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Ruling

Subject: Division 7A - deemed dividend

Question 1

Is a payment made by a company to an individual pursuant to an Order of the Family Court of Australia made under the Family Law Act 1975 (FLA 1975) a dividend in accordance with subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice/Answers

No.

Question 2

Will subsection 109C(1) of the ITAA 1936 apply to deem a dividend, a payment made by a private company to an individual pursuant to an Order of the Family Court of Australia made under the FLA 1975?

Advice/Answers

No.

Question 3

Is a payment made by a company to an individual pursuant to an Order of the Family

Court of Australia made under the FLA 1975 a non-share dividend as defined in

subdivision 974-E of the Income Tax Assessment Act 1997 (ITAA 1997) if the recipient of the payment has lent funds to the company on an at-call basis?

Advice/Answers

No.

This ruling applies for the following period

Financial year ending 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The rulee (X) is an individual and is about to enter into a financial settlement with the rulee's former spouse (Y).

X and Y are divorced and prior to that were separated for some time.

X and Y have interests in certain private companies, Company A, Company B, Company C and Company D.

X and Y together have the voting majority in the private companies either directly or indirectly.

All the abovementioned companies have distributable surpluses. Each company's annual turnover for the year ended 30 June 2011 was less than $20 million.

As part of the proposed financial settlement between X and Y, it is expected that the Family Court will make an order pursuant to the FLA 1975 (the Order).

Parties to the Order will be X and Y, and Company C and Company A (collectively known as the Companies).

Under the Order X and Y will transfer shares to each other with effect that X will no longer have any direct or indirect interest in Company B or Company C and Y will no longer have any direct or indirect interest in Company D.

Once the share transfers have occurred, the Companies will make cash payments to X.

X is not a director of the Companies or Company B.

Under the Order the Companies must make a cash payment to X and treat the payment as an expense. The Order will be binding on all parties, including the Companies.

From time to time in the past X and Y have made undocumented loans to the Companies. These loans were made on an ad hoc basis. It is understood, and is generally the case, that the loans are repaid by the Companies in a timely fashion, however repayment is not effectively non-contingent. The Companies may or may not pay interest in respect of funds advanced by X.

There are currently no loans owing to X.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1),

Income Tax Assessment Act 1936 Section 109C,

Income Tax Assessment Act 1936 Subsection 109C(1),

Income Tax Assessment Act 1936 Subsection 109C(2),

Income Tax Assessment Act 1936 Subsection 109J,

Income Tax Assessment Act 1936 Paragraph 109J(a),

Income Tax Assessment Act 1936 Paragraph 109J(b),

Income Tax Assessment Act 1936 Subsection 318(1),

Income Tax Assessment Act 1936 Subsection 318(2),

Income Tax Assessment Act 1997 Subsection 960-100(1) and

Income Tax Assessment Act 1997 Section 995.

Reasons for decision

Question 1

Summary

A payment made by a company to an associate or former associate of a shareholder is not considered a dividend as defined in subsection 6(1) of the ITAA 1936.

Detailed reasoning

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a shareholder in a company includes (relevantly) dividends paid to the shareholder out of profits derived by the company.

Dividends are defined in subsection 6(1) of the ITAA 1936 as including:

(a) any distribution made by a company to 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)

For a payment to be a dividend (and therefore to be considered under section 44 of the ITAA 1936, the payment must be made by the company to a shareholder. The definition of a dividend in subsection 6(1) of the ITAA 1936 does not include associates or former associates of a shareholder. Therefore, a payment made by a private company to a shareholder's spouse, an associate or former associate of a shareholder, would not be considered a dividend under subsection 6(1).

In this case the Companies will make payments to the rulee (X), a former spouse of a shareholder. However at the time of the payments X will not be a shareholder of any of the paying Companies, therefore the payments as described will not be dividends as defined in subsection 6(1) of the ITAA 1936.

As the payments by the Companies to the rulee are not dividends, subsection 44(1) of the ITAA 1936 has no application.

Question 2

Summary

A court ordered cash payment made by the Companies to the former spouse of the private company's shareholder would not be considered a deemed dividend under section 109C of the ITAA 1936 by virtue of the operation of section 109J of the ITAA 1936.

Detailed reasoning

Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity if the private Company Cakes a payment to the entity during the year and either:

(a) the entity is a shareholder or an associate of a shareholder in the company at the time of payment, or

(b) a reasonable person would conclude that the payment was made because the entity has been such a shareholder or associate at some time.

Entity is defined in subsection 960-100(1) of the ITAA 1997 and includes an individual.

An 'associate' of a natural person is defined in subsection 318(1) of the ITAA 1936. Associates of an individual include relatives of a natural person. Paragraph 995-1(a) of the ITAA 1997 defines 'relative' and includes the spouse of a natural person.

A 'spouse' is also defined in paragraph 995-1(a) of the ITAA 1997 to be a person who is in a relationship that is registered under a state or territory law, or who lives on a genuine domestic basis with another person as a couple.

The rulee is no longer married to Y, and they have been living separately and apart on a permanent basis for some time. X is no longer the spouse of Y. Consequently at the time of a court ordered cash payment the rulee would not be considered an associate of Y and paragraph 109(c)(1)(a) of the ITAA 1936 does not apply.

However, paragraph 109(c)(1)(b) of the ITAA 1936 will apply because a reasonable person would conclude that the payment was made as the rulee had been a spouse (and therefore an associate) of a shareholder at some time.

A court ordered payment made by each of the Companies to the rulee would satisfy subsection 109C(1) of the ITAA 1936, as each are private companies that will pay an amount to the rulee.

Accordingly section 109C of the ITAA 1936 would apply to treat the amount of the court ordered cash payment made by each of the Companies to the rulee as deemed dividends, subject to each of the Companies' distributable surplus for the relevant income year calculated under section 109Y of the ITAA 1936.

However, certain payments by a private company to an entity are excluded from the operation of section 109C of the ITAA 1936. Section 109J of the ITAA 1936 states:

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 expressly defined for the purposes of section 109J of the ITAA 1936 and therefore adopts its ordinary meaning. The Macquarie Dictionary defines obligation as follows:

a binding requirement as to action; the binding power or force of a promise, law, duty, agreement, etc; a binding promise or the like.

An order made under section 79 of the FLA 1975 as a result of proceedings in the Family Court regarding the property of parties to a marriage, may result in an entity who is not a party to the court proceedings (for example, a company or trust) making a transfer of property or payment of cash under the terms of that court order. Part VIIIAA of the FLA 1975 gives the Family Court the power to make an order under section 79 binding on third parties.

Therefore, any payments made by the Companies to the rulee as a result of a binding order made by the Family Court would satisfy paragraph 109J(a) of the ITAA 1936.

Paragraph 109J(b) of the ITAA 1936 would also be satisfied by the cash payment made by the Companies under a binding order made by the Family Court. Any settlement terms proposed by X and Y in relation to their property settlement must provide justice and equity between the parties if they are to be approved by the Family Court as required by the FLA 1975. In view of this, it is considered that the cash payment amounts ordered to be paid by the Companies to the rulee would represent arm's length transactions as the terms of the settlement would have been determined objectively by the Family Court to achieve a just and equitable result.

Therefore, as both elements of section 109J of the ITAA 1936 are satisfied, the Companies are not taken under section 109C of the ITAA 1936 to pay a dividend to the rulee when each of the Companies makes a payment to the rulee provided that this is done under a binding order by the Family Court to pay cash and not under an alternative obligation.

Question 3

Summary

Payments to the rulee by the Companies under a court order will not be 'non-share dividends' is defined in section 974-120 of the ITAA 1997.

Detailed reasoning

A 'non-share dividend' is defined in section 974-120 of the ITAA 1997 and is, broadly, any distribution by a company to a holder of a non-share equity interest, except to the extent to which the distribution is debited against the company's share capital account or non-share capital account.

Section 995-1 of ITAA 1997 defines a 'non-share equity interest' in a company as an equity interest in the company that is not solely a share.

The tests for an equity interest are found in section 974-75 of the ITAA 1997 and include:

1. An interest in the company as a member or stockholder of the company.

2. An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect contingent on the economic performance (whether past, current or future) of:

(a) the company; or

(b) a part of the company's activities; or

(c) a connected entity of the company or a part of the activities of a connected entity of the company.

The return may be a return of an amount invested in the interest.

3. An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of:

(a) the company; or

(b) a connected entity of the company.

The return may be a return of an amount invested in the interest.

4. An interest issued by the company that:

(a) gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company; or

(b) is an interest that will, or may, convert into an equity interest in the company or a connected entity of the company.

The loans are undocumented and were made on an ad hoc basis and repayment by the company is contingent on funds being available. The applicant states that the Company may or may not pay interest on the loans and that the loans are generally repaid in a timely manner. Given the nature of the loans they could reasonably be regarded as being 'at call'. Therefore the loans are effectively 'equity interests and any distributions in respect of these could be considered to be non-share dividends.

However subsection 974-75(6) of the ITAA 1997 provides that certain related party at-call loans are deemed to be debt interests (and not equity interests) in an income year if, at the end of the income year in question the following conditions are met:

§ the borrowing company has an annual turnover of less than $20 million

§ the loan satisfies the conditions in paragraphs 974-75(4)(a), (b) and (c)of the ITAA 1997

The conditions in paragraphs 974-75(4)(a), (b) and (c) of the ITAA 1997 are:

(a) a *financing arrangement takes the form of a loan to a company by a *connected entity; and

(b) the loan does not have a fixed term; and

(c) either:

(i) the loan is repayable on demand made by the connected entity, and repayment is required immediately on the making of the demand, or is required at the end of a particular period after the demand is made (being a period that is not longer than is reasonably necessary to arrange repayment); or

(ii) the loan is repayable on the death of the connected entity (if the connected entity is an individual); and

The applicant has stated that the annual turnovers of the Companies are less than $20,000,000, and the requirements of paragraphs 974-75(4)(a),(b) and (c) of the ITAA 1997 are met.

A 'connected entity' has the meaning given by section 995 of the ITAA 1997 to include an associate of the entity.

Under subsection 318(2) of the ITAA 1936, associates of a company include:

§ an entity with the majority voting interest in the company

§ an entity (either alone or together with another) that has sufficient influence over the company.

Having regard to the nature of these at-call loans as described and the likelihood that the former spouses X and Y acting together had sufficient influence over the Companies the Commissioner accepts that the loans by the rulee to the Companies are loans by an associate (and therefore by a connected entity).

As the other conditions are met, these loans meet the description of related party at-call loans under subsection 974-75(6) of the ITAA 1997. As such the loans would represent debt interests rather than being equity interests. It is also noted that there are no outstanding loan amounts owing to the rulee.

The earlier (now repaid) at call loans will not cause the court ordered payments to the rulee by the Companies to be considered 'non-share dividends' is defined in section 974-120 of the ITAA 1997.