Edited version of private ruling

Authorisation Number: 1011839622508

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Ruling

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

Question 1

Is a 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 the 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 an assessable dividend paid to the shareholder under section 109C of the ITAA 1936?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

01 July 2010

Relevant facts and circumstances

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

The private company owns residential properties that were held for investment purposes.

Shareholder A and Shareholder B are individuals that 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 an individual shareholder 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 individual 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 the individuals 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 individual shareholder will be the arm's length value of the property transferred to the respective shareholders subject to the distributable surplus of the private company calculated under section 109Y of the ITAA 1936.

Please note that as the deemed dividend by the private company is payable due to a family law obligation, the dividend received by the individual shareholders may be franked by the private company.

Question 2

Summary

There are no exceptions that apply to exclude the Court ordered transfer of property from the private company to the individual shareholder from being treated as an assessable 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 individual shareholder's assessable income.

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