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Ruling

Subject: Income - franked dividends and Division 7A

Question 1:

Will the Commissioner treat the payments by the company as dividends for the purposes of section 6(1) of the Income Tax Assessment Act 1936?

Answer:

Yes.

Question 2:

Will the Commissioner treat the dividends as fully franked in accordance with section 202-5(c) of the Income Tax Assessment Act 1997 (ITAA 1997) and allow further time to issue a distribution statement under section 202-75(5) of the ITAA 1997?

Answer:

Yes.

Question 3:

If the Commissioner considers that the payments are not ordinary dividends, do the loan rules in section 109D of Division 7A of the Income Tax Assessment Act 1936 apply?

Answer:

Not applicable.

Question 4:

If so will the Commissioner exercise his discretion under section 109RB to disregard the deemed dividends or to allow the dividends to be fully franked?

Answer:

Not applicable.

This ruling applies for the following period

1 July 2009 to 30 June 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The taxpayer passed away.

After a lengthy dispute over the estate it was established that the taxpayer's spouse would be entitled to the income of the estate during their lifetime.

The spouse did not receive income as a shareholder, an associate or a former associate of the company.

The spouse is the life tenant of the estate and is entitled to income of the state during their lifetime.

The estate, the deceased and the company are and at all times were residents of Australia for taxation purposes.

Shares in the company are held by the Trustee of the Estate.

The Supreme Court of X issued a consent order.

The consent order in relation to the income entitlement was that;

· A specified amount would be paid to the spouse and treated as fully franked dividend and as part of their income entitlement from the estate;

· The trustees of the Estate were to pay the spouse a specified amount per month as fully franked dividend, on account of their income entitlement; and

· The relevant companies would be caused to pay their net income to the estate every 6 months, as fully franked divided, and that the Estate must pay that amount to the spouse, by way of income.

The parties to the court proceedings were;

· The spouse - of the deceased

· The director of the companies and Executor of the Will and Trustee of the Estate

· Executor of the Will and Trustee of the Estate

The directions given in the Consent Order were made to director of the companies and Executor of the Will and Trustee of the Estate and the Executors of the Will and Trustees of the Estate.

At the time the consent order was granted, one of the two directors of the company was a defendant in the Consent Order and so aware of the details of the order.

The two directors were replaced.

After the directors were replaced it was discovered the payments by the company during two financial years were not treated as dividends and that the previous directors did not declare the amounts to be franked.

The accounting treatment of the amounts increased the loan account to the estate in the non-current assets section to the balance sheets.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 109D(3)

Income Tax Assessment Act 1936 Section 109L

Income Tax Assessment Act 1997 Section 202-75

Income Tax Assessment Act 1997 subsection 202-75(4)

Reasons for decision

Question 1:

Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) treats amounts as dividends paid by a private company. Under subdivision B, private company payments or loans made directly to an entity that is a shareholder or an associate of a share holder are taken to be a dividend paid to the shareholder or associate. Debts owned by the entity to a private company that are forgiven are also taken to be the payment of a dividend.

A loan is defined in subsection 109D(3) of Division 7a of the ITAA 1936. Taxation Ruling, TR 2010/3, discusses loans within the ordinary meaning. Based on the Federal Court decision in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd , the essential element of an ordinary loan is that there is an obligation to repay a borrowed amount.

Under subsection 109D(3) of Division 7A of the ITAA 1936 the definition of the term 'loan' is extended beyond its ordinary meaning to include advances of money, provision of credit, provision of other forms of financial accommodation and any transaction which effects a loan of money.

A dividend is defined in subsection 6(1) of the ITAA 1936 to include;

· "any distribution made by a company to any if its shareholders, whether in money or other property".

Dividends paid to Australian resident shareholders out of any profits of the company are assessable under section 44 of the ITAA 1936.

Under section 109L of the ITAA 1936, if a payment is assessable income by reason of some other provision under either the ITAA 1936 or Income Tax Assessment Act 1997 (ITAA1997), the deemed division provisions will not apply.

Application to your circumstances

Loan

The accounting treatment of the amounts was to increase the loan account balance to the estate in the non-current assets section of the balance sheets; accordingly the amounts appear to have been treated as loans by the Directors the company.

The Consent Orders issued by the Supreme Court which impose an obligation on the directors of the company to pay the amounts to the Estate and do not require the amounts to be repaid. The Consent Orders expressly refer to the payments as an income entitlement.

Furthermore the actions by the Directors in relation to the accounting treatment of the payments are clearly contrary to the Consent Order.

Therefore, the payments cannot be considered to be loans with the ordinary meaning.

Considering the term 'loan' in its extended meaning; there are no payments and repayment amounts involved which effect a loan of money.

Accordingly the payments are not considered to be an in substance loan within the extended meaning.

Ordinary dividend

The Consent Order refers to the payments to the spouse as being their income entitlement from the Estate; and require the net income of the companies (after payment of expenses and tax) paid to the Estate is paid to the spouse as fully franked dividends.

It is clear that the purpose and intention of the Consent Orders is that the relevant income would be paid by way of fully franked dividends, and as such, they would constitute dividends for the purposes of section (6(1) of the ITAA 1936.

In addition the reference to 'net income' in the wording of the Consent Orders specifically qualifies the net income as income "after the payment of expenses and tax". Therefore, it was not intended that the companies would make tax-fee distributions of profits to the Estate or to the spouse.

Accordingly, to give effect to the terms of the Consent Order, the Commissioner will allow the payments to be treated as dividends under section 6(1) of the ITAA 1936.

Question 2:

Franking of ordinary dividends is dealt with under Division 202 of the ITAA 1997. An entity that makes a frankable distribution must give the recipient a distribution statement under section 202-75 of the ITAA 1997.

The distribution statement provides documentary evidence of a number of factual issues concerning the making of the frankable distribution. The distribution statement cannot alter the amount of franking credits allocated by the company to the distribution

A private company must provide the statement within four months (or further time allowed by the Commissioner in writing) after the end of the income year in which the distribution is made.

Under subsection 202-75(4) of the ITAA 1997 an extension is not allowed for a franked distribution that would create or increase a liability to franking deficit tax.

Application to your circumstances

The private company, the Estate of the deceased and the deceased's spouse have at all times been Australian residents for taxation purposes. Therefore, the taxation threshold requirements are fulfilled.

The deceased estate has been involved in a lengthy and complex legal dispute which has now been resolved. However, as a result of the dispute the Directors did not issue a distribution statement within the required timeframe.

Further, one of the defendants in the Consent Order was at the time a director of the company and also the Executor of the Will and Trustee of the Estate. The shares in the company were held by the Trustee of the Estate.

The Consent Order specifically required the Directors to treat the payments as fully franked dividends. It could be argued that, as the Director was party to the Consent Order, a decision was made by the company to allocate the franking credits to the distribution, when the order was made by the court.

Accordingly, the Consent Order provides the evidence as to the decision that was made.

When the distribution statement is issued it will reflect the decision made under the direction of the Consent Order. Allowing further time to issue the distribution statement will not change the allocation of franking credits to the distribution.

Therefore; the Commissioner will exercise his discretion to allow the company further time to issue the distribution statement.

The Commissioner will allow the company the time it requested to issue distribution statements to shareholder/s.

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