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Ruling
Subject: Division 7A - court ordered payment
Question 1
Is the payment made to the rulee a discharge of an obligation of the company in accordance with section 109J of the Income Tax Assessment Act 1936 (ITAA 1936)?
Answer
No, section 109J has no application.
This ruling applies for the following periods:
Financial year ending 30 June 2012
Financial year ending 30 June 2013
The scheme commences on:
1 July 2011
Relevant facts and circumstances
The rulee entered into an agreement with their ex spouse regarding the division of property following the breakdown of their marriage. This agreement was made before the Magistrates Court in accordance with the Family Law Act 1975 (FLA 1975) and contains consenting orders in regards to matters including division of property. A copy of this agreement was provided with this application.
The agreement includes Company (a private company) as a party to the proceedings. The rulee is the sole shareholder of Company. Under the consenting orders in the agreement, Company was required to make a cash payment to the rulee. The amount of the payment is the proceeds from the sale of an asset of the Company, after deducting tax and other liabilities.
Company had a distributable surplus for the purposes of Division 7A both before and after payments made in accordance with the consenting orders.
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 109L
Income Tax Assessment Act 1936 section 109J
Family Law Act 1975
Summary
Section 109J of the ITAA 1936, has no application because the payment is a dividend under subsection 44(1) of the ITAA 1936 and excluded from Division 7A under section 109L of the ITAA 1936.
Detailed reasoning
Division 7A of the ITAA 1936 is an integrity measure aimed at preventing private companies from making tax-free distributions to shareholders (or their associates). In particular, advances, loans and other payments or credits to shareholders (or their associates) are treated as assessable dividends to the extent that the private company has a distributable surplus.
However, Subdivision D of Division 7A of the ITAA 1936 sets out specific exclusions for payments and loans that will not be treated as dividends.
In particular, subsection 109L(1) of the ITAA 1936 provides that a private company is not taken under section 109C or 109D of the ITAA 1936 to pay a dividend because of a payment or a loan the private company makes to the entity, to the extent that the payment or loan would be included in the entity's assessable income apart from this Division (as it operates in conjunction with section 44 of the ITAA 1936).
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)
In this case, Company has sold a property and made a capital gain. Company is to make a payment to the rulee, being the amount remaining from the sale of the property after deducting tax and other expenses. We consider the amount that will be paid to the rulee by the company will be a distribution to a shareholder which is a dividend under subsection 6(1) of the ITAA 1936.
None of the exclusions at paragraphs 6(1)(d), 6(1)(e) or 6(1)(f) of the ITAA 1936 apply to the distribution.
The dividend would then be included in the rulee's assessable income by the operation of subsection 44(1) of the ITAA 1936, as the amount will be paid out of profits derived by Company.
Through the operation of subsection 109L(1) of the ITAA 1936, Company is not taken to pay a dividend for the purposes of Division 7A of the ITAA 1936.
Accordingly, section 109J of the ITAA 1936 will have no application to the arrangement