Edited version of private ruling

Authorisation Number: 1011837436008

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Ruling

Subject: Division 7A deemed dividend - Court ordered property transfer

Question 1

Is the private company taken under section 109C of the Income Tax Assessment Act 1936 (ITAA 1936) to have paid a dividend to a shareholder in relation to a transfer of property made by the private company to a shareholder because of a court order made under the Family Law Act 1975 (FLA 1975)?

Answer

Yes.

Question 2

Are there any exceptions that apply to exclude the property transfer from being treated as a dividend under section 109C of the ITAA 1936?

Answer

No.

Question 3

If the transfer of property from the private company to its shareholders is deemed a dividend payment under Division 7A, can the payment be franked?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The rulee is a private company.

Shareholder A and Shareholder B are the private company's only shareholders.

The private company owns residential properties and held for investment purposes.

Shareholder A and Shareholder B were married and are now separated.

Court orders were sought and finalised under the FLA 1975 determining the financial and other relationships between the two parties to the marriage.

The Court orders directed, amongst other things, that the properties owned by the private company be transferred to the respective shareholders and the mortgages encumbering the properties be refinanced by the shareholders in the amounts/percentages set out by the Court.

The private company was not a party to the Consent Order.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Subsection 109C(1)

Income Tax Assessment Act 1936 Subsection 109C(2)

Income Tax Assessment Act 1936 Paragraph 109C(3)(c)

Income Tax Assessment Act 1936 Subsection 109C(4)

Income Tax Assessment Act 1936 Section 109J

Income Tax Assessment Act 1936 Paragraph 109J(a)

Income Tax Assessment Act 1936 Paragraph 109J(b)

Income Tax Assessment Act 1936 Section 109K

Income Tax Assessment Act 1936 Section 109L

Income Tax Assessment Act 1936 Subsection 109L(1)

Income Tax Assessment Act 1936 Subsection 109L(2)

Income Tax Assessment Act 1936 Section 109RC

Income Tax Assessment Act 1936 Subsection 109RC(3)

Income Tax Assessment Act 1936 Section 109Y

Income Tax Assessment Act 1936 Section 109ZD

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

Income Tax Assessment Act 1997 Section 126-5

Income Tax Assessment Act 1997 Part 3-6

Reasons for decision

Question 1

Summary

A court ordered property transfer made by the private company to its shareholders will be considered a deemed dividend under section 109C of the ITAA 1936.

Detailed reasoning

Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity if the private company makes a payment to the entity during the year and either:

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

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

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

Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is subject to the private company's distributable surplus calculated under section 109Y of the ITAA 1936.

Paragraph 109C(3)(c) of the ITAA 1936 specifically includes a transfer of property as a payment.

A court ordered transfer of property made by the private company to the respective shareholders, would satisfy both subsection 109C(1) of the ITAA 1936 and paragraph 109C(3)(c) of the ITAA 1936. Accordingly section 109C of the ITAA 1936 would apply to treat the court ordered property transfers made by the private company to it's shareholders as deemed dividends.

Where the payment is by transfer of property, subsection 109C(4) of the ITAA 1936 provides that the amount of the payment is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer.

Consideration is not defined in Division 7A. Therefore, the term will take on its ordinary meaning. According to the Macquarie Dictionary, the ordinary meaning of consideration is 'a recompense for service rendered, etc.; a compensation'.

The arrangement between the parties to the marriage in relation to the refinancing of the private company's outstanding mortgages over the properties is a private arrangement in satisfaction of the financial rights of the parties to the marriage, rather than consideration given to the private company for the transfer of the properties to the shareholders. Therefore, the value of the deemed dividends to each shareholder will be the arm's length value of the properties transferred to the respective shareholders subject to the distributable surplus of the private company calculated under section 109Y of the ITAA 1936.

Question 2

Summary

There are no exceptions that apply to exclude the Court ordered transfer of property from the private company to a shareholder from being treated as a dividend under section 109C of the ITAA 1936.

Detailed reasoning

Subdivision D of Division 7A defines the types of payments that are excluded from being treated as dividends under section 109C of the ITAA 1936. These payments include:

· payments of genuine debts (section 109J)

· payments to other companies (section 109K)

· payments that are otherwise assessable or that are specifically excluded from assessable income (section 109L).

Only section 109J of the ITAA 1936 and section 109L of the ITAA 1936 are applicable to the payments made by the private company.

Section 109J of the ITAA 1936 provides that a deemed dividend will not arise under section 109C in respect of a payment by a private company to the extent that it discharges an obligation of the company to pay money to the entity and does not exceed the amount required to discharge the obligation had the parties been dealing at arm's length.

The term obligation is not expressly defined for the purposes of section 109J of the ITAA 1936 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.'

A Court order made under the FLA 1975 may result in an entity who is not a party to the Court proceedings making a transfer of property under the terms of that court order however, the order only 'binds' a party to the proceedings who is subject to the order. In addition, the second element of section 109J of the ITAA 1936, requires an obligation to 'pay money'. The private company does not have a binding obligation as it is not a party to the Consent Order and the payment was a transfer of property rather than money. As such, neither element is satisfied and section 109J of the ITAA 1936 will not operate to prevent subsection 109C(1) of the ITAA 1936 to deem a dividend upon transfer of property.

Section 109L of the ITAA 1936 provides that a private company is not taken to pay a dividend under section 109C to the extent that:

· the payment would form part of the entity's assessable income because of some provision other than Division 7A as it operates in conjunction with section 44; subsection 109L(1); or

· a provision of the Act other than Division 7A specifically excludes the payment from the entity's assessable income; subsection 109L(2).

As the payment from the private company would not be assessable other than by virtue of Division 7A, subsection 109L(1) does not apply. Subsection 109L(2) also does not apply as there is no other provision of the Act that would specifically exclude the payment, being the transfer of property, from the shareholders assessable income.

Question 3

Summary

Section 109RC of the ITAA 1936 will apply to frank the deemed dividends arising from the transfer of property from the private company to its shareholders under a Court order.

Detailed reasoning

Section 109RC of the ITAA 1936 allows a dividend deemed under Division 7A to be franked if it is paid due to a family law obligation.

A 'family law obligation' is defined in section 109ZD of the ITAA 1936 as 'an order agreement or award mentioned in paragraph 126-5(1) (a), (b), (c), (d), (e) or (f) of the ITAA 1997. Those provisions refer to:

(a) a court order under the FLA or a corresponding foreign law;

(b) a maintenance agreement approved by a court under FLA section 87 or a corresponding agreement approved by a court under a corresponding foreign law;

(c) a court order under a state law, territory law or foreign law relating to de facto marriage breakdowns;

(d) something done under a binding financial agreement made under FLA Pt VIIIA or a corresponding foreign law;

(e) something done under an award made in an arbitration under FLA section 13H or a corresponding state law, territory law or foreign law; or

(f) something done under a written agreement that is binding because of a state law, territory law or foreign law relating to de facto marriage breakdowns and that cannot be overridden by an order of a court (except to avoid injustice).

Subsection 109RC(3) of the ITAA 1936 provides that the private company may frank the dividend in accordance with Part 3-6 of the ITAA 1997, subject to the dividend being franked at the private company's benchmark franking percentage for the period in which the dividend is taken to be paid, or if no franking percentage exists, at 100%.

Therefore, as the transfer of property from the private company will be made due to a family law obligation, the private company will be able to frank the dividend in accordance with section 109RC of the ITAA 1936.

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