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Ruling

Subject: Income Tax: Division 7A - payments treated as dividends

Issue 1

Division 7A - amounts paid by a private company to a shareholder or associate of a shareholder

Question 1

Where a company makes a payment during a year of income to an individual because of a court order made under section 79 of the Family Law Act 1975, to which the company is a party, will the company be taken to have paid a dividend to the individual at the end of the income year under section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

If the answer to question 1 is 'Yes', are those payments made by the company to the individual, not taken to be a dividend under section 109J of the ITAA 1936?

Answer

Yes.

Issue 2

Fringe Benefits Tax

Question 1

Where a company makes a payment during a year of income to an individual because of a court order made under section 79 of the FLA, to which the company is a party, has the company provided a fringe benefit to the individual for the purposes of the Fringe Benefits Tax Assessment Act 1986?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2012.

The scheme commences:

1 July 2011.

Relevant facts and circumstances

The company is an Australian proprietary company limited by shares. Shares in the company are held independently and in equal quantities by the individual and their former spouse, who are also Directors of the company.

The individual and their former spouse are now divorced and have been involved in proceedings for property settlement before the Family Court of Australia (the Family Court). The company will be made a party to the proceedings.

The individual, their former spouse and the company will enter into a Consent Order (the order) to be approved by the Family Court. The order will be made with the consent of all parties under section 79 of the Family Law Act 1975 (FLA). The terms of the order include:

The individual will resign as a Director

The individual will transfer their shareholding to their former spouse

The company will pay the individual an agreed amount in consideration for the transfer of the individual's shares in the company to their former spouse

The company will pay the agreed amount in instalments from its after tax reserves

The individual will retain a property, which forms part of the consideration for the transfer of the individual's shareholding in the company to their former spouse.

The property referred to in the order is owned by the individual and is the individual's main residence for the purposes of Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997). The property was not used for any other purpose apart from being the individual's main residence.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part III

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Subsection 109C(1)

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

Income Tax Assessment Act 1936 Paragraph 109C(1)(b)

Income Tax Assessment Act 1936 Subsection 109C(2)

Income Tax Assessment Act 1936 Subsection 109C(3)

Income Tax Assessment Act 1936 Paragraph 109C(3)(a)

Income Tax Assessment Act 1936 Subsection 109C(4)

Income Tax Assessment Act 1936 Subsection 109CA

Income Tax Assessment Act 1936 Section 109J

Income Tax Assessment Act 1936 Paragraph 109J(a)

Income Tax Assessment Act 1936 Paragraph 109J(b)

Income Tax Assessment Act 1936 Section 109RC

Income Tax Assessment Act 1936 Subsection 109RC(3)

Income Tax Assessment Act 1936 Section 109ZD

Income Tax Assessment Act 1936 Part X

Income Tax Assessment Act 1936 Section 318

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Issue 1

Division 7A - amounts paid by a private company to a shareholder or associate of a shareholder

Question 1

Detailed reasoning

General discussion of the law

Amounts paid by a private company to a shareholder or associate of a shareholder

Subdivision B of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) automatically treats certain amounts paid by a private company to a shareholder or an associate of a shareholder as a dividend paid by the company. This includes payments, loans and debt forgiveness made by a private company to a shareholder or an associate of a shareholder. However the amount of the dividend may be limited to the extent that the company has a distributable surplus.

Subsection 109C(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and 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.

Note 1:

Some payments do not give rise to dividends under Subdivision D. This section also does not give rise to a dividend if the amount is paid to a CGT concession stakeholder under subsection 152-325(1) of the Income Tax Assessment Act 1997 (see subsection 152-325(11)).

Note 2:

A private company is treated as making a payment to a shareholder or shareholder's associate if an interposed entity makes a payment to the shareholder or associate. See Subdivision E.

Where the provision refers to an 'entity', this includes an individual.

Paragraph 109C(1)(a) of the ITAA 1936

In order to determine whether paragraph 109C(1)(a) of the ITAA 1936 will be applicable we need to determine whether you were a 'shareholder' or 'associate of a shareholder' of the entity at the time of payment.

The word 'associate' used in section 109ZD of the ITAA 1936 has the same meaning as given by section 318 of the ITAA 1936. Paragraph 318(1)(a) of the ITAA 1936 defines that an 'associate' of a natural person includes a 'relative' of a natural person.

The definition of 'relative' for the purposes of section 318 of the ITAA 1936 is the meaning given by subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and includes a 'spouse' of a natural person.

The definition of 'spouse' in subsection 995-1(1) of the ITAA 1997 provides that a 'spouse' in relation to an individual includes another individual who, although not legally married to the individual, lives with the individual on a genuine domestic basis as a couple.

Paragraph 109C(1)(b) of the ITAA 1936

Paragraph 109C(1)(b) of the ITAA 1936 requires consideration of whether a reasonable person would conclude that you received the payment because you were a shareholder or associate at some time.

A reasonable person is not defined in the tax law. In relation to Tort law, the Encyclopaedic Australian Legal Dictionary (2012) defines a reasonable person as:

The ordinary person; a person with the characteristics of an ordinary person in the defendant's position; a fictitious, imaginary, or hypothetical person of ordinary prudence, intelligence, and skill under the circumstances: Heaven v Pender (1883) 11 QBD 503 ; King v Phillips [1953] 1 All ER 617 ; [1953] 1 QB 429 . Formerly known as `reasonable man'.

The reasonable person test has often been considered by the Courts. The test requires that upon the weighing up of all the facts, what would a reasonable person conclude on the given question. The person would also need to have an understanding of the purpose or intent of the legislation. The only challenge which may be made to the reasonable person test, is that the decision is so unreasonable that no reasonable person could have made such a decision on the basis of the supplied facts.

The Commissioner's view of the word 'because' in the context of subsection 109C(1) of the ITAA 1936 is discussed in Taxation Determination TD 2008/14 and states:

1. In this context 'because' means by reason that. The reason must be a real and substantial reason for the payment, loan or debt forgiveness concerned,¹ even if it is not the only reason or not the main reason for the transaction.

2. The test for determining whether the event falls within the relevant provisions of Division 7A is a reasonable person's conclusion which is an objective test requiring a weighing up of all the circumstances to determine whether the reason is real and substantial.

Paragraphs 22 to 24 of TD 2008/14 explain:

22. Paragraph 109C(1)(b) does require a causal relationship. The word 'because' is not defined in the Income Tax Assessment Act 1936. It is defined in The Australian Oxford Dictionary , 1999, Oxford University Press, Melbourne as 'for the reason that; since'. This directs attention to the question of whether the fact that the entity was in the past a shareholder or associate is a reason for the payment being made.

23. However, the Commissioner considers that to be a cause of the payment, a reason must be real and substantial and not merely remote or insignificant. Whether a reason is real and substantial is a question of fact and degree determined on balance, according to the facts and circumstances.

24. In some cases it may be reasonable to conclude that there is more than one reason for the payment being made. The Commissioner considers that, as a matter of ordinary language, an event may occur because of a particular circumstance even if it also occurs because of one or more other circumstances.

TD 2008/14 goes on to explain, at paragraphs 26 and 27, that:

26. …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.

27. 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.

In summary, the cause of the transfer does not have to be the dominant purpose for the transfer, merely, that it is one possible reason for the transfer to the entity as a shareholder or associate at some time.

Dividend

Amount of the dividend

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 calculated under section 109Y of the ITAA 1936.

By virtue of paragraph 109C(3)(c) of the ITAA 1936 the definition of 'payment' in subsection 109C(3) of the ITAA 1936 includes a transfer of property to the entity. Section 109CA of the ITAA 1997 (applicable from 1 July 2009) states that a payment includes the provision of an asset for use by the entity.

Where the payment is by transfer of property, subsection 109C(4) of the ITAA 1936 provides that the amount of a payment is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer.

Dividend may be franked

Under section 109RC of the ITAA 1936, if a dividend is taken to be paid under Division 7A of the ITAA 1936 because of a family law obligation, that dividend may be franked. This includes a court order under the FLA.

Under subsection 109RC(3) of the ITAA 1936, the dividend can be franked in accordance with the company's benchmark franking percentage for the year, or to 100% if there is no benchmark franking percentage.

Application of the law

The individual and their former spouse are divorced. The individual will transfer their shareholding because of the order and consequently will no longer be a shareholder. In addition, at the time the company makes a payment to the individual, the individual is not an 'associate' as defined under section 318 of the ITAA 1936.

Consequently, paragraph 109C(1)(a) of the ITAA 1936 will not be satisfied at the time the payment is made because the individual is not a shareholder or an associate of a shareholder.

However, it is necessary to determine whether, with regard to all the circumstances, a reasonable person would conclude that the company made those payments to the individual because the individual was a shareholder at some time, or that the individual was an associate of a shareholder at some time.

Under paragraph 109C(1)(b) of the ITAA 1936 you only need to be a shareholder or an associate of a shareholder at some time. The individual was a shareholder and also the 'spouse' of a shareholder at some time.

In objective analysis of the circumstances, a reasonable person would consider that for there to be an obligation under the FLA, there must have been a marriage or marriage like relationship. Further, the Family Court takes into account all the assets of all the relevant parties when giving consideration to a property settlement, which indicates that there is more than just an incidental connection between the parties to the settlement.

In addition, a reasonable person would conclude that, but for the fact the individual was both a shareholder and the spouse of a shareholder, there would have been no obligation by the company to make the payments set out in the order.

In consideration of the circumstances, for the purposes of paragraph 109C(1)(b) of the ITAA 1997, it is considered that a reasonable person would conclude (having regard to all the circumstances) that the payment the individual will receive is made because the individual has been a shareholder of the company or an associate of a shareholder at some time. Paragraph 109C(1)(b) of the ITAA 1936 will be satisfied.

Therefore, where the company makes a payment during a year of income to the individual because of a court order made under section 79 of the FLA, to which the company is a party, the company will be taken to have paid a dividend to the individual at the end of the income year under section 109C of the ITAA 1936.

However, the definition of payment in subsection 109C(3) of the ITAA 1936 includes a transfer of property. As the individual owns the property that forms part of the consideration in respect of the transfer of their shareholding in the company to their former spouse, there is no transfer. Therefore, the value of that property will not form part of any dividend that is taken to have been paid. In addition, the amount of any dividend that is taken to have been paid would be calculated subject to section 109Y of the ITAA 1936.

Question 2

Detailed reasoning

General discussion of the law

Exclusions to the operation of Division 7A

Subdivision D of Division 7A of Part III of the ITAA 1936 sets out rules about some payments that are not treated as dividends under subsection 109C(1) of the ITAA 1936. In particular, 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:

· discharges an obligation of the private company to pay money to the entity; and

· 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 Online, 2012, Macquarie Dictionary Publishers Pty Ltd, Sydney, NSW, Australia (Macquarie Online (2012)) defines 'obligation' as follows:

1. a binding requirement as to action; duty: to fulfil every obligation.

2. the binding power or force of a promise, law, duty, agreement, etc.

3.

a. a binding promise or the like.

b. the act of binding oneself by a promise, contract, etc.

4.

a. Law a legal relationship between two persons, such that one person's right entails the other person's duty.

b. the document containing such an agreement.

5. a bond containing a penalty, with a condition annexed for payment of money, performance of covenants, etc.

6. any bond, note, bill, certificate, or the like, as of a government or a company, serving as security for payment of indebtedness.

The second element that needs to be satisfied is the obligation to pay money. The term 'money' is not expressly defined for the purposes of section 109J of the ITAA 1936. Macquarie Online (2012) defines 'money' to include:

1. gold, silver, or other metal in pieces of convenient form stamped by public authority and issued as a medium of exchange and measure of value.

2. current coin.

3. coin or certificate (as banknotes, etc.) generally accepted in payment of debts and current transactions.

4. any article or substance similarly used.

5. a particular form or denomination of currency.

6. a money of account.

7. property considered with reference to its pecuniary value.

8. an amount or sum of money.

9. wealth reckoned in terms of money.

10. (plural) Law, Archaic pecuniary sums.

Family law obligation

For the purposes of Division 7A of the ITAA 1936, a 'family law obligation' is defined in section 109ZD of the ITAA 1936 as 'an order agreement or award mentioned in paragraph 126-5(1)(a), (b), (c), (d), (e) or (f) of the Income Tax Assessment Act 1997', which includes:

· a court order under the Family Law Act (FLA) or a corresponding foreign law

· a maintenance agreement approved by a court under FLA s 87 or a corresponding agreement approved by a court under a corresponding foreign law

· a court order under a state law, territory law or foreign law relating to de facto marriage breakdowns.

Application of the law

The order will require the company to make payments to the individual. As the company is a party to order, which will be issued under the FLA, there is a 'binding requirement' on the company.

With regard to the ordinary meaning of the term 'obligation', in addition to the definition of the term 'family law obligation' under section 109ZD of the ITAA 1936, it is considered that the requirement arising form the order is an obligation of the company (a private company). Further, it is considered that the company will make the payments required under the order to discharge that obligation. Therefore, paragraph 109J(a) of the ITAA 1936 will be satisfied.

In addition, the settlement terms agreed between the parties to the order must have provided justice and equity between the parties for it to have been approved by the Family Court as required by the FLA.

Given the circumstances, it is considered that payments ordered to be made by the company to the individual would represent an arm's length transaction, as the terms of the settlement would have been determined objectively by the Family Court to achieve a just and equitable result. It is considered that paragraph 109J(b) of the ITAA 1936 will be satisfied.

Therefore, in consideration of the circumstances, those payments made by the company to the individual are not taken to be a dividend under section 109J of the ITAA 1936.

Issue 2

Fringe Benefits Tax

Question 1

Detailed reasoning

General discussion of the law

Fringe benefit tax

Fringe benefits tax is a tax paid on certain benefits you provide to your employees or your employees' associates. FBT is separate from income tax and is based on the taxable value of the various fringe benefits you provide, which is calculated under the under the Fringe Benefits Tax Assessment Act 1986 (FBTAA).

A fringe benefit is a benefit provided in respect of the employment of an employee or an associate of an employee. This means a benefit provided to an employee (or their associate) because they are an employee. An employee can be a current, future or former employee.

The term 'associate' is defined under section 318 of the ITAA 1936.

'Benefit' is defined under section 136(1) of the FBTAA, which provides:

benefit includes any right (including a right in relation to, and an interest in, real or personal property), privilege, service or facility and, without limiting the generality of the foregoing, includes a right, benefit, privilege, service or facility that is, or is to be, provided under:

(a) an arrangement for or in relation to:

(i) the performance of work (including work of a professional nature), whether with or without the provision of property;

(ii) the provision of, or of the use of facilities for, entertainment, recreation or instruction; or

(iii) the conferring of rights, benefits or privileges for which remuneration is payable in the form of a royalty, tribute, levy or similar exaction;

(b) a contract of insurance; or

(c) an arrangement for or in relation to the lending of money.

'Fringe benefit' is defined under section 136(1) of the FBTAA, which includes:

fringe benefit, in relation to an employee, in relation to the employer of the employee, in relation to a year of tax, means a benefit:

(a) provided at any time during the year of tax; or

(b) provided in respect of the year of tax;

being a benefit provided to the employee or to an associate of the employee by:

(c) the employer; or

(d) an associate of the employer; or

(e) a person (in this paragraph referred to as the arranger) other than the employer or an associate of the employer under an arrangement covered by paragraph (a) of the definition of arrangement between:

(i) the employer or an associate of the employer; and

(ii) the arranger or another person; or

(ea) a person other than the employer or an associate of the employer, if the employer or an associate of the employer:

(i) participates in or facilitates the provision or receipt of the benefit; or

(ii) participates in, facilitates or promotes a scheme or plan involving the provision of the benefit;

and the employer or associate knows, or ought reasonably to know, that the employer or associate is doing so;

in respect of the employment of the employee, but does not include:

(f) a payment of salary or wages or a payment that would be salary or wages if salary or wages included exempt income for the purposes of the Income Tax Assessment Act 1936; or

(g) a benefit that is an exempt benefit in relation to the year of tax; or…

…(n) a payment of an amount that, under any provision of the Income Tax Assessment Act 1936, is deemed to be a dividend paid to the recipient; or…

…(r) anything done in relation to a shareholder in a private company (as those terms are defined in section 6 of the Income Tax Assessment Act 1936), or an associate of such a shareholder, that causes (or will cause) the private company to be taken under Division 7A of Part III of that Act to pay the shareholder or associate a dividend; or…

Application of the law

As the payments made by the company to the individual because of a court order are paid in respect of the transfer of the individual's shareholding in the company, not as an employee, a former employee or as an associate of an employee in respect of an employment arrangement, those payments do not amount to the provision of a fringe benefit.

In addition, as the individual owns the property that will form part of the court order, there is no benefit provided by the company involving that property in respect of an employment arrangement with the individual.

Therefore, where company makes a payment during a year of income to an individual because of a court order made under section 79 of the FLA, to which the company is a party, the company has not provided a fringe benefit to the individual for the purposes of the FBTAA.