Edited version of your written advice

Authorisation Number: 1051276636402

Date of advice: 1 September 2017

Ruling

Subject: Taxation Issues arising from Divorce Proceeding

Issue 1

Division 7A implications of Divorce Proceeding

Question 1

Will section 109T of the Income Tax Assessment Act 1936 Cth (ITAA 1936) apply to deem that Company X has paid a dividend to the Spouse 1 in respect of the Cash Sum from the Trust to the Spouse 1 pursuant to the Family Court order?

Answer

Yes

Question 2

If section 109T of the ITAA 1936 applies, will the Commissioner determine under section 109V of the ITAA 1936 that the deemed payment from Company X to the Spouse 1 should be nil?

Answer

Yes

Question 3

Will section 109T of the ITAA 1936 apply to deem that Company Y has paid a dividend to the Spouse 1 in respect of the transfer of the Property from the Trust to the Spouse 1 pursuant to the Family Court order?

Answer

No

Issue 2

Same-Asset Roll-overs – Marriage or relationship breakdowns

Question 1

Will the Trust be entitled to rollover relief on the transfer of the Property held by the Trust to the Spouse 1 under Subdivision 126-A of the Income Tax Assessment Act 1997 Cth (ITAA 1997) concerning matrimonial proceedings?

Answer

Yes

This ruling applies for the following period:

1 July 2017 to 30 June 2018

The scheme commences on:

The date of the court orders

Relevant facts and circumstances

1. The Spouse 1 and Spouse 2 have separated and are currently undergoing a divorce proceeding in the Family Court of Australia. Both the Spouse 1 and Spouse 2 are residents of Australia.

2. Company X and the Trust are also parties to the divorce proceeding.

3. Consent orders are in the process of being sought pursuant to section 79 of the Family Law Act 1975 (Cth) (FLA 1975) to govern the financial arrangement that should be implemented between the Spouse 2 and the Spouse 1 and the entities they control.

4. The Trust is a non-fixed unit trust. The Settlor of the Trust is X and the Appointors of the Trust are jointly the Spouse 2 and the Spouse 1. The Spouse 1 will resign as an appointor as part of the divorce proceedings.

5. The Trustee of the Trust is Company A. The Spouse 2 and the Spouse 1 are the only directors and shareholders of Company A.

6. The Spouse 2 and the Spouse 1 each subscribed for X redeemable units in the Trust on XX/YY/20ZZ.

7. The Trust issued XX million redeemable “A” class units to Company Y during the period from the 20XX income year to the end of the 20YY income year.

8. The Spouse 2 is the sole director and shareholder of Company Y.

9. On XX/YY/20ZZ the Trust purchased, from an unrelated party, a residential property (The Property). The purchase of the Property was funded by the subscription of the “A” class redeemable units by Company Y.

10. The Property was the main residence of the Spouse 2 and the Spouse 1 during part of their marriage and co-habitation. Following the separation the Property became the main residence of Spouse 1.

11. Under the consent orders the Spouse 1 has consented to transfer to the Spouse 2 the whole of their right, title and interest in the redeemable units they holds in the Trust. The Spouse 1 has also consented to transfer their shares in the trustee company, Company A to the Spouse 2 and to resign as a director of Company A.

12. The Trust owns all the shares in Company X. The Spouse 2 is the sole director of Company X.

13. Company X has a distributable surplus as at 31 December 2016.

14. The Trust does not have significant cash assets and will borrow an amount from Company X. This amount will be equal to the Cash Sum specified in the consent orders (see paragraph 15 below). The Trust and Company X will enter into a written loan agreement that is fully compliant with the requirements of section 109N of the ITAA 1936 and the Trust will make the minimum yearly repayments for the subsequent income years as required by section 109E of the ITAA 1936. The Trust has assets in addition to the Property which it will sell to enable it to repay the loan.

15. Once the Spouse 1 complies with their obligations under the consent orders the Trustee of the Trust will transfer the Property to the Spouse 1 and in addition pay them a Cash Sum.

16. The transfers of the Property and Cash Sum to the Spouse 1 are pursuant to the Family Court Orders and are not related to any interest in the Trust previously held by the Spouse 1.

17. There are no unpaid entitlements in the Trust.

18. Company Y has a distributable surplus.

Relevant legislative provisions

Section 109C of the Income Tax Assessment Act 1936

Section 109D of the Income Tax Assessment Act 1936

Section 109J of the Income Tax Assessment Act 1936

Section 109N of the Income Tax Assessment Act 1936

Section 109T of the Income Tax Assessment Act 1936

Section 109V of the Income Tax Assessment Act 1936

Section 318 of the Income Tax Assessment Act 1936

Subdivision 126-A of the Income Tax Assessment Act 1997

Section 118-180 of the Income Tax Assessment Act 1997

Reasons for decision

Issue 1 Question 1

Summary

Section 109T of the Income Tax Assessment Act 1936 (ITAA 1936) will deem that Company X has paid a dividend to the Spouse 1 in respect of the payment of the Cash Sum from the Trust to the Spouse 1 pursuant to the Family Court order.

Detailed reasoning

Division 7A in Part III of the ITAA 1936 is a specific anti-avoidance measure designed to prevent private companies from making tax –free distributions of profits to shareholders or to their associates in the form of payments, loans or debts that are forgiven.

There are 3 situations where a private company may be taken to pay a dividend:

i) An amount is paid by the company to a shareholder or to an associate of a shareholder (section 109C);

ii) An amount is lent by the company to a shareholder, or to an associate of a shareholder, during an income year (section 109D); or

iii) The company forgives a debt owed to the company by a shareholder or an associate of a shareholder (109F).

In each case, the amount of the dividend is restricted to the company’s distributable surplus (section 109Y).

The definition of an “associate” is found in section 318 of the ITAA 1936. Paragraph 318(3)(a) states that an associate of a trustee can include any entity that benefits under the trust.

Under subsection 109C(1) of the ITAA 1936 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.

Under subsection 109D(1) of the ITAA 1936 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 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 lodgement 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.

A loan by a private company to a shareholder or shareholder’s associate is not treated as a deemed dividend in the income year in which the loan is made if the following requirements under section 109N of the ITAA 1936 are satisfied before the relevant time:

a) The loan agreement is in writing; and

b) The interest rate on the loan for subsequent income years equals or exceeds the benchmark interest rate for the year; and

c) The maximum term of the loan does not exceed 25 years for certain secured loans or 7 years for all other loans.

The relevant time is the company’s lodgement day, which is the earlier of the due date for lodging the company’s return for the income year in which the loan is made and the actual date.

Section 109T of the ITAA 1936 extends the operation of Division 7A to certain back-to-back arrangements under which a payment or loan is made to a shareholder or an associate of a shareholder through an intermediary (called an “interposed entity”).

Subsection 109T states that a private company will be treated as having made a payment or loan to an entity (the target entity) 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.

Subsection 109T(3) has the effect that Division 7A does not apply to treat payments and loans through an interposed entity as dividends of a target entity, if the payment or loan to the first interposed entity is treated as a dividend under Subdivision B. For example, this would be the case if the first interposed entity was a shareholder of the private company and the other conditions of sections 109C or 109D were satisfied.

Paragraph 37 of Taxation Determination TD 2011/16 Income Tax: Division 7A – payments and loans through interposed entities – factors the Commissioner will take into account in determining the amount of any deemed payment or notional loan arising under section 109T of the Income Tax Assessment Act 1936 (TD 2011/16) states that if the loan between the private company and the interposed entity is a section 109N compliant loan (or the payment from the private company to the interposed entity is converted into a section 109N compliant loan) before the private company’s lodgement date for the income year in which that loan or payment was made, the private company will not be taken to have paid a dividend to the interposed entity. In this situation the exception in subsection 109T(3) will be insufficient of itself to prevent Division 7A from otherwise applying to the deemed payment or notional loan made by the private company to the target entity (the shareholder (or their associate)).

As outlined in paragraph 38 of TD 2011/16 there will need to be other reasons for the Commissioner not to apply section 109T such as if there was a 109N compliant loan between the interposed entity and the target entity.

Subsection 109V(1) of the ITAA 1936 states that if the target entity is paid an amount by the interposed entity, this Division operates as if the private company had paid the amount (if any) determined by the Commissioner to the target entity when the interposed entity paid the target entity.

Subsection 109V(2) states that in determining the amount of the payment the private company is taken to have made, the Commissioner must take account of:

a) The amount the interposed entity paid the target entity; and

b) How much (if any) of that amount the Commissioner believes represented consideration payable to the target entity by the private company or any of the interposed entities for anything (assuming that the consideration payable equals that for similar transactions at arm’s length).

Section 109W is worded similarly to section 109V except that it applies to private company loans to a target entity through one or more interposed entities.

Subsections 109V(2) and 109W(2) do not exhaustively describe the factors which the Commissioner can consider when quantifying the payment or loan. The additional factors which the Commissioner can consider are outlined in paragraph 2 of TD 2011/16 and include the extent to which any actual loans made as part of the arrangement have been repaid by the earlier of the due date for lodgement or the actual lodgement date and the extent to which any loan made from the private company to an interposed entity as part of the arrangement meets the criteria set out in section 109N (that is, ‘a section 109N compliant loan’) at that time.

Paragraphs 41 and 42 of TD 2011/16 state that in quantifying the payment or loan under subsections 109V(2) and 109W(2) it is relevant for the Commissioner to have regard to the commerciality of the loan from the private company to the interposed entity. Whether or not the loan from the private company to the interposed entity complies with 109N and repayments are made pursuant to section 109E are relevant factors when determining the commerciality of the originating loan.

The balance sheet of the Trust shows that its cash asset is insignificant. As a result in order to comply with the Family Court order in which the Trust has to pay the Spouse 1 the Cash Sum, the Trust will be borrowing money from Company X, a company of which the Spouse 2 is the sole director.

According to paragraph 318(3)(a) of the ITAA 1936 the Spouse 1 will be an associate of the Trustee as they are one of the unitholders of the Trust and thus can potentially benefit from the Trust. In addition the Spouse 1 is a director and shareholder of the trustee company. In this regard the interposed entity provisions under sections 109T and 109V can potentially apply as Company X is a private company, the Trust is an interposed entity and the Spouse 1 is an associate of a shareholder (the sole shareholder of Company X is the Trust).

By the time the Trust pays the Cash Sum to the Spouse 1, the Spouse 1 will no longer be a Unitholder in the Trust and thus will not be an associate of the Trustee. Under the Family Court Orders prior to the Trust paying the Cash Sum and transferring the property to the Spouse 1, the Spouse 1 would have already transferred the redeemable units they hold in the Trust to the Spouse 2. The Spouse 1 would have also transferred their shares in the trustee company, Company A, and resigned as a director of the trustee company. However, even though they will no longer be an associate of a shareholder, paragraph 109C(1)(b) of the ITAA 1936 can apply as it is reasonable to conclude that the payment was made to them because they have been an associate of a shareholder in the past.

As such the loan from Company X to the Trust and the subsequent Cash Sum transferred from the Trust to the Spouse 1 is subject to section 109T of the ITAA 1936 for the following reasons:

i. As required by paragraph 109T(1)(a) the private company (Company X) makes a loan to an interposed entity (the Trust);

ii. As required by paragraph 109T(1)(b) a reasonable person would conclude that the sole reason for Company X lending money to the Trust is so that the Trust can pay the Cash Sum to the Spouse 1 as required under the consent orders. This is evident by the fact that the amount which the Trust will be borrowing from Company X will be the same or close to the same amount of the Cash Sum that the Trust will be paying the Spouse 1 under the consent orders. Also, Company X will immediately lend the money to the Trust once the consent orders have been approved by the Court so that the Trust can comply with the consent orders by paying the Cash Sum to the Spouse 1.

iii. As required in subparagraph 109T(1)(c)(i) the first interposed entity (the Trust) makes a payment (the Cash Sum) to the target entity (the Spouse 1).

Even though section 109T will apply, subsection 109T(3) needs to be considered to see if Division 7A does not operate in these circumstances because the loan from Company X to the Trust is a dividend.

As Company X is a private company and the Trust is the sole shareholder, section 109D of the ITAA 1936 would ordinarily apply to deem that Company X has paid a dividend to the Trust. Also a review of Company X’s balance sheet as at 31 December 2016 indicates that there is likely to be a distributable surplus.

However, Company X and the Trust intend to enter into a written loan agreement pursuant to section 109N of the ITAA 1936. Provided that the loan satisfies the criteria under section 109N, there will be no deemed dividend between Company X and the Trust under section 109D.

The criteria under section 109N of the ITAA 1936 will be met as the loan will be in writing, the interest rates on the loan will be in line with the benchmark interest rates for Division 7A and the maximum term of the loan will not exceed 7 years.

As the loan between Company X and the Trust is compliant with section 109N the exception in subsection 109T(3) cannot apply. This is on the basis that there is no deemed dividend from the private company to the interposed entity because there is a section 109N compliant loan in place. Thus section 109T has the potential to give rise to a deemed payment from Company X to the Spouse 1 even though there is a section 109N loan agreement in place between Company X and the Trust.

There will be need to be other reasons for the Commissioner not to apply section 109T apart from the fact that there is a section 109N compliant loan in place between Company X and the Trust.

Even though section 109T applies the Commissioner can consider several factors under section 109V of the ITAA 1936 to quantify the payment and even determine that the amount should be nil.

Issue 1 Question 2

Summary

As section 109T of the ITAA 1936 applies the Commissioner will determine under section 109V that the deemed payment from Company X to the Spouse 1 should be nil.

Detailed reasoning

After considering subsection 109V(2) of the ITAA 1936 and the additional factors outlined in paragraph 2 of TD 2011/16 the Commissioner has decided that the deemed payment from Company X to the Spouse 1 should be nil for the following reasons:

i. The amount which the Trust will pay the Spouse 1 is the same amount that Company X will advance to the Trust under the section 109N loan agreement. This suggests that there was no motivation of making tax–free distributions of profits and that the transaction will be made for the sole intention of complying with the Family Court Orders.

ii. Regular repayments will be made by the Trust to Company X. The repayments that will be made will comply with the minimum yearly repayments that need to be made under section 109E of the ITAA 1936.

iii. The Section 109N loan agreement between Company X and the Trust will be put on a commercial footing as the loan will be in writing, the interest rates on the loan will be in line with the benchmark interest rates for Division 7A and the maximum term of the loan will not exceed 7 years.

iv. There are other factors which reflect that this is a genuine transaction that is not designed to avoid the application of Subdivision E of the ITAA 1936. In this regard the Trust has the intention and capacity to repay the loan. It will fund the repayment of the loan to Company X by selling some of its assets.

Issue 1 Question 3

Summary

Section 109T of the ITAA 1936 will not deem that Company Y has paid a dividend to the Spouse 1 in respect of the transfer of the Property from the Trust to the Spouse 1 pursuant to the Family Court order.

Detailed reasoning

The acquisition of the Property was funded from capital raised on the issue of the redeemable “Q” units in the Trust to Company Y.

As Company Y has a distributable surplus there is potential for the Commissioner to apply section 109T of the ITAA 1936 and deem the transfer of the property to be a dividend paid to the Spouse 1. In this regard Company Y is the private company, the Trust is the interposed entity and the Spouse 1 is an associate of a shareholder. The sole shareholder of Company Y is the Spouse 2 and under paragraph 318(1)(a) of the ITAA 1936 an associate of a natural person includes a relative of the primary entity. The definition of “relative” in section 995-1 of the ITAA 1997 includes the person’s spouse.

Looking at the factors that need to be met in order for section 109T of the ITAA 1936 to apply, paragraph 109T(1)(a) will be satisfied as the private company (Company Y) made a payment to the interposed entity (the Trust) for the subscription of the redeemable “A” units in the Trust. Likewise, subparagraph 109T(1)(c)(i) will be satisfied as the first interposed entity (the Trust) makes a payment to the target entity (the Spouse 1). Under paragraph 109C(3)(c) of the ITAA 1936 a payment can be a transfer of property to the target entity.

However, in order for a deemed dividend to occur, under paragraph 109T(1)(b) of the ITAA 1936 the Commissioner will have to be satisfied that a reasonable person would conclude that the subscription of the Redeemable “A” class units was made as part of an arrangement for the purpose of transferring the Property to the Spouse 1. Given that the first subscription of the “A” class units to fund the purchase of the Property was made on XX/YY/20ZZ, the Commissioner is of the view that, considering the time that has elapsed since then, there is a lack of evidence to support a conclusion that the primary motivation was to transfer the property to the Spouse 1 as a tax-free distribution. Also, at the time the Property was purchased, it could not have been anticipated that the Spouse 2 and Spouse 1 would go through a divorce proceeding several years later.

Given that section 109T does not apply in these circumstances it is not necessary to consider subsection 109T(3) to see if section 109T doesn’t operate because of the possibility of the payment from Company Y to the Trust being a dividend. Likewise, it is not necessary to consider whether section 109J of the ITAA 1936 prevents the operation of sections 109C and 109T.

Issue 2 Question 1

Summary

The Trust will be entitled to rollover relief on the transfer of the Property to the Spouse 1 under Subdivision 126-A of the ITAA 1997.

Detailed reasoning

Subsection 126-15(1) of the ITAA 1997 provides that the rollover consequences in section 126-5 apply if the CGT event (trigger event) involves a company or a trustee (referred to as the “transferor”) and a spouse or former spouse (“the transferee”) of another individual.

For the Subdivision 126-A of the ITAA 1997 roll-over to apply, the relevant CGT trigger event must arise as a result of a specified kind of formal order, agreement or award listed in subsection 126-15(1). One of these specified in paragraph 126-15(1)(a) is a court order under the FLA 1975 or under a State, Territory or foreign law relating to breakdowns of relationships between spouses.

The subdivision 126-A rollover applies in respect of a specific set of CGT trigger events listed in subsection 126-5(2) of the ITAA 1997 that result in the disposal of an asset to, or the creation of an asset for, a spouse or former spouse. The CGT event is referred to as a trigger event because the roll-over applies automatically at the time of the CGT event.

The CGT events relevant to a disposal case are CGT event A1 (disposal of a CGT asset) and CGT event B1 (use and enjoyment before title passes). A disposal case requires legal and beneficial ownership of the asset to be transferred to the spouse or former spouse.

Under section 104-10, CGT Event A1 occurs when a taxpayer disposes of a CGT asset and there is a change of ownership from the taxpayer to another entity whether because of some act or event or by operation of the law.

Subsection 108-5(1) states that a CGT asset is any kind of property or a legal or equitable right that is not property.

In a disposal case, under subsection 126-5(4) of the ITAA 1997 any capital gain or capital loss that a corporate or trustee transferor would otherwise make from the CGT event is disregarded. Likewise, in a disposal case, under subsection 126-5(5) of the ITAA 1997 if the transferee acquired the property on or after 20 September 1985, the first element of the transferee’s cost base of the asset is the transferor’s cost base at the time of the transfer.

In respect of these family court proceedings the CGT event will be triggered by the consent orders. Tax Determination TD 1999/47 Income tax: capital gains: is there a roll-over under section 126-5 or 126-15 of the Income Tax Assessment Act 1997 if a CGT event happens because of a court order under the Family Law Act 1975 made by consent? states that an order made by consent is a ‘court order’ in terms of paragraphs 126-5(1)(a) and 126-15(1)(a) of the ITAA 1997. If a CGT Event happens because of a consent order under the FLA 1975, there is a roll-over under sections 126-5 or 126-15 of the ITAA 1997.

The Property is a GCT asset under paragraph 108-5(1)(a) of the ITAA 1997. The relevant trigger event in respect of the Property will be CGT event A1. As required by subsection 104-10(2) of the ITAA 1997 the legal and beneficial ownership of the Property will pass from the Trust to the Spouse 1 once the Trust complies with the consent orders.

As such the Subdivision 126-A of the ITAA 1997 rollover will be available with respect to the transfer of the Property from the Trust to the Spouse 1. This means under subsection 126-5(4) any capital gain or capital loss the Trust makes in respect of the Property will be disregarded. Likewise under subsection 126-5(5) the first element of the Property’s cost base in the hands of the Spouse 1 will be the Property’s cost base in the hands of the Trust at the time they acquire it.

There will be no further consequences for the Spouse 1 under subsection 126-15(2) of the ITAA 1997 as by the time the Trust transfers the Property to the Spouse 1, the Spouse 1 will no longer be a Unitholder in the Trust. Under the Family Court Orders prior to the Trust paying the Cash Sum and transferring the Property to the Spouse 1, the Spouse 1 would have already transferred the redeemable units they hold in the Trust to the Spouse 2.

It must be mentioned that should the Spouse 1 sell the Property they will only be entitled to a partial main residence exemption under section 118-180 of the ITAA 1997 even though the Property was their main residence before they became the owner of the Property. Under subsection 118-180(1) the main residence exemption applies as if a taxpayer owned an ownership interest in land or a dwelling during a period when it was actually owned by a company or a trustee if:

a) The taxpayer acquired the interest from the company or trustee; and

b) It was acquired by the company or trustee on or after 20 September 1985; and

c) The marriage breakdown rollover was available to the company or trustee under Subdivision 126A.

In this event under subsection 118-180(2), a dwelling cannot be treated as the taxpayer’s main residence during this period, despite other provisions relating to the main residence exemption that would allow the taxpayer to treat it as his/her main residence during this period.

This provision has two effects:

1) The taxpayer is treated as having owned the asset transferred at all times during the period it was owned by the company or trustee, and

2) A dwelling to which section 118-180 applies is not treated as the main residence of the taxpayer during any part of the period that the dwelling was in fact owned by the company or trustee.

In this instance section 118-180 will apply to the Spouse 1 for the following reasons:

i) Under the family court order they will acquire the Property from the Trust; and

ii) The Trust acquired the property on XX/YY/20ZZ; and

iii) The marriage breakdown rollover will be available to the Trustee of the Trust under Subdivision 126-A.

As such subsection 118-180(2) will deem that the Spouse 1 has commenced owning the Property on XX/YY/20ZZ but to have used the dwelling as their main residence from the date the Property is transferred to them under the consent orders. Accordingly, the Spouse 1 will only be entitled to a partial main residence exemption from the date the Property is transferred to them under the consent orders until the date they sell the Property or it ceases to be their main residence.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).