Fred and Jen operated a number of separate businesses through different entities including a private company and a trust. They were the trustees of the trust and the only shareholders and directors of the private company. The beneficiaries of the trust are Fred and Jen and members of their immediate family.
During the 2005-06 income year, the trust was incurring substantial losses due to a downturn in business conditions. As no other source of funds was available, the private company made loans to the trust for working capital purposes during the year.
In preparing the 2005-06 income tax returns, their tax adviser considered the application of Division 7A but mistakenly believed that only loans to individual shareholders would be subject to Division 7A. There was no qualifying section 109N written loan agreement put in place before the lodgment day of the private company's 2005-06 tax return and no loan repayments had been made to the private company. However, the loan is recognised in the balance sheets of the private company and the trust and the loan is minuted along with a note that the trust is envisaged to resume profitability by the 2008-09 year, at which time loan repayments will commence.
Fred and Jen changed tax advisers during the 2006-07 income year and the new tax adviser brought to their attention the Division 7A problem in the 2005-06 year. On finding out about the problem, Fred and Jen wished to correct the mistake and promptly advised the Commissioner. Division 7A had not operated previously in relation to the private company or the trustee.
The trustees or the private company (or both) may apply to the Commissioner to exercise his discretion to disregard the deemed dividend. If there has been an honest mistake or inadvertent omission, the Commissioner would have regard to the following when considering whether to exercise his discretion in favour of the trust:
- the fact that the mistake was the result of a misreading of the legal requirements of Division 7A by a professional adviser
- the relatively short period of time that has elapsed between the year in which the dividend was deemed to be paid and the notification to the Commissioner
- the disclosure of the transaction as a loan in the balance sheets of the private company and trust
- the quantum of the sums involved, and
- that Division 7A had not operated previously in relation to the private company or the trustee.
As a condition of exercising his discretion, the Commissioner could require that there be a written loan agreement put in place that satisfied all of the requirements of section 109N and for the trustee to make additional payments equal to the repayments that would have been made if the trustee had satisfied the requirements of section 109E.