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Ruling

Subject: Division 7A and Part IVA

Question and answer

1. Is the taxpayer taken to have received a deemed dividend pursuant to section 109C of the Income Taxation Assessment Act 1936?

Yes.

2. Does section 109J of the Income Taxation Assessment Act 1936, in relation to a payment made by the company to the taxpayer, apply?

Yes.

3. Is the payment to the taxpayer a dividend as defined in section 6(1) of the Income Taxation Assessment Act 1936?

No.

4. Is the payment to the taxpayer statutory income under section 44(1) of the Income Taxation Assessment Act 1936?

No.

5. Will provision of Part IVA of the Income Taxation Assessment Act 1936 be applied to the payment?

No.

This ruling applies for the following periods

1 July 2012 to 30 June 2013

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.

Your representative advised the following facts;

Individual 1 and the company are both parties to proceedings presently before the Family Court regarding a property settlement between Individual 2 and Individual 1. Individual 1 and the company are both residents of Australia for tax purposes.

Individual 1 and Individual 2 were in a de facto relationship for a substantial period of time. Individual 1 and Individual 2 separated and Individual 2 made an application to the Family Court regarding the property settlement.

The property settlement between Individual 1 and Individual 2 has been the subject of numerous applications to the court and protracted negotiations and proceedings. The relationship between Individual 1 and Individual 2 is acrimonious.

The Orders are binding on all the parties to the proceedings, i.e. they are binding on Individual 1, Individual 2, the company and Company 2 as trustee for the trust.

The order ends the financial connection between Individual 1, Individual 2 and the company to allow them to get on with their lives.

Pursuant to paragraph 3 of the Orders (orders not made by consent), the company paid to Individual 1 an amount. In order to obtain funds to make the payment to Individual 1, the company called on an unpaid present entitlement it was owed by the Trust As a large portion of the Trust's assets consisted of property, the Trust did not have sufficient cash to make payment of the unpaid present entitlement. Accordingly, the Trust borrowed from a bank to fund a portion of the payment.

Whilst the orders were made at the discretion of the Family Court, we are instructed that the parties contemplated that sooner or later the company could be wound up in the short to mid term.

Pursuant to paragraph 3 of the Orders; from the money the company is to pay to individual 1, individual 1 is to pay Individual 2 an amount.

You are not aware of why the Family Court did not order the amount of money to be paid by the company directly to Individual 2. The Orders were interim orders only and it was expected that a further payment would later be made to Individual 2 (from a source to be determined).

The remaining amount of funds was lent by Individual 1 to the Trust to assist the Trust in repaying its borrowings.

The company was registered in Australia.

The shareholding in the company at the time of the Payment was as follows:

No changes to the shareholding have occurred from the time of the Payment to the date of this application.

Individual 1 was a director and the secretary of the company at the time of the Payment and at the time of the making of this application for private ruling.

Individual 2 was a director of the company at the time of the Payment and at the time of the making of this application for private ruling.

Part IVA

In considering the 8 points of Part IVA you representative advised the following;

First Matter: The manner in which the scheme will be entered into or carried out

In this context, "manner" includes a consideration of the way in which and the method or procedure by which the particular scheme was established (FCT v Spotless Ltd & Anor 96 ATC 5201).

The company was required to make the payment pursuant to the Family Court order (the Orders). The need for the Orders in the first place arose as a result of the separation of Individual 1 and Individual 2, and the need to divide the property of their relationship between them (including property accumulated during their relationship, but owned by companies and trusts which one or both of them control).

The payment the subject of the Orders represents a partial property settlement between Individual 1 and Individual 2 necessarily arising as a consequence of their separation.

Individual 1 and Individual 2 have at all times been dealing at arm's length in relation to the property settlement which is evidenced by the fact that each of them has been represented by a separate set of lawyers and advisers. Further, the amount of the payments made to each of them represent arm's length amounts, being amounts ordered by the Family Court, presumably considered consistent with their entitlements to share in the division of the property of their relationship.

The Orders of the Family Court are consistent with normal commercial or family dealings in the context of a property settlement following the breakdown of a marriage or relationship. The Orders do not contemplate section l09J applying. Section 109J happens to be a provision which applies to the circumstances which have arisen as a result of the financial settlement between Individual 1 and Individual 2 which is expressed in the Orders.

This points to the conclusion that the requisite purpose in section 177D of the ITAA 1936 does not exist.

Second Matter: The form and substance of the scheme

The second factor to be considered under section 177D(b) of the Income Taxation Assessment Act 1936 (ITAA 1936) is the form and substance of the scheme.

The Rulees have been ordered by the Family Court under the Family Law Act 1975 (Cth) to make the payments in the manner contemplated by the Orders.

There is no artificial or contrived actions in the proposed transactions the subject of the Orders for which the only explanation is the pursuit of the relevant tax benefits.

Relevantly, the Orders, as a matter of substance, have the effect of imposing legally binding obligations on the parties to the Orders. The Orders were interim orders in the proceedings to end the financial relationship between Individual 1 and Individual 2.

The ruling, prevailing or most influential purpose of taxpayers in complying with Family Court orders is typically, as is the case here, to end the financial connections or relationship between the individuals. The form and substance of such transactions in these circumstances will typically, as is the case here, reflect that prevailing purpose

This points to the conclusion that the requisite purpose in section 177D of the ITAA 1936 does not exist.

Third Matter: The time at which the scheme will be entered into and the period of time during which the scheme will be carried out

The third factor to be considered under section 177D(b) of the ITAA 1936 is the time at which the scheme was entered into and the length of the period during which the scheme was carried out.

In Hart & Anor 2002 ATC 4608, Hill J said that an example of a case where timing would be most relevant to Part IVA of the ITAA 1936 would be a scheme involving a flurry of activity around the end of the tax year directed at obtaining a deduction in that year.

In the present case, the timing of the entering into the Orders and the carrying out of the transactions the subject of the Orders is not in any way tax driven so as to enable any or all of the Rulees or any other taxpayer to obtain a tax benefit. Rather, the proceedings have been on foot for some considerable time and the parties wish to finalise the property settlement between them as soon as possible.

This points to the conclusion that the requisite purpose in section 177D of the ITAA 1936 does not exist.

Fourth Matter: The result in relation to the operation of the ITAA 1936 and the Income Taxation Assessment Act 1997 (ITAA 1997) that, but for Part IVA, would be achieved by the scheme

The fourth factor to be considered for the purposes of section 177D(b) of the ITAA 1936 is the result in relation to the operation of the ITAA 1936 and the ITAA 1997 that, but for Part IVA of the ITAA 1936, would be achieved by the scheme.

Whilst the transactions the subject of the Orders do result in one of the Rulee taxpayers obtaining, aside from the application of Part IVA, a tax free amount, these results must be weighed against other aspects of the arrangement in order to determine the dominant purpose of the relevant Rulee. In FCT v Mochkin 2003 ATC 4272 at 4289 the Full Federal Court stated;

"91. The result in relation to the operation of the ITAA that, apart from Part IVA, would be achieved by the scheme, included the distribution of income generated by Daccar and Ledger to the beneficiaries of the No 1 and No 2 Trusts. As I have already noted, it is difficult to see how the result of the scheme, in the sense in which that term was used in s 177D(b)(iv), could be said to be tax neutral, Viewed objectively, the result sought by the scheme, so far as the ITAA was concerned, was the opportunity to distribute net commission income derived by Daccar and Ledger in a tax effective manner. This result nonetheless must be weighed against other aspects of the scheme in order to determine the Taxpayer dominant purpose."

In the present case, when the relevant tax benefits are considered in conjunction with factors one and two, this fourth factor is essentially neutral.

Matters five, six and seven - the effect of the scheme

The fifth, sixth and seventh factors focus on the non-tax effects of the scheme, not only for the relevant taxpayer, but also for all connected parties. These factors look to the practical financial, legal, economic and any other outcomes achieved by the scheme for the taxpayer and connected parties.

In summary, the transactions the subject of the Orders to which the ruling requests are concerned, in essence resulted in a transfer of money from The company to Individual 1 and then to Individual 2, resulting in an increase in money and property held by Individual 1 and Individual 2 and a decrease in money and/or property held by The company. However, these consequences are commercial in character when considered in context, relevantly being that they reflect the Orders made by the Family Court in order to end the financial relationship between Individual 1 and Individual 2.

It is generally accepted by the ATO that the fifth, sixth and seventh factors will often require consideration in conjunction with the second factor (paragraph 106 of PS LA 2005/24), i.e. the form and substance of the scheme. In the present case, when the relevant tax benefits are considered in conjunction with factor two, the fifth, six and seventh factors are essentially neutral.

Factor eight - the nature and connection between the relevant taxpayer and any person connected with the taxpayer

Paragraph 110 of PS LA 2005/24 provides that:

"The existence of any connection between the taxpayer and those other persons is relevant to the identification of the other factors, such as the manner of the scheme, the form and substance of the scheme, and the tax, financial and other consequences of the scheme ".

In the present case Individual 1 and Individual 2 were in a relationship for a substantial period of time and that relationship has ceased, Individual 1 was and is, in essence, the controller of the company and the trust. However, the connection between the parties in the present case is essentially neutral as regards determining the requisite purpose in section 177D(b) of the ITAA 1936 when considered in conjunction with the first three matters.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 subsection 109C(1)

Income Tax Assessment Act 1936 Section 109J

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177A(3)

Income Tax Assessment Act 1936 subsection 177A(5)

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 subsection 177C(1)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Reasons for decision

Subsection 109C(1) and 109J of the Income Tax Assessment Act 1936

Subdivision B of Part III of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) deals with the circumstances under which certain private company payments will be treated as dividends.

A Family Court order directing the company to pay cash to the Rulee is a payment for the purposes of section 109C of the ITAA 1936 and would meet the requirements to be treated as a dividend for the purposes of subsection 109C(1) of the ITAA 1936.

However Subdivision D of Division 7A of Part III of the ITAA 1936 sets out rules about some payments which are not treated as dividends under subsection 109C(1) of the ITAA 1936. Section 109J of the ITAA 1936 in Subdivision D is specifically relevant to the circumstances here.

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.

Subsection 6(1) of the Income Tax Assessment Act 1936

Subsection 6(1) of the ITAA 1936 defines 'dividend' to include:  

(a) any distribution made by a company to any of its shareholders, whether in money

or other property; and  

(b) any amount credited by a company to any of its shareholders as shareholders;  

(c) (Repealed by No 63 of 1998)

but does not include:  

(d) moneys paid or credited by a company to a shareholder or any other property

distributed by a company to shareholders (not being moneys or other property to

which this paragraph, by reason of subsection (4), does not apply or moneys paid

or credited, or property distributed for the redemption or cancellation of a

redeemable preference share), where the amount of the moneys paid or credited,

or the amount of the value of the property, is debited against an amount standing

to the credit of the share capital account of the company; or  

(e) moneys paid or credited, or property distributed, by a company for the redemption

or cancellation of a redeemable preference share if:  

(i) the company gives the holder of the share a notice when it redeems or

cancels the share; and  

(ii) the notice specifies the amount paid-up on the share immediately before

the cancellation or redemption; and

(iii) the amount is debited to the company's share capital account;

except to the extent that the amount of those moneys or the value of that property, as the case may be, is greater than the amount specified in the notice as the amount paid-up on the share; or  

(f) a reversionary bonus on a life assurance policy. 

Subsection 44(1) of the Income Tax Assessment Act 1936

Subsection 44(1) of the ITAA 1936 states that the assessable income of a resident shareholder includes dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source and all non-share dividends paid to the shareholder by the company.

Application to your circumstances

Effectively, section 109J of the ITAA 1936 provides that such a payment is not taken to be the payment of a dividend for the purposes of section 109C of the ITAA 1936 to the extent that it discharges an obligation of the private company to pay money to a shareholder or an associate of the shareholder, and does not exceed the arm's length amount required to discharge that obligation.

Consequently, provided the Family Court order binding the company, as a party to the proceedings, is an explicit order binding the company to specifically pay cash to you, and not some other alternative obligation, the payment would not be considered a dividend by virtue of section 109J of the ITAA 1936.

The payment would not come within the definition of the word 'dividend' in subsection 6(1) of the ITAA 1936. The payment to the shareholder is a payment made pursuant to court proceedings and is not in the nature of being a distribution as required in the definition.

As the payment is not a dividend section 44(1) has no application.

Application of Part IVA

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

· there is a scheme (see section 177A)

· a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C)

· the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

Application to your circumstances

What you are proposing is a 'scheme' capable of attracting the operation of Part IVA. However, when considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. Therefore, Part IVA will not apply to this arrangement.

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