Edited version of private ruling

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Ruling

Subject: Income tax - property settlement

Questions

1. Apart from section 109J of the Income Tax Assessment Act 1936 would subsection 109C(1) of the Income Tax Assessment Act 1936 apply when Company X makes a cash payment to Person Y due to a Court Order?

Answer: Yes

2. Does section 109J of the Income Tax Assessment Act 1936 apply when a private company makes a cash payment to an individual due to a Family Court order under the Family Law Act 1975?

Answer: Yes

Question 3

3. Will the payment by a private company to an individual fall within the definition of 'dividend' in subsection 6(1) Income Tax Assessment Act 1936?

Answer: No

4. Will the payment by a private company to an individual be statutory income under subsection 44(1) of the Income Tax Assessment Act 1936?

Answer: No

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts and circumstances

The taxpayer and spouse were granted a divorce in 2008 which became effective the same year.

As part of the Family Court Orders the judge ordered that the property of the Parties be divided in a certain way.

Pursuant to those orders the taxpayer's spouse wishes to effect a settlement upon the taxpayer which includes a part of the taxpayer's entitlements being paid in cash.

The taxpayer wishes to have a substantial cash settlement to invest. The taxpayer proposes that all or part of the cash settlement be paid by a private company.

The shares in the private company are held by the taxpayer's spouse and another entity.

The taxpayer has never held shares in the private company. The taxpayer's name has never been entered on the private company's share register, the taxpayer has never been entitled as against the private company to be registered as a shareholder and the private company has never been absolutely entitled to register the taxpayer as a member.

The taxpayer and spouse have been the directors of the private company.

Subject to the Family Court's approval and following the resolution of this private ruling application, the taxpayer will seek to have the following orders made by the family court under the Family Law Act 1975 in satisfaction of the remainder of the property settlement:

· That the private company be made a party to the proceedings.

· In settlement of the orders the private company pay the taxpayer:

(i) a cash payment equivalent to a percentage of the private company's net asset value, with the remainder of the taxpayer's entitlement to the assets of the Parties to be satisfied by the transfer of property and cash by the spouse and/or entities associated with the spouse, or

(ii) a cash payment equivalent to a percentage of the private company's net asset value, with the remainder of the taxpayer's entitlement to the assets of the Parties to be satisfied by the transfer of property and cash by the spouse and/or entities associated with the spouse.

Assumption

That the private company will be made a party to the proceedings in the Family Court.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109C,

Income Tax Assessment Act 1936 Section 109J,

Income Tax Assessment Act 1936 Subsection 6(1) and

Income Tax Assessment Act 1936 Subsection 44(1).

All references made in these reasons for decision are to the Income Tax Assessment Act 1936 unless otherwise stated.

Question 1

Under subsection 109C(1) where a private company pays an amount to an entity during the year, that payment is deemed to be a dividend where 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.

An entity includes an individual.

The payment resulting from the court order would be a payment as defined in subsection 109C(3).

Section 109ZD states that 'associate' has the meaning given by section 318, which includes a relative as an associate. A relative includes a spouse (subsection 6(1)).

Paragraph (a

Paragraph (a) will not be satisfied at the time the payment is made because the taxpayer is no longer the spouse of a shareholder.

Paragraph (b)

The taxpayer was an associate of a shareholder at some time.

As noted in Taxation Determination TD 2008/14, in the context of paragraph 109C(1)(b), because means by reason that. The reason must be a real and substantial reason for the payment even if it is not the only or main reason for the transaction.

At paragraphs 26 and 27, TD 2008/14 states:

… Given the breadth of paragraph 109C(1)(a), which as mentioned above requires no causal relationship between the making of the payment and the entity's status, the Commissioner considers it appropriate to take a broad view of the rule in paragraph 109C(1)(b) that is intended to support its operation. In particular, it would tend to make paragraph 109C(1)(b) ineffective if the existence of some other reason for a payment were enough to prevent the paragraph from applying. In other words, because paragraph 109C(1)(b) is there to stop people contriving ways to avoid paragraph 109C(1)(a), paragraph 109C(1)(b) in turn should be interpreted in a way that makes it relatively difficult to avoid, including by means of further contrivances.

In conclusion therefore, the existence of multiple reasons for a transaction does not prevent a reasonable person from concluding that the payment, loan or debt forgiveness occurred because the entity has been a shareholder or associate at some time.

A reasonable person would conclude that the reason for the payment to the taxpayer is the fact that the taxpayer was previously an associate of a shareholder.

Therefore apart from subsection 109J, subsection 109C(1) would apply to the payment to be made by the private company to the taxpayer.

Question 2

Under section 109J 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.

Paragraph (a)

As noted in ATOID 2004/462, the term obligation is not defined for the purposes of section 109J and therefore takes on its ordinary meaning. The Macquarie Dictionary 2003 rev. edn, the Macquarie Library Pty Ltd, NSW, defines obligation as 'a binding requirement as to action; the binding power or force of a promise, law, duty agreement, etc.; a binding promise or the like'.

In the situation described in ATOID 2004/462 the exemption provided by section 109J did not apply. This was because the order was not an obligation of the private company for the purposes of this exemption. The order was an obligation of the spouse subject to the order.

Unlike the situation in ATOID 2004/462 the private company will be a party to the Family Court proceedings. Thus, an obligation will arise from a court order made to it as a party to the proceedings. Since that order involves the payment of money to an individual, paragraph (a) will be satisfied.

Paragraph (b)

The payment that will be made must not be more than what would be required to discharge the obligation had the company and the taxpayer been dealing with each other at arm's length.

The Explanatory Memorandum to Taxation Laws Amendment Bill (No. 3) 1998, which introduced Division 7A to the Income Tax Assessment Act 1936 states the following in relation to the section 109J:

An amount paid to discharge a pecuniary obligation owed by a private company to a shareholder or associate will not be treated as a dividend to the extent that the payment is not more than the amount the pecuniary obligation would have been if the private company and shareholder or associate had been dealing with each other at arm's length [new section 109J]. This section ensures that such commercial dealings are not unfairly taxed and that, for example, disguised distributions are not made by inflating the amount of a debt owed to a shareholder or associate by a private company.

Given the circumstances under which the amount of the payment is being determined and taking into account the intention of section 109J, it is considered that paragraph (b) is satisfied.

Since section 109J applies to the payment to be made by the private company to the taxpayer, the payment will not be taken to be a dividend paid under section 109C.

Question 3

Subsection 6(1) defines 'dividend' as including any distribution made by a company to any of its shareholders, whether in money or other property.

Under subsection 6(1) a shareholder includes member or stockholder.

Since the taxpayer has never been a shareholder of the private company the payment will not be a distribution made by the company to the taxpayer as a shareholder. Therefore the payment is not a dividend.

Question 4

Under subsection 44(1) the assessable income of a shareholder in a company who is a resident includes:

a) 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

b) all non-share dividends paid to the shareholder by the company.

The payment to be made by the private company to the taxpayer is not a dividend and the taxpayer is not a shareholder, therefore it will not be assessable under subsection 44(1).