Edited version of private ruling

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Ruling

Subject: Payment pursuant to Family Court order

Question 1

Will section 109J of the Income Tax Assessment Act 1936 (ITAA 1936) apply to a Family Court order or consent order that explicitly directs the Company to make a payment to the taxpayer?

Answer

Yes. Section 109J of the ITAA 1936 will apply so that the Company is not taken to pay a dividend under section 109C of the ITAA 1936.

Question 2

Will the payment of cash to the taxpayer pursuant to a Family Court consent order be a dividend pursuant to subsection 6(1) of the ITAA 1936?

Answer

No.

This ruling applies for the following period<s>:

Year ended 30 June 2011

Year ended 30 June 2012

Relevant facts and circumstances

The taxpayer and their spouse were married several years ago. Their marriage has since broken down and they have commenced divorce proceedings. They are currently in the process of negotiating a property settlement. They will apply to the Family Court for a property settlement order by consent.

The taxpayer and their spouse own all the shares in the Company in equal proportion. The Company is a private company. The assets of the Company were acquired by it during the course of the taxpayer's marriage. The Company will be a party to the Family Court proceedings/consent order.

As part of resolving the property settlement dispute, the taxpayer and their spouse are applying to the Family Court for an explicit order directing the Company to make a cash payment to the taxpayer. Their spouse will not receive a payment from the Company.

As part of the settlement, the taxpayer will transfer all their shares in the Company to their spouse, who will assume total control of the Company.

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 Section 109J

Reasons for decision

Question 1

Under section 109C of the ITAA 1936 a private company is taken to pay a dividend to an entity at the end of its year of income if the private company pays an amount to the entity during the year and the payment is made when the entity is a shareholder of the company. Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is the amount paid, subject to the private company's distributable surplus as calculated under section 109Y of the ITAA 1936.

In this case, the taxpayer is a shareholder of the Company. Accordingly section 109C of the ITAA 1936 would apply to treat the amount of any cash payment by the Company to her as a deemed dividend, subject to the Company's distributable surplus for the relevant income year.

However section 109J of the ITAA 1936 states 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.

The Division 7A implications of court orders under the Family Law Act 1975 (FLA) are discussed in ATO ID's 2004/461 and 2004/462.

The term 'obligation' is not expressly defined for the purposes of section 109J of the ITAA 1936 and therefore adopts its ordinary meaning. The Macquarie Dictionary 2003 defines 'obligation' as "a binding agreement as to action; the binding power or force of a promise, law, duty, agreement etc.; a binding promise or the like."

In this case, the applicant has stipulated that the Company will be a party to the Family Court proceedings and consent order. As such the Company will be legally bound by the Family Court order that is the subject of the application for private ruling. When the Company makes the payment of money as ordered by the Court, the payment discharges that obligation, and therefore paragraph 109J(a) is satisfied.

The applicant has also advised that the payment of cash by the Company will not exceed the arm's length amount required to discharge that obligation.

The two elements of section 109J are therefore satisfied, and the Company will not be taken to have paid a dividend under section 109C as a result of the payment made to the taxpayer.

Issue 2 Question 1

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 or 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 properly 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 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; and

f) a reversionary bonus on a life assurance policy.

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a resident shareholder in a company includes dividends that are paid to the shareholder by a company out of profits derived by it from any source.

It is therefore necessary to consider whether the proposed payment by the Company to the taxpayer constitutes a 'distribution' for the purpose of paragraph a) of the definition of dividend.

'Distribution' is defined in subsection 6(1), but only when used in a franking context.

Income Tax Ruling IT 2637, which discusses the application of section 108 of the ITAA 1936, states at paragraph 23 that:

the ordinary meaning of the word 'distribute', according to the Macquarie Dictionary (1981 edition) , is to "divide and bestow in shares; deal out; allot". Given that the word 'distribution' means "that which is distributed", the expression "distribution of profits" in subsection 108(1) is considered to mean shares or portions of profits that are dealt out or bestowed upon recipients.

In its narrow sense 'dividend' means that part of the profits which a company decides to pay to its shareholders. However, whilst the taxpayer and their spouse are equal shareholders in the Company, the taxpayer will receive a cash payment from the Company but their spouse will not receive any payment.

In this case the payment to the taxpayer will be made pursuant to court proceedings, and is not in the nature of a distribution to a shareholder in their capacity as a shareholder. The payment is not a distribution by the Company in the sense of distributing a profit to its members; rather it is made in satisfaction of an obligation of the company under the Court order.

It is therefore considered that the payment by the Company to the taxpayer is not a dividend as defined in subsection 6(1) of the ITAA 1936 and will therefore not be assessable under subsection 44(1) of the ITAA 1936.