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Ruling

Subject: Income Tax: Division 7A - payments treated as dividends

Question 1

Will section 109J of the Income Tax Assessment Act 1936 ('ITAA 1936') apply to a Family Court Order that explicitly directs the company to pay cash amounts to the Taxpayer?

Answer

Yes. The payments satisfy both elements of section 109J of the ITAA 1936.

Question 2

Will the payment of cash to the Taxpayer pursuant to a Family Court Order be a dividend pursuant to subsection 6(1) of the ITAA 1936 or assessable under subsection 44(1) of the ITAA 1936?

Answer

No. The payments do not meet the definition of 'dividend' in subsection 6(1) of the ITAA 1936 and therefore cannot be included in the Taxpayer's assessable income by the operation of subsection 44(1) of the ITAA 1936.

This ruling applies for the following periods:

I July 2011 to 30 June 2013

The scheme commences on:

The date of the court order.

Relevant facts and circumstances

The Taxpayer has separated from their spouse and together they have negotiated a property settlement as detailed in the Family Court of Australia Order No xxxxxxx dated and stamped xxxxx 2012. The Court Order is binding on all parties. A copy of the order is attached to the ruling request at Appendix C.

The Taxpayer is one of two directors of a company, the other being the Taxpayer's parent. The company is a private company.

The Taxpayer is the trustee of the XXXX Trust which is the majority shareholder in the company. The other shareholder is the AAAAA Family Trust, the trustees of which are the Taxpayer's parents.

The company is a party to the Family Court proceedings and was named as third respondent in the Court order. The company is explicitly directed to do the following in accordance with clause 9.7 of the order:

The company must pay the Taxpayer the following sums:

· Clause 9.7.1 - the sum of $xxxxx within twenty eight days of the Court order; and

· Clause 9.7.2. - the sum of $xxxxx within six months form the date of the payment of the sum specified in clause 9.7.1.

The company made the payment of $xxxxx to the Taxpayer. It is expected the remaining payment of $xxxxx will be paid to the Taxpayer before the due date as specified by the Court order.

Relevant legislative provisions

Subsection 6(1)

Section 44

Division 7A

Section 109C

Section 109J

Section 109RC

Section 109ZD

Part X

Section 318

Income Tax Assessment Act 1997

Subdivision 126-A

Paragraph 126-5(1)

Section 960-100

Section 995-1

Reasons for decision

Question 1

Summary

A court ordered cash payment by the private company to an associate of the company's shareholder would not be considered to be a deemed dividend under section 109C of the ITAA 1936 by virtue of the operation of section 109J 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 the 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.

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

An 'associate' of a company is defined in subsection 318(2) of the ITAA 1936. An associate of a company can include another entity which has "sufficient influence" over a company, either in its own right or in conjunction with other entities. An associate of a company can also be an entity which holds a majority voting interest in the company.

The Taxpayer is an associate of the company by virtue of the fact that they are the trustee of a trust which holds a majority voting interest in the company and as an individual they are a director of the company and is therefore capable of exerting "sufficient influence" over the company.

According to paragraph 318(6)(b) of the ITAA 1936 a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts).

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.

A court ordered payment made by the private company to the Taxpayer would satisfy subsection 109C(1) of the ITAA 1936. At the time of the initial payment the Taxpayer would be considered to be an associate of the company as defined in subsection 318(2) of the ITA 1936. Accordingly section 109C of the ITAA 1936 would apply to treat the amount of the court ordered cash payment made by the private company to the Taxpayer as a deemed dividend, subject to the company's distributable surplus for the relevant income year.

However, certain payments made by a private company to an entity are excluded from the operation of section 109C of the ITAA 1936. Section 109J of the ITAA 1936 provides that:

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:

(a) discharges an obligation of the private company to pay money to the entity; and

(b) 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 of the ITAA 1936 and therefore adopts its ordinary meaning. The Macquarie Dictionary defines obligation as follows:

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

For the purposes of Division 7A of the ITAA 1936, 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 paragraphs refer to:

· a court order made under the Family Law Act (FLA) or a corresponding foreign law;

· a maintenance agreement approved by a court under FLA s 87 or a corresponding agreement approved by a court under a corresponding foreign law;

· (Repealed by No 144 of 2008);

· Something done under: (i) a financial agreement made under Part VIIIA of the Family Law Act 1975 that is binding because of section 90G of that Act; or (ii) a corresponding written agreement that is binding because of a corresponding foreign law; or

· Something done under: (i) a Part VIIIAB financial agreement (within the meaning of the Family Law Act 1975) that is binding because of section 90UJ of that Act; or (ii) a corresponding written agreement that is binding because of a corresponding foreign law; or

· Something done under: (i) an award made in an arbitration referred to in section 13H of the Family Law Act 1975; or (ii) a corresponding award made in an arbitration under a corresponding State law, Territory law or foreign law; or

· Something done under a written agreement: (i) that is binding because of a State law, Territory law or foreign law relating to breakdowns of relationships between spouses; and (ii) that, because of such a law, prevents a court making an order about matters to which the agreement applies, or that is inconsistent with the terms of the agreement in relation to those matters, unless the agreement is varied or set aside,

· An order made under section 79 of the Family Law Act 1975 '(FLA 1975') as a result of proceedings in the Family Court regarding the property of the parties to a marriage, may result in an entity who is not a party to the proceedings (for example, a company or trust) making a transfer under the terms of that court order. Part VIIIAA of the FLA 1975 gives the Family Court the power to make an order under section 79 of the FLA 1975 binding on third parties.

In this instance the company is confirmed as a party to the Family Court order as it is bound by clause 10.10 to act in accordance with the court order. Accordingly, the company is required by force of law to make the payments of cash to the Taxpayer.

Therefore any payment made by the company to the Taxpayer as a result of a binding order made by the Family Court would satisfy paragraph 109J(a) of the ITAA 1936.

Paragraph 109J(b) of the ITAA 1936 would also be satisfied by the cash payments made by the company under a binding order made by the Family Court. Any settlement terms proposed by the spouses in relation to their property must provide justice and equity if they are to be approved by the Family Court. In view of this it is considered that the cash payments ordered to be paid by the company to the Taxpayer would represent an arm's length transaction as the terms of the settlement would have been determined objectively by the Family Court to achieve a just and equitable result.

Therefore, as both elements of section 109J of the ITAA 1936 are satisfied, the cash payments made by the company to the Taxpayer under an order of the Family Court will not be considered to be a dividend.

Question 2

Summary

A payment made by a company to an associate or former associate of a shareholder is not considered to be a dividend under subsection 6(1) of the ITAA 1936. As the payments are not considered to be dividends, subsection 44(1) of the ITAA 1936 cannot apply to include the amounts in the assessable income of the Taxpayer.

Detailed reasoning

Section 995-1 of the ITAA 1997 provides that 'dividend' has the meaning given by subsection 6(1) of the ITAA 1936.

Dividends are defined as:

· any distribution made by a company to its shareholders, whether in money or other property; and

· any amount credited by a company to any of its shareholders as shareholders;

· (Repealed by No 63 of 1998)

For a payment to be considered a dividend, the payment must be made by the company to a shareholder. The definition does not include payments to associates or former associates of a shareholder. Therefore the payment made by the company to the Taxpayer would not be considered to be a dividend under subsection 6(1) of the ITAA 1936.

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a shareholder in a company shall include dividends paid to the shareholder by the company out of profits derived by it from any source.

Under Division 7A of the ITAA 1936 certain payments made to shareholders and their associates may be treated as dividends. However in this instance the payments made to the Taxpayer are not considered to be dividends as they satisfy both elements of section 109 J of the ITAA 1936, as explained above.

As the payments are not dividends, subsection 44(1) of the ITAA 1936 cannot apply to treat the payments as assessable income of the Taxpayer.

Does Part IVA, or any other anti-avoidance provision, apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

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