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Ruling

Subject: Are payments relating to calls made on units in a unit trust deemed dividends.

Question 1

Will payments made by the private company in relation to calls made on its unit holding in the unit trust be considered to be a deemed dividend under Section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will payments made by the private company in relation to calls made on its unit holding in the unit trust be considered to be a deemed dividend under Section 109D of the ITAA 1936?

Answer

No.

This ruling applies for the following periods:

Year ended 31 December 2012

Year ended 31 December 2013

Year ended 31 December 2014

Year ended 31 December 2015

Year ended 31 December 2016

Year ended 31 December 2017

Year ended 31 December 2018

Year ended 31 December 2019

Year ended 31 December 2020

Year ended 31 December 2021

The scheme commences on:

During the year ended 30 June 2012

Relevant facts and circumstances

The scheme the subject of this ruling has been ascertained from:

· the private ruling application,

· the trust deed of the unit trust and

· additional information from the applicant clarifying the facts of the scheme.

The unit trust

The unit trust established by the Trust Deed.

The Trustee for the unit trust is A Pty Ltd, being a corporate trustee.

During 2012, the unit trust acquired a property.

The unit trust paid a deposit for the property representing 10% of the total contract purchase.

The unit trust paid the deposit by the funding from the allotment units in the unit trust. The following units were allotted:

· 'A Class' units paid to 10 cents in the dollar to the private company, and

· 'Ordinary' units paid to 10 cents in the dollar to the family trust, and

· 'Ordinary' units fully paid to $1 to Mr X

· 'Ordinary' units fully paid to $1 to Mrs X

The shareholders of the private company are Z Pty Ltd, Mr X and Y Pty Ltd as trustee for the family trust.

The family trust holds Ordinary units. Mr and Mrs X are the co directors of the trustee for the family trust.

Unit holders' rights and entitlements

The Trustee of the unit trust resolved that the net income of the Trust for the years ending 31 December 2012 to 2021 (inclusive) will be distributed across all unit holders in proportion with the number of units held, irrespective of the class of unit.

The Trustee of the unit trust resolved to make equal calls on partly paid units across both 'A Class' and 'Ordinary' units in the unit trust over the same period.

Under the terms of the Trust Deed, the 'A Class' unit holders do not have a right to vote and are only entitled to receive a rateable proportion of the trust income as the Trustee appoints.

The voting control of the unit trust is held by Mr X and Mrs X.

Mr X and Mrs X each hold 10 fully paid Ordinary units, and, are the co-directors of Y Pty Ltd as trustee for the family trust.

Acquisition of the property

Settlement for the property took place on in early 2012.

At settlement, the unit trust borrowed an amount from the Bank and was required to pay stamp duty and other settlement adjustments such as land tax and legal costs.

Prior to settlement, the unit trust made a call on 'Ordinary' and 'A Class' unit holders of 5 cents per unit to partially cover stamp duty and the other settlement adjustments. The call on the investors was as follows:

· 'A Class' units at 5 cents in the dollar contributed by A Pty Ltd; and

· 'Ordinary' units at 5 cents contributed by the family trust.

The balance of the stamp duty payable and the other settlement adjustments was funded by a loan from A Pty Ltd.

The property is currently leased to a related entity.

Other Relevant Facts

The Unit Trust Deed provides information in regard to calls able to be made by the Trustee.

All parties are dealing with each other on an arm's length basis and on commercial terms. The applicant has confirmed that the payments made by A Pty Ltd for the 'A Class' units in the unit trust, whether partially paid or fully paid, reflect arm's length value (market value) of the 'A Class' units in the unit trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 subsection 109C (3)

Income Tax Assessment Act 1936 paragraph 109C (1)(a)

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 subsection 109D (1)

Income Tax Assessment Act 1936 subsection 109D (3)

Income Tax Assessment Act 1936 paragraph 109D (1)(a)

Income Tax Assessment Act 1936 section 109J

Income Tax Assessment Act 1936 subsection 109J (a)

Income Tax Assessment Act 1936 subsection 109J (b)

Income Tax Assessment Act 1936 section 109ZD

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1936 subsection 318 (2)

Income Tax Assessment Act 1936 paragraph 318 (2)(c)

Income Tax Assessment Act 1936 paragraph 318 (2)(d)

Income Tax Assessment Act 1936 paragraph 318 (6)(b)

Reasons for decision

Question 1

Will payments made by the private company in relation to calls made on its unit holding in the unit trust be considered to be a deemed dividend under Section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Detailed reasoning

Division 7A of the ITAA 1936 treats certain amounts as dividends paid by a private company including:

· amounts paid by a company to a shareholder or shareholder's associate (section 109C of the ITAA 1936), and

· amounts lent by a company to a shareholder or shareholder's associate (section 109D of the ITAA 1936).

Application of section 109C of the ITAA 1936

For the purposes of Division 7A of the ITAA 1936, subsection 109C(3) of the ITAA 1936 defines a payment to an entity as:

a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and

a credit of an amount to the extent that it is:

· to the entity; or

· on behalf of the entity; or

· for the benefit of the entity; and

· a transfer of property to the entity.

When a call is made by the Trustee of the unit trust in relation to the 'A Class' units, A Pty Ltd will be considered to be making a payment to an entity.

The defined terms in section 109ZD of the ITAA 1936 states that an 'associate' has the meaning given by section 318 of the ITAA 1936. Paragraph 318(1)(d) of the ITAA 1936 provides that a trustee of a trust will be considered an associate where a primary entity, or another entity that is an associate of the primary entity because of another paragraph in subsection 318(1) of the ITAA 1936, benefits under the trust. Accordingly, the unit trust is considered to be an associate of Mr X as they are a shareholder of A Pty Ltd.

As a payment from A Pty Ltd to the unit trust (when a call is made), will be a payment to an associate of a shareholder, section 109C of the ITAA 1936 will apply. However, section 109J of the ITAA 1936 provides an exception to the operation of section 109C in certain circumstances.

Application of section 109J of the ITAA 1936

Section 109J of the ITAA 1936 states:

· 109J 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 defined for the purposes of section 109J of the ITAA 1936. However, the common, ordinary definition of 'obligation' can be found in the Macquarie Dictionary as

1. a binding requirement as to action; duty: to fulfil every obligation.

2. the binding power or force of a promise, law, duty, agreement, etc.

Both elements in section 109J of the ITAA 1936 are required to be satisfied in order to exclude a payment from the operation of section 109C of the ITAA 1936. That is, the payment must discharge an obligation of A Pty Ltd to pay money to the unit trust. In addition, that obligation must be no more than would have been required where A Pty Ltd and the unit trust are dealing with each other at arm's length.

The payments made by A Pty Ltd to the unit trust relate to the discharge of an obligation by A Pty Ltd for the purposes of the Trust Deed (a contractual obligation).

A call on the partly paid 'A Class' units made by the Trustee of the unit trust pursuant to the Trust Deed obliges A Pty Ltd, who holds 'A Class' units, to make a payment to the unit trust. The calls will be made for the purpose of enabling the unit trust to pay down its external debt obligations and for other obligations associated with the acquisition of the property.

Any payment made by A Pty Ltd in relation to the calls made on 'A Class' units will satisfy subsection 109J(a) of the ITAA 1936, being the discharge of an obligation of A Pty Ltd to pay an amount to the unit trust.

The parties, being A Pty Ltd and the Trustee of the unit trust are associates. They are required for the purposes of satisfying subsection 109J(b) of the ITAA 1936 to show that they are dealing at arm's length. The payments made by A Pty Ltd for the 'A Class' units in the unit trust, whether partially paid or fully paid, reflect the arm's length value (market value) of the A Class units in the unit trust. This means that A Pty Ltd and the unit trust are dealing with each other at arm's length and A Pty Ltd is not paying more than would have been required (market value) to discharge the obligation had the transaction been entered into by an independent third party.

Any payments made by A Pty Ltd in relation to the calls made on 'A Class' units will qualify for the exemption provided by subsection 109J(b) of the ITAA 1936, to the extent that the payments are not more than would be required had A Pty Ltd and the unit trust been dealing with each other at arm's length.

Therefore, the payments made by A Pty Ltd to the unit trust when a call is made on 'A Class' units held by A Pty Ltd, will not be deemed to be dividends under section 109C of the ITAA 1936, as its operation would be excluded under section 109J of the ITAA 1936.

Question 2

Will payments made by the private company in relation to calls made on its unit holding in the unit trust be considered to be a deemed dividend under Section 109D of the ITAA 1936?

Detailed reasoning

Section 109 of the ITAA 1936 treats a loan made by a private company to a shareholder to be a deemed dividend in certain circumstances. Subsection 109D(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity in an income year if the company makes a loan during the year to a shareholder or an associate of a shareholder, which is not fully repaid before the company's lodgment day and no exclusion in Subdivision D of Division 7A of the ITAA 1936 prevents the company from being taken to pay a dividend.

Subsection 109D(3) of the ITAA 1936 provides the following in regard to loans:

109D(3)What is a loan?

· an advance of money; and

· a provision of credit or any other form of financial accommodation; and

· a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and

· a transaction (whatever its terms or form) which in substance effects a loan of money.

Advance of money - paragraph 109D(3)(a) of the ITAA 1936

As outlined in paragraph 85 of Taxation Ruling TR 2010/3, the phrase 'advance of money' is taken to mean 'a payment of moneys ahead of a due date, or a payment in expectation of repayment or reimbursement.'

This was reinforced in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (1997) 72 FCR 300; 97 ATC 4151; (1997) 34 ATR 635 (Radilo). In this case, the Court considered the definition of a loan, stating that it 'involves an obligation on the borrower to repay the sum borrowed.'

A Pty Ltd will make payments to the unit trust. However, there is no corresponding obligation for the amount to be repaid. The payment is not considered an advance for money for the purposes of subsection 109D(3) of the ITAA 1936.

Provision of credit and financial accommodation - paragraph 109D(3)(b) of the ITAA 1936

The meaning of the phrase 'provision of credit' is set out in paragraph 87 of TR 2010/3 as follows:

87. The term 'credit' used in the phrase 'provision of credit' involves allowing time to pay a debt (including by granting a right to defer payment of a debt). A loan itself amounts to the provision of credit (see, for example, the decision of the High Court in Herbert v. R where lending money, which necessarily involved allowing time for it to be repaid, was held to be the provision of credit). The provision of credit extends to allowing time to pay any debt, nor just that arising under a loan agreement, as is evident from the judgments in Herbert v. R. Whether or not it also extends to allowing time to pay an equitable obligation is not clear from the cases.

The meaning of the phrase 'any other form of financial accommodation' is outlined in paragraph 96 of TR 2010/3 to be as follows:

96. In the Commissioner's view, the statutory context in which the phrase appears limits what amounts to financial accommodation under this definition to:

· the supply or grant of some form of pecuniary aid or favour…;

· under a consensual arrangement (similarly to Radilo); and

· where the principle sum or equivalent is ultimately payable (similarly to Radilo).

As outlined in paragraph 119 of TR 2010/3, the phrase 'transaction (whatever its term or form)' suggests a wide meaning of the word. Paragraph 120 of TR 2010/3 discusses the majority decision in Grimwade v. Federal Commissioner of Taxation [1949] HCA 9; (1949) 78 CLR 199, that a transaction must be bilateral (that is, to be a transaction at least two parties must be involved).

There is no obligation to advance monies until a call is made by the unit trust to its unit holders. A Pty Ltd does not provide monies ahead of a due date and there is no expectation of repayment or reimbursement. The payment from A Pty Ltd to unit trust is not an advance of monies for the purposes of paragraph 109D(3)(b) of the ITAA 1936.

There is no timeline to pay a debt and no monetary arrangement. Therefore, the payment from A Pty Ltd to the unit trust is not the provision of credit nor providing financial accommodation for the purposes of paragraph 109D(3)(b) of the ITAA 1936.

Amount requiring repayment - paragraph 109D(3)(c) of the ITAA 1936

The Trust Deed states that there is no express and implied obligation on the trustee to pay any amount to 'A Class' unit holders other than a share of income. The monies paid to the 'A Class' unit holders occur because they are unit holders. That is, there is no obligation on the unit trust to repay any amount paid by A Pty Ltd. Instead, as a result of the payment, A Pty Ltd acquires an asset (being a unit in the unit trust).

Therefore, the payment from A Pty Ltd to the unit trust is not an amount requiring repayment for the purposes of paragraph 109D(3)(c) of the ITAA 1936.

A transaction which in substance effects a loan - paragraph 109D(3)(d) of the ITAA 1936

As stated in paragraph 116 of TR 2010/3, this extended definition of a loan covers arrangements that in substance effect a loan of money (that is, consisting of a payment requiring repayment).

Although there is a transfer of money between two parties, there is no debtor/creditor relationship between A Pty Ltd and the unit trust, that is, there is no obligation for the unit trust to repay the amount.

Therefore, the repayment from A Pty Ltd to the unit trust is not a transaction which in substance effects a loan for the purposes of paragraph 109D(3)(d) of the ITAA 1936.

Conclusion

The payment by A Pty Ltd to the unit trust for partially paid units in the trust would not be considered a loan for the purposes of subsection 109D(3) of the ITAA 1936 for the following reasons:

There is no obligation on the unit trust to repay any amount paid by A Pty Ltd. However, these payments would result in A Pty Ltd acquiring an asset, being a unit in the unit trust.

The calls on the partly paid 'A Class' units in the unit trust represent an investment by A Pty Ltd for which it may receive a portion of the net income of the trust.

The return on investment is not considered interest. It is also not in the nature of interest.

Therefore, as the payment to A Pty Ltd to the unit trust is not a loan, section 109D of the ITAA 1936 will not apply. Accordingly, the payment by A Pty Ltd to the unit trust is not considered a deemed dividend under section 109D of the ITAA 1936.

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