Edited version of your written advice

Authorisation Number: 1012971074043

Date of advice: 17 February 2016

Ruling

Subject: Commissioner's discretion to disregard Division 7A

Question 1

Will the Commissioner exercise his discretion under section 109RB of the Income Tax Assessment Act 1936 (ITAA1936) to disregard the deemed dividends in relation to loans to the Unit Trust.

Answer

Yes

This ruling applies for the following periods:

1 July 2009 - 30 June 2010

1 July 2010 - 30 June 2011

1 July 2011 - 30 June 2012

1 July 2012 - 30 June 2013

1 July 2013 - 30 June 2014

The scheme commences on:

1 July 2009

Relevant facts and circumstances

Loan 1

During the year ended 30 June 20XX a loan was made to the Unit Trust.

Interest was charged on this loan and capitalised, however, the interest amounts were not paid by the Unit Trust to Holdings. Some repayments were made by the Unit Trust, generally by way of payment of expenses by the Unit Trust on behalf of Holdings.

The interest charged on this loan in each year was higher than or equal to the benchmark rate for Division 7A ITAA 1936.

In April 20XX, the Unit Trust lodged an amended income tax return for the year ended 30 June 20XX which included deemed dividends arising from this loan.

The balance of this loan from Holdings, including capitalised interest, was fully repaid in June 20XX.

Loan 2

Initial net loans were made to the Unit Trust in the year ended 30 June 20XX. Further advances and repayments were made in subsequent years. These loans are referred to henceforth as a singular loan.

The interest charged on this loan in each year was higher than or equal to the benchmark rate for Division 7A ITAA 1936.

In April 20XX, the Unit Trust lodged amended income tax returns for the years ended 30 June 20XX and 20XX and original tax returns for the years ended 30 June 20XX, 20XX and 20XX which included deemed dividends arising from this loan.

If the Commissioner exercises his discretion under s109RB to disregard the deemed dividends that have arisen due to Loan 2, it is proposed that dividends equal to the amount of the disregarded deemed dividends will be paid enabling the Unit Trust to repay its loan in full.

It is proposed that the dividends which have arisen due to loan 2 will be repaid in full, in a timely manner following the exercise of the Commissioner's discretion.

Facts in relation to both Loan 1 and Loan 2

The Unit Trust is an associate of both companies pursuant to the definition in section 318(2) of ITAA 1936.

The making of these loans was initially a consequence of a larger restructure plan that had the objective of replacing bank debt with inter-group debt for other entities within the corporate group.

The pre-existing bank debt was used to finance the acquisition and subsequent development of commercial property.

Any loans made to the Unit Trust which remain unpaid by the lodgment day for that year are deemed by section 109D ITAA 1936 to be dividends paid to the Unit Trust, unless one of the applicable exceptions in Division 7A ITAA 1936 apply. One exception is where the loan meets requirements contained in section 109N. These requirements include a complying loan agreement, a minimum interest rate and a maximum term.

The former accountants have stated that they believe that there is no written loan agreement in relation to Loan 1 or Loan 2.

Accordingly, the initial loan amounts are deemed to be dividends by Division 7A ITAA 1936 and each additional amount borrowed in subsequent year and remaining unpaid by the lodgment day will also be deemed to be dividends in those years.

The capitalisation of interest in relation to the loans should constitute "financial accommodation" which is included in the definition of loan for Division 7A ITAA 1936 purposes in section 109D(3). Accordingly, interest capitalised and remaining unpaid will be considered to be a separate loan and be deemed to be a dividend in the year in which the capitalisation of interest occurs.

None of the members of the Group have been aware of the failure to comply with Division 7A ITAA 1936.

The former accountants of the Group did not advise any of the relevant parties that the loans were subject to Division 7A ITAA 1936.

The former accountants for the Group have acted as accountants and tax agents for the Group since the early 1990s.

In December 20XX, a firm of solicitors were engaged by members of the Group in relation to various corporate matters, in particular, the potential liquidation of Holdings. As a result of the work conducted by this firm, they felt it appropriate that an independent firm of accountants be engaged to review the financial reports.

In February 20XX that firm of solicitors engaged Chartered Accountants and Business Advisors to review the financial reports and position of the company. They subsequently identified that there were potential breaches of Division 7A ITAA 1936 and superannuation legislation and advised the Group of the same.

On 16 September 20XX, the accounts issued to the Group its findings of the tax issues concerning the Group spanning a period of more than ten years, including the application of Division 7A ITAA 1936 to the loans made to the Unit Trust.

In October 20XX, another accountant was engaged to provide a second opinion in relation to the issues identified.

The former accountants were dismissed from their role as accountants and tax agents.

In April 20XX, voluntary disclosures to the Australian Taxation Office were made by relevant members of the Group.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109RB

Income Tax Assessment Act 1936 Paragraph 109RB(1)(b)

Income Tax Assessment Act 1936 Section 109RB(2)

Income Tax Assessment Act 1936 Section 109RB(3)

Income Tax Assessment Act 1936 Paragraph 109RB(3)(a)

Income Tax Assessment Act 1936 Paragraph 109RB(3)(b)

Income Tax Assessment Act 1936 Paragraph 109RB(3)(c)

Income Tax Assessment Act 1936 Paragraph 109RB(3)(d)

Income Tax Assessment Act 1936 Section 109RB(4)

Reasons for decision

Question 1

Will the Commissioner exercise his discretion under section 109RB of the Income Tax Assessment Act 1936 (ITAA1936) to disregard the deemed dividends in relation to loans to the Unit Trust.

Summary

The discretion may be exercised if the deemed dividend arose because of an honest mistake or inadvertent omission.

Detailed reasoning

Section 109RB Discretion

Section 109RB of Division 7A of Part III of the ITAA 1936 provides the Commissioner the discretionary power to either disregard the operation of Division 7A or allow a deemed dividend to be franked. This can be exercised only when the deemed dividend arose because of an honest mistake or inadvertent omission by any of:

• the recipient;

• the private company;

• any other entity whose conduct contributed to that result. [s109RB(1)(b)]

Practice Statement Law Administration PS LA 2011/29 provides guidance for Tax Office staff exercising the discretion. The Practice Statement describes a two-step procedure; the first step being the identification of an honest mistake or inadvertent omission giving rise to a Div  7A deemed dividend, and the second step being the application of factors in subsection 109RB(3) of the ITAA 1936 to determine whether the discretion should be exercised.

Did the Division 7A deemed dividend arise due to an honest mistake or inadvertent omission?

In considering whether the operation of Division 7A arose because of an honest mistake or inadvertent omission, the following is relevant:

• The loans provided were commercial in nature and were used by the Unit Trust to refinance pre-existing bank debt and to improve the properties that are used by the Unit Trust to produce its assessable income.

• It was not until ATO ID 2003/839 was published on 19 September 2003 that the ATO had published a view making it clear that Division 7A applied in these types of circumstances. Both of the original loans were made approximately 15 months prior to that date.

• Prior to ATO ID 2003/839 there existed a school of thought that Division 7A did not apply where a private company made a loan for commercial purposes to a shareholder (or their associate).

• In 20XX, voluntary disclosures to the Australian Taxation Office were made by relevant members of the group.

• Not before professional advice was given did the directors have the knowledge or experience to address matters in respect of Division 7A. Before that date, the directors relied on the professional advice of their former accountants.

• The Group voluntarily engaged with numerous specialised professional advisers, making all necessary voluntary disclosures to the Australian Taxation Office, involving the inclusion of deemed dividends in its income tax returns and also the dismissal of its former accountants for new accountants and tax agents which are knowledgeable as to the operation of Division 7A.

All of these factors support the view that extensive corrective action has been undertaken.

Applying the factors in subsection 109RB (3) to determine whether the discretion should be exercised

It would be reasonable to conclude that the Commissioner's discretion should be exercised, the honest mistake or inadvertent omission being the former accountant's failure to recognise the application of Division 7A to the amounts provided to the Trust. The former accountants have acted for the entities since early 1990, they did not advise any of the relevant parties that the loans were subject to Division 7A ITAA 1936. Ignorance of the application of Division 7A to loans made to trusts for business purposes meant that none of the parties involved considered the requirements of Division 7A. The former accountants were provided with the trial balance of each entity's accounting records. The trial balances clearly and accurately disclosed related party loan balances including all respective interest income and expense amounts where relevant. Detailed accounting records were provided to the former accountants to enable them to exercise their professional judgement as to the application of Division 7A to each particular loan transaction. The recording of transactions and accounting systems in place indicate that this was not deliberate conduct to avoid taxation liabilities.

Further corrective action

The corrective action proposal you have provided includes the repayment of Loan 2 in full in a timely manner. Loan one was fully repaid in June 20XX.

The interest charged on the loans each year was higher than or equal to the benchmark rate for Division 7A ITAA 1936.

The proposed corrective action is considered acceptable to the Commissioner.

 Previous application of Division 7A

There is no evidence of any prior breaches of Division 7A.

 Other matters

You have made all necessary voluntarily discloses to the ATO including the inclusion of deemed dividends in the income tax returns, you have dismissed your former accountant and engaged an agent that is knowledgeable in the operation of Division 7A. The loans were commercial in nature and used by the Unit Trust to refinance pre-existing bank debt and to improve the properties that are used by the unit trust to produce its assessable income.

Decision

In relation to the application of Division 7A that resulted from loans made by the company to the Unit Trust, the Commissioner is of the view that the application of Division 7A arose because of an honest mistake.

The Commissioner has decided to exercise his discretion in accordance with subsection 109RB(2) of the ITAA 1936 to disregard the deemed dividend, on the condition that the corrective action proposal is fully implemented.

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