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Ruling

Subject: Division 7A: deemed dividends under section 109C and 109D of the Income Tax Assessment Act 1936.

Question 1

Will payments made by the private company in relation to calls made on its unit holding in the unit trust be considered to be a deemed dividend under Section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will payments made by the private company in relation to calls made on its unit holding in the unit trust be considered to be a deemed dividend under Section 109D of the ITAA 1936?

Answer

No.

This ruling applies for the following periods:

1 January 2011 to 31 December 2020

The scheme commences on:

In the 2010 year

Relevant facts and circumstances

Establishing the unit trust

The unit trust was established during 2010.

The trustee for the unit trust is a corporate trustee being W Pty Ltd. The directors of the corporate trustee are Mr and Mrs X.

In 2010 the unit trust acquired a property (the property), and paid a 10% deposit.

The unit trust paid the deposit by the funding from the allotment units in the unit trust. The following units were allotted:

• 'A Class' units paid to X cents in the dollar to the private company, and
• 'Ordinary' units paid to X cents in the dollar to the family trust, and
• 'Ordinary' units fully paid to $X to Mr X
• 'Ordinary' units fully paid to $X to Mrs X

The shareholders of the private company are Z Pty Ltd, Mr X and Y Pty Ltd as trustee for the family trust.

The family trust holds Ordinary units. Mr and Mrs X are the co directors of the trustee for the family trust.

The applicant has advised that at this point in time the trustee of the unit trust does not intend to issue further units in the trust. The applicant has also advised that the trustee of the unit trust intends that the trust will hold only the property.

Purchase of the Property

Settlement occurred at a later date in 2011. At settlement the unit trust was required to pay stamp duty (payable to the State Revenue Office) and the remaining purchase price.

Prior to settlement the unit trust made a call on the partly paid Ordinary units and A Class units to pay the stamp duty. The call on the units was for X cents per unit as follows:

• A Class units at X cents in the dollar from the private company, and
• Ordinary units at X cents in the dollar from the family trust.

To fund the remaining purchase price the unit trust borrowed an amount from a Bank at settlement. This loan is at commercial rates and is for a period of X years. In order to pay down the Bank loan the unit trust will make further calls on the units issued to pay down debt in line with the loan terms with the Bank.

The property is currently leased to the trading trust for an amount per year plus GST, which the applicant has advised is a fair market rental for the property.

Unit holders' rights and entitlements

The trust deed allows the trustee of the unit trust, where Ordinary units and Special units are issued, absolute and uncontrolled discretion in determining whether to declare income for the benefit of unit holders.

The trust deed outlines that:

• Ordinary units have the right to receive anything specified in the Trust Deed (right to income and right to capital)
• A Class units have a right to receive a rateable proportion of income (right to income only).

A resolution was made by the trustee of the unit trust on a day in 2011 that between the years ending 31 December 2011 to 31 December 2020 the net income of the unit trust will be distributed to all unit holders in proportion to the number of units held, irrespective of the class of unit. This resolution was made in accordance with the trust deed.

Voting control of the unit trust is held by Mr and Mrs X. This is because Mr and Mrs X each hold some fully paid Ordinary units, and are the co-directors of Y Pty Ltd as trustee for the family trust which holds some Ordinary units. As such, under the trust deed Mr and Mrs X are the only persons eligible to vote on general meeting resolutions.

Future calls on partly paid units

The trust deed states that the trustee of the unit trust may make calls on partly paid units.

In order to pay down its external borrowings the unit trust intends to make future calls on unit holders to pay down debt in line with the loan terms over a maximum period of X years.

Other matters

The applicant advises that the private company and unit trust are dealing with each other at arm's length. The applicant also advises that the payment/s being made by the private company for the A Class units in the unit trust, whether partially paid or fully paid, reflect the arm's length value (market value) of the A Class units in the unit trust.

The arrangement in respect of which the Ruling applies will be in accordance with the terms of the following documents;

• copy of the unit trust deed,
• copy of minutes of W Pty Ltd's Directors Meeting, and
• further information provided to the Commissioner.

Relevant legislative provisions

Section 109C of the Income Tax Assessment Act 1936

Subsection 109C (3) of the Income Tax Assessment Act 1936

Paragraph 109C (1)(a) of the Income Tax Assessment Act 1936

Section 109D of the Income Tax Assessment Act 1936

Subsection 109D (1) of the Income Tax Assessment Act 1936

Subsection 109D (3) of the Income Tax Assessment Act 1936

Paragraph 109D (1)(a) of the Income Tax Assessment Act 1936

Section 109J of the Income Tax Assessment Act 1936

Subsection 109J (a) of the Income Tax Assessment Act 1936

Subsection 109J (b) of the Income Tax Assessment Act 1936

Section 109ZD of the Income Tax Assessment Act 1936

Section 318 of the Income Tax Assessment Act 1936

Paragraph 318 (1)(d) of the Income Tax Assessment Act 1936

Reasons for decision

Issue 1

Question 1

Summary

The payment the private company makes to the unit trust is a payment to an associate within the meaning of section 109C of the ITAA1936. In this case the payment will satisfy the exception in section 109J of the ITAA 1936 as the payment is to discharge an obligation of the private company, and is not more than would have been required to discharge the obligation had the private company and the unit trust been dealing with each other at arm's length.

The payment/s by the private company when a call is made on A Class units, will not be considered a deemed dividend under section 109C of the ITAA 1936.

Detailed reasoning

Application of section 109C of the ITAA 1936

Whether a payment made by a private company to a shareholder will be a deemed dividend is addressed in section 109C of the ITAA 1936. Paragraph 109C(1)(a) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity if it pays an amount to a shareholder in the private company, or an associate of such a shareholder, during an income year.

The term "payment" is defined in subsection 109C(3) of the ITAA 1936 as:

(a)   a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and

(b)   a credit of an amount to the extent that it is:

                              i.        to the entity; or

                             ii.        on behalf of the entity; or

                            iii.        for the benefit of the entity; and

(c)   a transfer of property to the entity.

On this basis the private company will, when a call is made on the A Class units in the unit trust by the trustee pursuant to the trust deed, be making a payment to the unit trust.

Section 109ZD of the ITAA 1936 states that 'associate' has the meaning given by section 318 of the ITAA 1936.

As stated in paragraph 318(1)(d) of the ITAA 1936, the unit trust is an associate of Mr X, who is a shareholder of the private company.

As the payment from the private company to the unit trust when a call is made will be a payment to an associate of a shareholder within the meaning of section 109C of the ITAA 1936, the exclusions to section 109C of the ITAA 1936 need to be considered.

Application of section 109J of the ITAA 1936

Section 109J of the ITAA 1936 allows an exception to section 109C. It provides 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 term 'obligation' is not defined for the purposes of section 109J of the ITAA 1936. Obligation is defined in the Macquarie Dictionary 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.

The two elements in section 109J of the ITAA 1936 must be satisfied to exclude a payment from the operation of section 109C of the ITAA 1936. That is, the payment must discharge an obligation of the private company to pay money to the unit trust, and that obligation must be no more then would have been required where the private company and the unit trust are dealing with each other at arm's length.

The payments made by the private company to the unit trust relate to the discharge of an obligation by the private company for the purposes of the trust deed (a contractual obligation). A call on the partly paid A Class units made by the trustees of the unit trust pursuant to the trust deed obliges the private company, who holds A Class units, to make a payment to the unit trust. Any payment made by the private company in relation to the calls made on A Class units will satisfy subsection 109J(a) of the ITAA 1936, being the discharge of an obligation of the private company to pay an amount to the unit trust.

The parties, being the private company and the trustee of the unit trust, are associates. They are required for the purposes of satisfying subsection 109J(b) of the ITAA 1936 to show that they are dealing at arm's length. The payments made by the private company for the A Class units in the unit trust, whether partially paid or fully paid, reflect the arm's length value (market value) of the A Class units in the unit trust. This means that the private company and the unit trust are dealing with each other at arm's length and the private company is not paying more than what would have been required (market value) to discharge the obligation had the transaction been entered by an independent third party.

Any payment made by the private company in relation to the calls made on A Class units will qualify for the exemption provided by subsection 109J(b) of the ITAA 1936, to the extent that the payment is not more than would be required had the private company and the unit trust been dealing with each other at arm's length.

Conclusion

The payment/s made by the private company to the unit trust when a call is made on A Class units held by the private company, will not be deemed dividends under section 109C of the ITAA 1936, as section 109J of the ITAA 1936 would exclude its operation.

Question 2

Summary

The payment/s by the private company to the unit trust when a call is made on the A Class units, is not considered to be a loan for the purposes of subsection 109D(3) of the ITAA 1936. The payment/s will not be considered a deemed dividend under section 109D of the ITAA 1936.

Detailed reasoning

Whether a loan made by a private company to a shareholder will be a deemed dividend is addressed in section 109D of the ITAA 1936. Subsection 109D(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity in an income year if the company makes a loan during the year to a shareholder or an associate of a shareholder, which is not fully repaid before the company's lodgment day, and no exclusion at Subdivision D in Division 7A of the ITAA 1936, prevents the company from being taken to pay a dividend.

In accordance with subsection 109D(3) of the ITAA 1936, a loan is:

(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.

Advance of money- paragraph 109D(3)(a) of the ITAA 1936

As outlined in paragraph 85 of Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements (TR 2010/3), the phrase 'advance of money' is taken to mean "a payment of moneys ahead of a due date, or a payment in expectation of repayment or reimbursement."

This is reinforced in Federal Commissioner of Taxation v Radilo Enterprises Pty Ltd (1997) 72 FCR 300, where the definition of a loan was discussed. It was said that the essence of a transaction is the promise of repayment.

In this case there is a payment from the private company to the unit trust but no obligation to repay this amount. The payment is not an advance of money for the purposes of paragraph 109D(3)(a) of the ITAA 1936.

Provision of credit and financial accommodation- paragraph 109D(3)(b) of the ITAA 1936

The meaning of the phrase 'provision of credit' is set out at paragraph 87 of TR 2010/3 as follows:

87. 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.

The meaning of the phrase "any other form of financial accommodation" is outlined at paragraph 96 of TR 2010/3 to be as follows:

96. 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...;

·         under a consensual arrangement (similarly to Radilo); and

·         where the principle sum or equivalent is ultimately payable (similarly to Radilo).

As outlined in paragraph 119 of TR 2010/3, the phrase 'transaction (whatever its terms or form)' suggests a wide meaning of the word. Paragraph 120 of TR 2010/3 discusses the majority decision in Grimwade v. Federal Commissioner of Taxation, that a transaction must be bilateral (that is, to be a transaction at least two parties must be involved).

In this case, there is no obligation to advance any monies until a call is made by the unit trust to its unit holders. The private company does not provide monies ahead of a due date and there is no expectation of repayment or reimbursement. The payment from the private company to the unit trust is not an advance of monies for the purposes of paragraph 109D(3)(b) of the ITAA 1936.

There is no timeline to pay a debt and no monetary arrangement. Therefore, the payment from the private company to the unit trust is not the provision of credit nor providing financial accommodation for the purposes of paragraph 109D(3)(b) of the ITAA 1936.

Amount requiring repayment- paragraph 109D(3)(c) of the ITAA 1936

The unit trust deed states that there is no express and implied obligation on the trustee to pay any amount to A Class unit holders other than a share of income. The monies paid to the A Class unit holders occurs because they are unit holders. That is, there is no obligation on the unit trust to repay any amount paid by the private company. Rather, as a result of the payment, the private company acquires an asset (being a unit in the unit trust). Therefore, the payment from the private company to the unit trust is not an amount requiring repayment for the purposes of paragraph 109D(3)(c) of the ITAA 1936.

A transaction which in substance effects a loan- paragraph 109D(3)(d) of the ITAA 1936

As stated in paragraph 116 of TR 2010/3, this extended definition of a loan covers arrangements that in substance affect a loan of money (that is, consisting of a payment requiring repayment).

Although there is a transfer of money between two parties, there is no debtor/creditor relationship between the private company and the unit trust, that is, there is no obligation for the unit trust to repay the amount. Therefore, the payment from the private company to the unit trust is not a transaction which is substance affects a loan for the purposes of paragraph 109D(3)(d) of the ITAA 1936.

Conclusion

The payment by the private company to the unit trust for partially paid units in the trust would not be considered a loan for the purposes of subsection 109D(3) of the ITAA 1936 for the following reasons:

• There is no obligation on the unit trust to repay any amount paid by the private company. Rather, as a result of the payment, the private company acquired an asset (being a unit in the unit trust).
• The calls on the partly paid A Class units in the unit trust represent an investment by the private company for which it may receive a portion of the net income of the trust.
• The return on investment is not interest, and is not in the nature of interest.

As the payment by the private company to the unit trust is not a loan, section 109D of the ITAA 1936 will not apply. Accordingly, the payment by the private company to the unit trust is not a deemed dividend under section 109D of the ITAA 1936.

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