Edited version of private ruling

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Ruling

Subject: Division 7A and marriage breakdown

Question 1

Will the taxpayer be taken to have received a deemed dividend pursuant to subsection 109XA(1) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the transfer of property from a Trust to the taxpayer pursuant to a Family Court Order made under the Family Law Act 1975 (FLA)?

Answer

No

Question 2

Will the taxpayer be taken to have received a dividend pursuant to section 109C of the ITAA 1936 in respect of an obligation by a private company to pay money to the taxpayer pursuant to a Family Court Order made under the FLA?

Answer

No

This ruling applies for the following period

1 July 2009 to 30 June 2011

The scheme commenced in

Year ended 30 June 2010

Relevant facts

The taxpayer and her spouse are currently negotiating a marriage settlement and are in the process of obtaining consent orders pursuant to section 81 of the FLA to split assets.

The orders will involve not only the personal assets of the taxpayer and her spouse, but those assets owned by a Trust and a private company.

It is proposed under the settlement that the taxpayer will receive shares from the Trust, in addition to a cash payment and a number of shares from the private company.

Additional facts include:

· The beneficiaries of the Trust include the taxpayer, spouse and a private company;

· The taxpayer and spouse are shareholders and directors of the private company;

· The private company has an unpaid present entitlement owed by the Trust, of which no part amounts to an unrealised gain;

· The taxpayers spouse has an unpaid present entitlement owed to him by the Trust, of which no part amounts to an unrealised gain;

· The taxpayer has no unpaid present entitlement owed by the Trust;

· The unpaid present entitlement owed to the private company will remain unpaid before the earlier of the due date for lodgement and the date of lodgement of the Trust's income tax return for the year in which the property is transferred;

· The private company has a distributable surplus for the year ended 30 June 2009 (retained earnings do not include any revaluation reserves);

· The transfer of shares from the Trust to the taxpayer will be accounted for as either:

i) a disposal for nil monetary consideration; or

ii) a transfer by way of distribution from the Trust;

· The taxpayer will resign as trustee, guardian and appointer of the Trust; and

· The taxpayer will resign as director of the private company and shall transfer the taxpayer's shares in that company to the taxpayer's spouse.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109XA

Income Tax Assessment Act 1936 Section 109XB

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Section 109J

Income Tax Assessment Act 1997 Subsection 960-100(1)

All legislative references hereafter are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise indicated.

Question 1

Summary

The taxpayer will not be taken to have received a deemed dividend pursuant to subsection 109XA(1) in respect of the transfer of property from the Trust to the taxpayer under a Family Court Order.

Detailed reasoning

Subdivision EA of Division 7A contains the rules for determining whether a shareholder of a private company (or an associate of the shareholder) will, by virtue of Division 7A, be treated as having received an assessable dividend as a result of obtaining a financial benefit in the form of a loan, payment or a forgiven debt through a trust.

Section 109XA sets out the conditions where certain payments made by trustees, including transfers of property, are treated as deemed dividends in accordance with section 109XB.

Subsection 109XA(1) provides:

Payments. Section 109XB applies if:

(a)     a trustee makes a payment to a shareholder or an associate of a shareholder of a private company (except a shareholder or associate that is a company) (the actual transaction); and

(b)     the payment is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain; and

(c)     either:

(i)      the company is presently entitled to an amount from the net income of the trust estate at the time the actual transaction takes place, and the whole of that amount has not been paid to the company before the earlier of the due date for lodgement and the date of lodgement of the trustees return of income for the trust for the year of income of the trust in which the actual transaction takes place; or

(ii)     the company becomes presently entitled to an amount from the net income of the trust estate after the actual transaction takes place, but before the earlier of the due date for lodgement and the date of lodgement of the trustees return of income for the trust for the year of income of the trust in which the actual transaction takes place, and the whole of the amount has not been paid to the company before the earlier of those dates.

A 'payment' for the purposes of Division 7A is defined in subsection 109C(3) and includes a transfer of property to the shareholder, or an associate of the shareholder.

A present entitlement will be attributable to an amount that is an unrealised gain, within the meaning of paragraph109XA(1)(b), where the trust deed empowers the trustee to declare present entitlement to an amount representing the unrealised gain, and the trustee has declared present entitlement to that amount.

There is no definition of the term 'present entitlement' in the ITAA 1936 or the Income Tax Assessment Act 1997 (ITAA 1997); therefore, it is necessary to establish its ordinary meaning given by the courts. The principal cases concerning the concept of present entitlement are the High Court decisions of FC of T v. Whiting (1943) 68 CLR 99 and Taylor v. FC of T (1970) 119 CLR 444. 

The main principles that emerged from these cases are:

· the income must be legally available for distribution to the beneficiary. It does not matter whether the amount of income has been precisely ascertained; and

· the beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent; the beneficiary must have the right to demand immediate payment (or would have had the right to demand payment had they not been under a legal disability).

Unrealised gain is defined in subsection 109XA(7) and provides:

Unrealised gain, in relation to a trust estate and an actual payment, means any unrealised gain, whether of a capital or income nature, but does not include an unrealised gain to the extent that it has been or would be included in the assessable income of the trust, apart from this Division, for:

(a)    a year of income before the year in which the actual payment was made;

(b)    the year of income in which the actual payment was made; or

(c)    the year of income following the year in which the actual payment was made.

Further, the Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 1) Bill 2004 provides at paragraph 8.13:

….the term 'unrealised gain' is intended to apply very broadly. It is defined to mean any unrealised gain whether of a capital or income nature. For the purposes of these rules, realisation will be taken to have occurred when a gain converts into a recoverable debt.

Application of subsection 109XA(1)

The rules in 109XA(1) are only applicable to payments that are wholly or partly attributable to an amount that is an unrealised gain.

Specifically, paragraph 109XA(1)(b) requires that the payment by the trustee to the shareholder (or associate of the shareholder) be one that discharges or reduces the present entitlement of the shareholder, and the present entitlement arose from amounts attributable to unrealised gains.

Based on the facts provided by the Applicant, although the trustee of the Trust will make a payment to the taxpayer who is a shareholder of a private company, thereby satisfying paragraph 109XA(1)(a), the payment will not discharge or reduce any present entitlement of the taxpayer arising from unrealised gains as required by paragraph 109XA(1)(b).

Therefore, subsection 109XA(1) has no application and the transfer of the shares to the taxpayer by the Trust pursuant to a Family Court Order will not be treated as a deemed dividend by section 109XA.

Question 2

Summary

The taxpayer will not be taken to have received a dividend pursuant to section 109C in respect of an obligation by a private company to pay money to the taxpayer pursuant to a Family Court Order.

Detailed reasoning

Payments treated as dividends

Section 109C treats certain payments, loans and debt forgiveness made by a private company to shareholders, or associates of shareholders as dividends.

Subsection 109C(1) provides that a private company is taken to pay a dividend to an entity if the private company pays an amount to the entity during the income year and either:

· the entity is a shareholder or associate of a shareholder in the company at the time of the payment; or

· a reasonable person would conclude that the payment was made because the entity has been a shareholder or associate at some time.

Payment by virtue of subsection 109C(3) includes a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity.

Entity is defined in subsection 960-100(1) of the ITAA 1997 and includes an individual.

Subdivision D of Division 7A sets out certain payments that are excluded from the operation of section 109C.

In particular, section 109J provides:

A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment:

· discharges an obligation of the private company to pay money to the entity; and

· is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length.

The term 'obligation' is not expressly defined for the purposes of section 109J and therefore adopts its ordinary meaning. The Macquarie Dictionary defines 'obligation' as:

'a binding requirement as to action; the binding power or force of a promise, law, duty, agreement, etc. ; a binding promise or the like'.

Hence, an obligation can only arise from a court order made under the FLA where the entity is a party to the proceedings.

Application of sections 109C and 109J

Under the proposed marriage settlement, a private company will provide a cash payment to the taxpayer, a shareholder of the company. As such it is considered that the payment falls within the operation of section 109C.

For the exclusion in section 109J to apply, the payment must discharge an obligation of the private company to pay money to the taxpayer and the payment does not exceed the amount required to discharge the obligation had the parties been dealing at arms length.

Provided the private company will be a party to the proceedings of the court order, it is considered that the amount of the payment will be at arms length as the divorce settlement is subject to review and consideration by lawyers representing the taxpayer and their spouse.

Consequently, provided the court order makes the private company a party to the proceedings and the order specifically binds the company to pay cash to the taxpayer, and not some other alternative obligation, the payment would not be a dividend by virtue of section 109J.

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