lodgment day, the term of the loan is no greater than 7 years, and the rate of interest payable in subsequent income years equals or exceeds the benchmark interest rate for those years.

    End of example

    Refinancing loans

    For the 2007 income year onwards, certain loans can be refinanced without resulting in a deemed dividend:

    • An unsecured loan which is converted to a loan secured by a registered mortgage over real property can have the loan term extended. The maximum term of the loan becomes 25 years less the period of the term already expired when the loan was unsecured.
    • A secured loan can also be converted to an unsecured loan but there will be a corresponding reduction in the loan term. The maximum of the unsecured loan is 7 years if the remaining term on the secured loan at the time of conversion was 18 years or less. If the secured loan has already been in place for more than 18 years, the maximum term of the unsecured loan will be reduced so that the total term of the loan (in both its secured and unsecured form) will be no more than 25 years. That is, deduct from seven years the difference between
      • the length of the period starting when the loan was made and ending when the loan was converted
      • 18 years.
       

    A private company loan can also be refinanced when the loan becomes subordinated to another loan from another entity. The subordination must arise as a result of circumstances beyond the control of the entity to which the original loan was made. The private company and the other entity must have dealt with each other at arm's length in relation to the subordination.

    In these circumstances, the repayment of the old loan as part of the refinancing is not disregarded for Division 7A purposes.

    Example 5 – refinancing a loan

    Hilda Pty Ltd has made a loan secured by a mortgage over real property to an associate of a shareholder, Sachin. The term of the loan was 25 years. However, after 20 years, the terms of the loan are changed so it is no longer secured by a mortgage over real property. If the expired term of the old secured loan was less than 18 years, the maximum term of the unsecured loan would be 7 years. However in this instance, the original secured loan had already been in place for more than 18 years. As a result, in the written agreement governing the new loan, the maximum term of the loan will be 5 years (i.e. 7 years less the number of years by which the existing loan has exceeded 18).

    End of example

    Amalgamated loans

    A private company will be taken to make an amalgamated loan during an income year if the company makes one or more loans to the shareholder or the associate during the year and each loan (called a 'constituent loan'):

    • is not fully repaid before the private company's lodgment day
    • would be treated as a dividend but for the exclusion for loans with a written agreement (as discussed above)
    • has the same maximum term (i.e. 25 years for a secured loan or 7 years for other loans)

    The amount of the amalgamated loan is the sum of the constituent loans that have not been repaid before the lodgment day for the year of income in which the amalgamated loan is made.

    From the 2007 income year onwards, an unsecured loan can be converted to a loan secured by a mortgage over real property with a longer maximum term. When the term of an existing loan is extended because of a mortgage, a new amalgamated loan is taken to be made in the income year prior to the income year in which the extension is made. The old amalgamated loan is disregarded if the amalgamated loan comprised one constituent loan. If the old amalgamated loan comprised more than one constituent loan, the amount of the old amalgamated loan is reduced by the amount treated as a new amalgamated loan.

    A private company may have a number of amalgamated loans to a shareholder or their associate at any one time. This will occur where relevant constituent loans have been made over a number of income years. Private companies with more than one amalgamated loan will need to maintain records for each amalgamated loan.

    Minimum yearly repayment

    The Division 7A calculator and decision tool can be used to calculate the minimum yearly loan repayment of principal and interest required to repay the amalgamated loan over its maximum term.

    However, to calculate the repayment manually, the following formula can be used:

    Formulae for minimum yearly payment.

    The 'amount of the loan' referred to in the formula is the amount of the amalgamated loan.

    The formula above, which is given in section 109E of he Income Tax Assessment Act 1936, can be expressed more clearly as:

    Formulae for minimum yearly payment.

    Where:

    MYR = minimum yearly repayment

    P = amount of loan not repaid by the end of the previous income year

    I = current year's benchmark interest rate

    T = remaining loan term ( in years)

    The minimum yearly repayment needs to be worked out for each income year after the year in which the loan is made.

    If the private company has more than one amalgamated loan, each amalgamated loan is considered separately. The loans cannot be grouped for the purposes of calculating a minimum yearly repayment. There will be a minimum yearly repayment in respect of each amalgamated loan.

    A number of specific concepts apply to the minimum yearly repayment formula. They are the:

    • amount of loan not repaid by the end of the previous income year
    • current year's benchmark interest rate
    • remaining term of the loan.

    Working out the amount of the loan not repaid by the end of the previous income year

    As a general rule, the amount of the loan not repaid by the end of the previous income year is calculated by subtracting the opening balance of the amalgamated loan at the beginning of the previous income year from the amount of principal repaid during that income year.

    Note that the calculation differs depending on whether the income year is the first year after the amalgamated loan is made, or the second or subsequent years.

    For the first income year after the amalgamated loan is made
    • no interest is payable in respect of the year the loan is made
    • the amount of the loan not repaid by the end of the previous income year is calculated by subtracting the total principal repayments made before the private company's lodgment day from the original amount of the loan.

    If no repayments are made before the lodgment day, the balance of the amalgamated loan that has not been repaid before the end of the precious income year, is the sum of the constituent loan balances at the end of that year.

    Example 6 – amount of amalgamated loan not repaid by the end of the first income year (2014)

    During the 2014 income year a private company made loans of $50,000 and $25,000 to a shareholder.

    The loans were made under complying written loan agreements. Both loans were unsecured loans with a term of 7 years with interest rates set at the benchmark interest rates.

    On 31 August 2014 the shareholder made a repayment of $20,000 on the $50,000 loan.

    The private company's lodgment day for its 2014 income tax return was 15 May 2015 and the return was lodged on that date.

    The amount of the amalgamated loan not repaid by the end of the 2014 income year is $55,000.

    End of example
    The second and subsequent income years after the amalgamated loan is made

    The amount of the amalgamated loan not repaid by the end of the income year is calculated on the basis that interest is payable on the balance of the amalgamated loan, at a rate equal to the benchmark interest rate for the income year.

    For the following income years, to calculate the amount of the loan not repaid by the end of the previous income year, it is important to know how much of the repayment made in the income year is attributable to interest and how much is applied to reduce the principal.

    The Division 7A calculator and decision tool provides a breakdown of the interest and principal components of the payment. To calculate this manually, apply the relevant benchmark interest rate to the amounts outstanding. Note that even if the interest rate in the written agreement is different from the benchmark interest rate, the benchmark interest rate is used to calculate the minimum yearly repayment for Division 7A purposes.

    The amount of the loan repaid during an income year is obtained by deducting the interest from the actual repayments made during the year. The opening balance of the loan for the next year is the opening balance at the beginning of the previous year less the principal repaid during that year.

    Where a repayment is made before the private company's lodgment day for the year in which the amalgamated loan is made, the principal amount at 1 July of the first income year after the loan is made, is not the sum total of the constituent loans at 1 July. Rather, it is the sum of the constituent loans immediately before the lodgment day. For this purpose, payments made before lodgment day are taken to have been made in the year the amalgamated loan is made.

    Example 7 – amount of amalgamated not repaid by the end of the second income year (2015)

    This example uses the same facts as example 5, except on 30 May 2015 the shareholder paid the private company a further $8,000, being a $4,000 payment for each loan. No other repayments were made during the 2015 income year.

    Calculations:

    Interest is calculated annually in arrears by reference to the daily balance throughout the year as follows:

    Annual interest calculation

     

    Credit

    $

    Loan balance

    $

    Principal at 01/07/2014

     

    55,000

    Repayments at 30/05/2015

    8,000

    47,000

    Interest payable

    =(interest payable on $55,000 from 01/07/2014 to 29/05/2015) + (interest payable on $47,000 from 30/05/2015 to 30/06/2015)

    =(5.95% of $55,000 x (333/365)) + (5.95% of $47,000 x (32/365))

    =$2,985.59 + $245.17

    =$3,231 (rounded to the nearest dollar)

    Of the $8,000 repayment made on 30 May 2015, $3,231 is taken to have been applied against the interest amount and $4,769 is taken to have been applied against the loan principal. This leaves $50,231 as the amount of the loan remaining at the end of the 2015 income year. This figure is used to work out the minimum yearly repayment for the 2016 income year, as it is the opening balance of the amalgamated loan for the second income year after it is made.

    The payment made before the lodgment day is reflected in the opening balance at 1 July 2015.

    If the actual interest rate used in the written agreement exceeds the benchmark rate, the 'amount of the loan remaining at the end of the previous income year' will be a notional amount.

    End of example

    Working out the remaining term

    The remaining term is the difference between:

    • the number of years in the longest constituent loan
    • the number of years between the end of the private company's income year in which the loan was made, and the end of the private company's income year before the income year for which the minimum yearly repayment is being worked out.

    If the answer is not a whole number, it is rounded up to the next whole number.

    Example 8 – calculate the minimum yearly repayment for the second income year (2015)

    This example uses the same facts as example 6.

    To work out the first minimum yearly repayment, the amount of the amalgamated loan not repaid by the end of the 2014 income year is $55,000 (loans made less principal repayments made before the lodgment day for the 2014 income year) and the benchmark interest rate for the income year ended 30 June 2015 is 5.95%.

    The remaining term is worked out as the difference between:

    • the number of years in the longest constituent loan included in the amalgamated loan (7 years)
    • the number of years between the end of the private company's income year in which the loan was made (2014), and the end of the private company's income year before the income year for which the minimum yearly repayment is being worked out (2015), that is 0 years.

    The remaining term is 7 years (that is, 7 - 0 = 7).

    The minimum yearly repayment for the income year ended 30 June 2015 is worked out as follows:

    Example 8 formulae and minimum yearly repayment.

    Example of minimum yearly repayment

    In determining if there is a minimum yearly repayment shortfall, all repayments made during the 2015 income year, including those made prior to the private company's lodgment day for the 2015 year, are taken into account.

    The total of the repayments made in the 2015 income year is $28,000 (the $20,000 payment made on 31 August 2014 and the $8,000 payment made on 30 May 2015) and as this exceeds $9,835, there is no shortfall and therefore no deemed dividend arises for the 2015 income year.

    End of example

     

    Example 9 – calculate the minimum yearly repayment for the third income year (2016)

    This example uses the same facts as example 7.

    The amount of the loan remaining at the end of the previous income year (that is, the year ended 30 June 2015) is $50,231 (see conclusion to example 6).

    The benchmark interest rate for 2016 is 5.45%.

    The remaining term is worked out as the difference between:

    • the number of years in the longest constituent loan included in the amalgamated loan (7 years)
    • the number of years between the end of the private company's income year in which the loan was made (2014) and the end of the private company's income year before the income year for which the minimum yearly repayment is being worked out (2016), that is one year.

    The remaining term is six years (that is, 7 - 1 = 6).

    The minimum yearly repayment for the 2016 income year will be worked out as follows:

    Example of minimum yearly repayment for 2016

    The shareholder would need to make repayments on the loan totalling at least $10,039 to not trigger any Division 7A dividend.

    End of example

    Loan repayments not taken into account

    Some payments that a shareholder or their associate makes to a private company in respect of a loan will not be taken into account for the purpose of working out the minimum yearly repayment or how much of the loan has been repaid.

    A payment will not be taken into account if:

    • a reasonable person would conclude that, when the shareholder or their associate made the payment, they intended to obtain a loan from the private company of an amount similar to or larger than the payment, and
    • from 1 July 2009, a loan payment will not be taken into account if a reasonable person would conclude that, before making the payment, the shareholder or their associate obtained a loan from the private company of a total amount similar to, or larger than, the repayment.

    Additionally, the payment transaction must be made before the 'required time'. The ATO will not accept that there has been a repayment for Division 7A purposes, if it is a back-dated journal entry where the actual transaction takes place after the 'required time'.

    Example 10 – amount not taken to be repayment

    Alicia obtains a loan of $10,000 from Cleary Pty Ltd. Alicia has until the lodgment day to repay the loan. Two weeks before the lodgment day Alicia obtains a further $10,000 from Cleary Pty Ltd. She then repays the original $10,000 loan a week before the lodgment day.

    The repayment of the original $10,000 loan is not a repayment for the purposes of sections 109D. This is because Alicia has borrowed a similar amount from Cleary Pty Ltd and in this case, a reasonable person would conclude that the loan was obtained to make the repayment of the original $10,000.

    The original $10,000 loan is treated as a deemed dividend subject to the distributable surplus of the private company.

    End of example

    Some payments will always be taken into account, even if there is an intention to obtain another loan at the time the payment is made. These payments are made by offsetting the following amounts against the balance of the loan:

    • a dividend payable to the shareholder or their associate by the private company
    • work and income support related withholding payments and benefits payable by the private company to the shareholder or their associate (for example, salary or wages)
    • payments covered by a voluntary agreement to withhold
    • if the shareholder or their associate transferred property to the private company, an amount equal to the difference between the arm's length value of property and the amount that the company has already paid the shareholder or their associate for the transfer.

    In addition, a payment by another entity to the private company on behalf of the shareholder or their associate will be taken into account, regardless of any intention to obtain another loan if the amount of the payment:

    • is payable by the other entity to the shareholder or their associate
    • forms part of the shareholder's or their associate's assessable income in the income year in which the payment is made, or in an earlier income year.

    An entity can include an individual, company, trust or partnership.

    Failure to make a minimum yearly repayment in respect of an amalgamated loan

    From the 2007 income year, a shortfall in a minimum yearly repayment on an amalgamated loan may be deemed to be a dividend (subject to the private company's distributable surplus) if:

    • a private company made an amalgamated loan to a shareholder or their associate in an earlier year of income
    • the amalgamated loan is not repaid at the end of the current year
    • the amount paid to the private company during the current year in respect of the loan is less than the minimum yearly repayment for the current year
    • the Commissioner does not exercise his discretion not to treat the amount as a dividend.

    If a shareholder or their associate makes a repayment for a constituent loan in an income year after the year in which the constituent loan was made, the repayment is taken to be a repayment in respect of the amalgamated loan.

    Commissioner's discretion not to treat an amalgamated loan as a dividend

    If a shareholder or their associate makes a repayment in respect of an amalgamated loan from a private company that is less than the required minimum yearly repayment, and they satisfy the Commissioner that the minimum yearly repayment was not met because of circumstances beyond their control (and they would suffer undue hardship if the loan were treated as a dividend), the private company will not be taken to pay a dividend.

    The Commissioner must consider:

    • the shareholder's or their associate's ability to repay the loan at the end of the income year in which the amalgamated loan was made
    • any circumstances that reduced the shareholder's or their associate's ability to repay the loan
    • whether the shareholder or their associate took all reasonable steps to make the minimum yearly repayment for the current income year
    • whether the shareholder or their associate made payments equal to the amount of the deficiency as soon as possible after the current income year.

    The Commissioner may also disregard a deemed dividend and extend the period for repayments where the shareholder or their associate was unable to make the minimum yearly repayments on an amalgamated loan because of circumstances beyond their control. The Commissioner will specify a later time by which the minimum yearly repayments must be made and, provided the amount of the shortfall is paid within the specified time, the shortfall will not be taken to be a dividend.

    In addition to the above discretion, where a deemed dividend arises under Division 7A because of an honest mistake or inadvertent omission, the Commissioner has the discretion under section 109RB of the Income Tax Assessment Act 1936 to disregard the deemed dividend (subject to conditions being complied with), or allow the dividend to be franked.

    See also:

    Amount of the dividend

    Where there is no loan agreement in place, the amount treated as a dividend is the amount of the loan that has not been repaid before the company's lodgment day.

    For loans made under a written complying loan agreement entered into before the private company's lodgment day, a deemed dividend may arise in subsequent years if the required minimum yearly repayment is not made.

    For 2006-07 and later income years, the amount by which the payments made to the company in the current year for the loan falls short of the required minimum yearly repayment for that year.

    If the loan is made in the previous year of income in the course of winding-up a company, the amount treated as a dividend is the amount of the loan that has not been repaid at the end of the current income year.

    Example 11 – non-complying loan to shareholder with repayment

    On 1 January 2014, ABC Pty Ltd made a cash advance of $10,000 to Peter, a shareholder of ABC Pty Ltd. ABC Pty Ltd lodged its income tax return for the 2014 income year on 28 February 2015. At that date, Peter had not repaid an amount of $2,000 and the loan had not been put on a qualifying commercial footing.

    The amount treated as a dividend on 30 June 2014 is the amount of the loan not repaid before the lodgment day (i.e. $8,000) subject to ABC Pty Ltd's distributable surplus.

    End of example

    Franking the dividend

    Amounts treated as dividends under Division 7A are generally not frankable, even though they are taken to be paid out of the private company's profits. However, there are exceptions.

    When an amount is taken to be a dividend under Division 7A because of an honest mistake or inadvertent omission, the Commissioner has the discretion to:

    • disregard the deemed dividend (subject to conditions being complied with)
    • allow the private company to choose to frank the dividend

    See also:

    Shareholder's or beneficiary's loan account

    Each entry in a shareholder's or beneficiary's loan account needs to be analysed to determine what type of transaction it represents (that is, whether it is a payment, a loan or a debt forgiveness to which Division 7A applies). Additionally, entries representing loan repayments must be analysed to determine if they can be taken into account in working out the amount of a loan repaid or the minimum yearly repayment.

    The balance of a shareholder's or beneficiary's loan account in the company or trustee accounts respectively may be in debit or credit at the end of the income year. Although a debit balance at the end of a year of income may indicate that there are loans that have not been repaid and a credit balance may indicate that no loans remain unpaid, neither result leads to the automatic conclusion that Division 7A does or does not apply.

    If a private company has more than one shareholder's or beneficiary's loan account, the private company in calculating the Division 7A exposure cannot use a credit balance in one account to offset the debit balance in another account. Calculations of Division 7A loans are done in respect of transactions in the loan accounts of each individual shareholder.

    The 'lender' is the private company or trustee who made the loan that is subject to Division 7A.

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      Last modified: 08 Feb 2017QC 17341