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Ruling

Subject: Tax Implications

1. The subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust is not considered a loan under section 109D of the ITAA 1936.

Detailed reasoning

2. Subsection 109D(1) of the ITAA 1936 states:

A private company is taken to pay a dividend to an entity at the end of one of the private company's years of income (the current year) if:

(a) the private company makes a loan to the entity during the current year; and

(b) the loan is not fully repaid before the lodgment day for the current year; and

(c) Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and

(d) either:

(i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or


(ii) a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time.

The ordinary meaning of the term ‘loan'

3. Taxation Ruling TR 2010/3 (TR 2010/3) outlines the Commissioner's view on the circumstances in which a private company with a present entitlement to an amount for an associated trust estate makes a loan to that trust within the meaning of subsection 109D(3) of Division 7A of Part III of the ITAA 1936. While the present case concerns the subscription for units in a unit trust and not any consequent present entitlement, section two, which concerns what constitutes a loan within the ordinary meaning of the word, is directly relevant.

4. Paragraph 46 of TR 2010/3 cites the case of Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (1997) 34 ATR 635 as authority for what constitutes a loan according to the ordinary meaning of the word:

46. What amounts to an ordinary loan was explained by Sackville and Lehane JJ in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (Radilo) as follows:

A loan involves an obligation on the borrower to repay the sum borrowed. The matter is put this way by Dr Pannam:

A loan of money may be defined, in general terms, as a simple contract whereby one person ('the lender') pays or agrees to pay a sum of money in consideration of a promise by another person ('the borrower') to repay the money upon demand or at a fixed date. The promise of repayment may or may not be coupled with a promise to pay interest on the money so paid. The essence of the transaction is the promise of repayment. As Lowe J put it in a judgment delivered on behalf of himself and Gavan Duffy and Martin JJ: ''Lend' in its ordinary meaning in our view imports an obligation on the borrower to repay'.... Repayment is the ingredient which links together the definitions of 'loan' to be found in the Oxford English Dictionary , the various legal dictionaries and the text books. In essence then a loan is a payment of money to or for someone on the condition that it will be repaid.

5. On the basis of the above, it is clear that an obligation to repay forms an integral and indispensable characteristic of a loan in terms of the ordinary meaning of the word.

6. In seeking to ascertain the existence of any such obligation in the facts presented, it is appropriate to consider the terms upon which the capital units in XYZ Finance Unit Trust were issued to XYZ Family Holdings Pty Ltd.

7. It is clear from XYZ Finance Unit Trust's deed of settlement that the units are perpetual and have no fixed date of redemption (subject to the Rule Against Perpetuities). This is inconsistent with the ordinary definition of a loan as explicated above.

8. Furthermore, in accordance with the deed, any redemption amount is only payable to the holder of the capital units at the time of redemption. There is therefore no guarantee that the initial unit holder will receive any ‘repayment', as the units may be disposed of in the intervening period. This clause also provides that XYZ Finance Unit Trust has no obligation to pay any redemption amount until the trust is vested or the members request that the trustee exercises its discretion to redeem the units.

9. Similarly, the deed provides that all units must be issued, redeemed and forfeited at market value. This means that any redemption amount is uncertain and subject to fluctuation on the basis of XYZ Finance Unit Trust's activity.

10. Both of these clauses are inconsistent with the notion of a ‘repayment', which is generally a definitive function of the initial payment amount.

11. Based on the terms on which the capital units in XYZ Finance Unit Trust were issued to XYZ Family Holdings Pty Ltd, the underlying subscription is considered to lack the essential characteristic of a repayment obligation and will therefore not constitute a loan for the purposes of section 109D of the ITAA 1936.

Extended definition of the term ‘loan' under Subsection 109D(3) of the ITAA 1936

12. Subsection 109D(3) of the ITAA 1936 extends the definition of a loan for the purposes of Division 7A of Part III of the ITAA 1936 to include:

(a) an advance of money; and

(b) a provision of credit or any other form of financial accommodation; and

(c) 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

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

(a) An advance of money

13. The term ‘advance of money' is not defined in the legislation. Guidance in interpreting this term is, however, provided at paragraph 85 of Taxation Ruling TR 2010/3, wherein it is stated:

‘Paragraph 109D(3)(a) provides that an 'advance of money' is a loan for the purposes of Division 7A. This phrase suggests a payment of moneys ahead of a due date, or a payment in expectation of repayment or reimbursement.' …

14. Once again, it can be inferred that an obligation of repayment is an essential characteristic of an ‘advance of money' for the purposes of Division 7A of Part III of the ITAA 1936. For the reasons outlined above, the subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust is not considered to give rise to any attendant obligation of repayment on the part of XYZ Finance Pty Ltd as trustee for XYZ Finance Unit Trust as the receiving entity.

15. Furthermore, the subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust is not considered a payment in advance of a future obligation.

16. The subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust is therefore not considered to constitute an ‘advance of money' for the purposes of section 109D of the ITAA 1936.

(b) A provision of credit or any other form of financial accommodation

17. Guidance in interpreting the term ‘provision of credit or any other form of financial accommodation' is also provided at paragraphs 86 to 115 of TR 2010/3.

In relation to the first aspect of the term (i.e. ‘provision of credit'), paragraph 87 of TR 2010/3 states:

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, not 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.

18. It is not considered that the subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust amounts to the ‘provision of credit' as, for the reasons stated above, we do not consider there to be any obligation on the part of XYZ Finance Pty Ltd as trustee for XYZ Finance Unit Trust to pay an amount to a private company, let alone any deferral thereto.

19. As to the second aspect of the term (i.e. ‘any other form of financial accommodation'), paragraph 96 of TR 2010/3 relevantly provides:

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 (as suggested by the ordinary meaning of this term - see paragraphs 90 to 92 of this Ruling);

● under a consensual arrangement (similarly to Radilo);

● where a principal sum or equivalent is ultimately payable (similarly to Radilo).

20. As previously stated, XYZ Finance Pty Ltd as trustee for XYZ Finance Unit Trust is not considered to be ultimately liable for the payment of any principal sum to XYZ Family Holdings Pty Ltd in relation to the latter entity's subscription for units.

21. Consequently, that unit subscription will not constitute ‘any other form of financial accommodation' for the purposes of section 109D of the ITAA 1936.

(c) 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

22. As discussed above in relation to parts (a) and (b) of this question, it is not considered that the subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust gives rise to any express or implied obligation to repay the amount paid for the unit subscription.

23. Therefore, any payment referable to that subscription will not constitute ‘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' for the purposes of section 109D of the ITAA 1936.

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

24. As discussed above, an obligation of repayment on the part of the recipient of the relevant payment is an essential characteristic of both the ordinary definition of a loan and the extended definition of a loan contained in subsection 109D(3) of the ITAA 1936.

25. The terms upon which the capital units in XYZ Finance Unit Trust issued to XYZ Family Holdings Pty Ltd evince the absence of any such obligation on the part of XYZ Finance Pty Ltd as trustee for XYZ Finance Unit Trust (the recipient of the relevant payment).

26. Such terms include the fact that the units are perpetual and without any fixed date of redemption (subject to the Rule Against Perpetuities), the fact that any redemption amount is only payable to the holder of the capital units at the time of redemption and that all units must be issued, redeemed and forfeited at market value.

27. Given that XYZ Family Holdings Pty Ltd's subscription for units in XYZ Finance Unit Trust is inescapably constrained by such terms, it is impossible to conclude that any transaction referable to that subscription in substance effects a loan. There is no obligation of repayment, in substance or in form, which is an essential characteristic of a loan.

Question 2

Summary

28. Any payment referable to the subscription for units by XYZ Family Holdings Pty Ltd in XYZ Finance Unit Trust will be a ‘payment' under section 109C of the ITAA 1936.

Detailed reasoning

29. Subsection 109C(1) of the ITAA 1936 states:

A private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or

(b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time

30. It is noted that section 109ZD of the ITAA 1936 provides that for the purposes of that part, the term ‘associate' has the meaning given by section 318 of the ITAA 1936.

31. The shares in XYZ Family Holdings Pty Ltd are held by a group of discretionary trusts, with each of Mr. T's children having an exclusive and discrete beneficial interest in a respective discretionary trust.

31. As XYZ Family Holdings Pty Ltd is a company, subsection 318(2) of the ITAA 1936 is relevant:

318(2)  [Associates of a company]  

For the purposes of this Part, the following are associates of a company (in this subsection called the "primary entity"):

(a) a partner of the primary entity or a partnership in which the primary entity is a partner;

(b) if a partner of the primary entity is a natural person otherwise than in the capacity of trustee - the spouse or a child of that partner;

(c) a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;

(d) another entity (in this paragraph called the "controlling entity") where:

(i) the primary entity is sufficiently influenced by:


(A) the controlling entity; or


(B) the controlling entity and another entity or entities; or


(ii) a majority voting interest in the primary entity is held by:


(A) the controlling entity; or


(B) the controlling entity and the entities that, if the controlling entity were the primary entity, would be associates of the controlling entity because of subsection (1), because of subparagraph (i) of this paragraph, because of another paragraph of this subsection or because of subsection (3);

(e) another company (in this paragraph called the "controlled company") where:

(i) the controlled company is sufficiently influenced by:


(A) the primary entity; or


(B) another entity that is an associate of the primary entity because of another paragraph of this subsection; or


(C) a company that is an associate of the primary entity because of another application of this paragraph; or


(D) 2 or more entities covered by the preceding sub-subparagraphs; or


(ii) a majority voting interest in the controlled company is held by:


(A) the primary entity; or


(B) the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the other paragraphs of this subsection; or


(C) the primary entity and the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the other paragraphs of this subsection;


(f) any other entity that, if a third entity that is an associate of the primary entity because of paragraph (d) of this subsection were the primary entity, would be an associate of that third entity because of subsection (1), because of another paragraph of this subsection or because of subsection (3).

32. XYZ Family Holdings Pty Ltd owns all of the issued units of XYZ Finance Unit Trust and it is not contemplated that any units in XYZ Finance Unit Trust will ever be issued to an entity other than XYZ Family Holdings Pty Ltd. It is therefore clear that XYZ Finance Unit Trust will be considered an associate of XYZ Family Holdings Pty Ltd by virtue of the conjunctive operation of paragraphs 318(2)(c) and 318(2)(e) of the ITAA 1936.

33. In subscribing for units in XYZ Finance Unit Trust, XYZ Family Holdings Pty Ltd made a payment that entity.

34. Therefore, this payment will satisfy the conditions prescribed in section 109C of the ITAA 1936.

Question 3

Summary

35. Section 109J of the ITAA 1936 will apply to any payment referable to the subscription for units by XYZ Family Holdings Pty Ltd in XYZ Family Trust to preclude such payment being deemed as a dividend.

Detailed reasoning

36. Section 109J of the ITAA 1936 provides an exemption to the otherwise automatic operation of section 109C of the ITAA 1936, where the relevant payment relates to the discharge of a pecuniary obligation. The provision is stated thus:

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.

37. The subscription for units in XYZ Finance Unit Trust by XYZ Family Holdings Pty Ltd created a legally-enforceable, contractual obligation on the part of XYZ Family Holdings Pty Ltd to pay the agreed upon consideration (i.e. money) for those units to XYZ Finance Unit Trust. The payments made by XYZ Family Holdings Pty Ltd were therefore in discharge of that obligation.

38. That XYZ Family Holdings Pty Ltd endorsed promissory notes in favour of XYZ Finance Unit Trust to discharge its obligation in respect of the subscription for units in XYZ Finance Unit Trust is considered inconsequential for the purposes of this provision.

40. It is well-established that promissory notes are considered equivalent to cash at law. Such treatment is evident in the following quote by Lord Denning M.R. in Fielding and Platt Ltd v Selim Najjar [1969] 1 W.L.R 357 at 361:

‘We have repeatedly said in this court that a bill of exchange or promissory note is to be treated as cash. It is to be honoured unless there is some good reason to the contrary.'

41. The endorsement of these promissory notes legally discharged XYZ Family Holdings Pty Ltd's pecuniary obligation to XYZ Finance Unit Trust in relation to its subscription for capital units in that entity. Thus, paragraph (a) will be satisfied.

42. In relation to paragraph (b), it is reiterated that the deed provides that all units must be issued, redeemed and forfeited at market value. Furthermore, XYZ Finance Unit Trust is involved entirely in lending funds to both related and non-related entities and as such does not own any appreciating assets. It distributes the profit it makes from its financing activities to unit holders and its units are issued in for a dollar being their market value, the consideration for which is utilised in the financing activities. It follows that the market value of the units will be their subscription price with no discount or premium attributable.

43. It is therefore concluded that paragraph (b) is satisfied. Consequently, it is considered that while the subscription by XYZ Family Holdings Pty Ltd for units in XYZ Finance Unit Trust would prima facie be considered a payment under section 109C, section 109J would apply to preclude any such payment being deemed as a dividend, as the payments are at arms length and discharge a pecuniary obligation.

Question 4

Summary

44. From the facts presented to the Commissioner, section 109T of ITAA 1936 will not apply to the initial subscription for units in XYZ Finance Unit Trust by XYZ Family Holdings Pty Ltd.

Detailed reasoning

Section 109T of the ITAA 1936

45. Subsection 109T(1) of the ITAA 1936 states:

This Division operates as if a private company makes a payment or loan to an entity (the target entity) as described in section 109V or 109W if:

(a) the private company makes a payment or loan to another entity (the first interposed entity) that is interposed between the private company and the target entity; and

(b) a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment or loan solely or mainly as part of an arrangement involving a payment or loan to the target entity; and

(c) either:

(i) the first interposed entity makes a payment or loan to the target entity; or

(ii) another entity interposed between the private company and the target entity makes a payment or loan to the target entity.

46. Subsection 109T(2) of the ITAA 1936 goes on to stipulate that section 109T of the ITAA 1936 operates regardless of certain factors. Specifically it states:

For the purposes of this section, it does not matter:

(a) whether the interposed entity made the payment or loan to the target entity before, after or at the same time as the first interposed entity received the payment or loan from the private company; or

(b) whether or not the interposed entity paid or lent the target entity the same amount as the private paid or lent the first interposed entity.

47. For completeness, subsection 109T(3) of the ITAA 1936 provides a carve-out as to when Subdivision E of Division 7A of Part III of the ITAA 1936 will not operate. Specifically it states:

This Division does not operate as described in subsection (1) (and section 109V and 109W) if the private company is taken under Subdivision B (as it applies apart from this subdivision) to pay a dividend as a result of the payment or loan to the first interposed entity.

Paragraph 109T(1)(a) of the ITAA 1936

48. As discussed at paragraphs 39 to 41, the Commissioner accepts the common law principle that promissory notes are considered equivalent to cash and that the endorsement of promissory notes by XYZ Family Pty Ltd in favour of XYZ Finance Unit Trust therefore amounted to a payment under section 109C of the ITAA 1936.

49. For the purposes of applying paragraph 109T(1)(a) of the ITAA 1936 and based on the facts provided to the Commissioner, the payment referable to the initial subscription for units in XYZ Finance Unit Trust by XYZ Family Holdings Pty Ltd on 1 July 2010 is considered by the Commissioner to be a discrete transaction, independent of XYZ Finance Unit Trust's financing activities.

50. On 1 July 2010, XYZ Family Holdings Pty Ltd subscribed for and was issued with capital units in XYZ Finance Unit Trust for consideration equal to the units' market value. That the units were issued and acquired at market value is supported by the fact that XYZ Finance Unit Trust is involved solely in the lending of funds to related and non-related entities and therefore does not own any appreciating assets. Furthermore, all profits derived by XYZ Finance Unit Trust are paid out to units holders and there is no accumulation of profit. It is also noted that XYZ Finance Unit Trust's deed of settlement provides that all units must be issued by the Trustee at market value. The deed similarly provides that all units must be redeemed at market value.

51. From the facts presented in the ruling application, one of the key operations of the XYZ Finance Unit Trust is:

Investing of funds raised via:

- Lending of funds to related entities, being trustees and corporations within the group, with terms dependent on the cost of funds plus a margin (which is determined based on the risk profile of the borrower and the security offered);

52. Notwithstanding XYZ Finance Unit Trust's financing activity and operations, the payment on 1 July 2010 from XYZ Family Holdings Pty Ltd to XYZ Finance Unit Trust is considered to relate solely to the former entity's subscription for capital units in the latter entity.

Paragraph 109T(1)(b) of the ITAA 1936

53. Paragraph 109T(1)(b) of the ITAA 1936 requires as a condition precedent to the application of Section 109T of the ITAA 1936, that a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment or loan solely or mainly as part of an arrangement involving a payment or loan to the [a] target entity.

54. Given the analysis at paragraphs 48 and 52, a reasonable person would not conclude that XYZ Family Holdings Pty Ltd made the payment to XYZ Finance Unit Trust on 1 July 2010 solely or mainly as part of an arrangement involving a payment or loan to a target entity.

55. From the facts presented to the Commissioner, the payment was exclusively referable to XYZ Family Holdings Pty Ltd's subscription for units in XYZ Finance Unit Trust and represented the market value of the capital units for which the payment represented consideration. The payment is not considered to be directed at any target entity extraneous to the initial capital unit subscription transaction and therefore the requirements of paragraph 109T(1)(b) is not satisfied.

56. As paragraph 109T(1)(b) is a condition precedent to the application of section 109T and a failure to satisfy the requirements of paragraph 109T(1)(b) will preclude the application of section 109T, there is no need to consider any further provisions within section 109T.

Question 5

Summary

57. From the facts presented to the Commissioner, section 109R of the ITAA 1936 will not apply to the initial subscription for units in XYZ Finance Unit Trust by XYZ Family Holdings Pty Ltd.

Detailed reasoning

Section 109R of the ITAA 1936

58. Section 109R operates to disregard a payment relating to the repayment of a loan in certain circumstances:

SECTION 109R  SOME PAYMENTS RELATING TO LOANS NOT TAKEN INTO ACCOUNT  

109R(1)  [Some payments not considered]  

This section provides for some payments to a private company in relation to a loan the private company made to an entity not to be taken into account for the purpose of working out:

(a) how much of the loan has been repaid for the purposes of sections 109D and 109E (which treat amounts of loans that have not been repaid as dividends); or

(b) the minimum yearly repayment for the loan under subsection 109E(5).


109R(2)  [Intention to obtain loan]  

A payment must not be taken into account if:

(a) a reasonable person would conclude (having regard to all the circumstances) that, when the payment was made, the entity intended to obtain a loan or loans from the private company of a total amount similar to, or larger than, the payment; or

(b) both of the following subparagraphs apply:

(i) the entity obtained, before the payment was made, a loan or loans from the private company of a total amount similar to, or larger than, the amount of the payment;

(ii) a reasonable person would conclude (having regard to all the circumstances) that the entity obtained the loan or loans in order to make the payment.

59. It is clear from the wording of paragraph 109R(2)(a) that this provision is intended to apply in circumstances where a payment is made to a private company by an entity in anticipation of the same entity receiving a loan of a similar or greater amount from the same private company.

60. In your circumstances, although the relevant ‘loan' (being a UPE) from XYZ Family Holdings Pty Ltd to XYZ Finance Trust was repaid by the issue of the promissory note, the subsequent endorsement of the note by XYZ Family Holdings Pty Ltd was for units in the XYZ Finance Unit Trust which is a separate entity.

61. Additionally, the promissory note that was endorsed to XYZ Finance Unit Trust in satisfaction of the issuing of units to XYZ Family Holdings Pty Ltd represented market value consideration paid for those units.

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