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Ruling

Subject: Shareholder loans

Question 1

In relation to the treatment of a loan made by a private company to a shareholder (that meets the criteria of section 109N of the Income Tax Assessment Act 1936 (ITAA 1936)) upon the death of that shareholder where the minimum loan repayments are not met in the 2011, 2012 and 2013 years, does failure to meet the minimum yearly payments result in a dividend being taken to have been paid under section 109E of the ITAA 1936 to the Executor of the Estate of the deceased shareholder?

Answer

No.

Question 2

In relation to the loan amount that was borrowed prior to late 1997 (not repaid as at the date of death of the shareholder) and forgiven by the private company in either 2012 or 2013 year, does the debt forgiveness result in a dividend being taken to have been paid under section 109F of the ITAA 1936 to the Executor of the Estate of the deceased shareholder?

Answer

No.

Question 3

In relation to the loan amount that was borrowed after late 1997 (not repaid as at the date of death of the shareholder) and forgiven by the private company in either 2012 or 2013 year, does the debt forgiveness result in a dividend being taken to have been paid under section 109F of the ITAA 1936 to the Executor of the Estate of the deceased shareholder?

Answer

Yes.

Question 4

Does the debt forgiveness result in assessable income to the Estate under any other provisions of the ITAA 1936 and/or ITAA 1997, such as the Commercial Debt Forgiveness provisions contained in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following periods:

1 July 2010 to 30 June 2013

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The company is an Australian resident private company. A shareholder in this company (the shareholder) passed away during the year ended 30 June 2011 and upon their death, their shareholding in the company passed to the Executors of their estate in accordance with their will.

The shareholder was also indebted to the company at the time of their death, of which an amount represented loans that were made from the company to the shareholder prior to late 1997. This amount has not changed from prior to late 1997 and no interest was charged on this loan which was used for private purposes.

The remaining amount represented loans made after late 1997.

These post late 1997 loans are subject to written loan agreements, which specify the benchmark interest rate as set out in the taxation law and do not exceed terms of 7 years. These loans therefore meet the requirements of section 109N of the ITAA 1936. These loans were used for private purposes and the company charged interest on these loans and returned the interest as income.

Prior to the shareholder's death, dividends were declared by the company and credited to the loan accounts on an annual basis to meet the minimum yearly payments in accordance with section 109E of the ITAA 1936.

The last loan repayments were made in the 2010 comprising principal and interest and were made in accordance with subsection 109E(5) of the ITAA 1936.

No loan repayments have been made by the executors of the shareholder's estate in respect of these loans in the 2011 and 2012 year and it is intended that no repayments will be made in the 2013 year.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 109E

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 section 109F

Income Tax Assessment Act 1936 section 109N

Income Tax Assessment Act 1936 section 109G

Income Tax Assessment Act 1997 section 245-10

Reasons for decision

Question 1

Subsection 109E(1) of the ITAA 1936 provides:

109 E(1) Amalgamated loan treated as a dividend in first year in which payment is less than minimum yearly repayment. A private company is taken to pay a dividend to an entity at the end of one of the private company's years of income (the current year) if:

(a) the private company made an amalgamated loan to the entity in an earlier year of income; and

(b) the amalgamated loan is not repaid at the end of the current year; and

(c) the amount (if any) paid to the private company during the current year in relation to the amalgamated loan falls short of the minimum yearly repayment of the amalgamated loan worked out under subsection (5) for the current year; and

(d) section 109Q does not apply in relation to the current year.

Note: The amalgamated loan does not give rise to a dividend for that year if the minimum yearly repayment is not made and the entity satisfies the Commissioner that treating the loan as a dividend would cause hardship. See section 109Q.

Under this provision if an entity makes payments in respect of the loan that are less than the minimum yearly repayment, a potential deemed dividend will arise equal to the difference between the minimum yearly repayment and the amount actually paid.

The entity to whom the private company is taken to have paid the dividend must be the same entity to whom the private company made the amalgamated loan.

In the circumstances of this case, for subsection 109E(1) of the ITAA 1936 to potentially apply, the private company would need to have made the loan to the executors of the deceased estate. However as the private company actually made the loan to the shareholder during his lifetime, the executors of the deceased estate are not treated as having received a deemed dividend in respect of the amalgamated loans if they do not make minimum yearly repayments in respect of the loans.

Question 2

Under the relevant limitations legislation the statutory period for a creditor to sue to recover a loan is six years. The Commissioner's view is that a loan by a private company to a shareholder or a shareholder's associate will be deemed to be a forgiven debt merely by the fact that the statutory period under the relevant Limitation Act ends.

Taking into account the limitation period the latest time that the limitation period for any loans borrowed by shareholders and/or their associates prior to late 1997 would be just prior to late 2003. This means that such loans would have become statute barred and technically forgiven no later than this time. In such circumstances, the company would have been taken to have paid a dividend arising under subsection 109F(1) of the ITAA 1936 no later than the income year ended 30 June 2004.

However Practice Statement Law Administration (General Administration) PS LA 2006/2 (GA) advised 'that the Commissioner has decided to take no active compliance action that would treat statute barred private company and trustee loans made prior to the enactment of Division 7A of the ITAA 1936 as giving rise to a deemed dividend under Division 7A'. This means that while the Commissioner acknowledges that loans made to shareholders and their associates prior to late1997 were deemed to have been forgiven when they became statute barred, it is intended that no further action is to take place in respect of these loans.

If a company formally writes off such a loan at a time after it has become statute barred, no further deeming of the loan as a dividend can take place, under subsection 109F(8) of the ITAA 1936.

Question 3

For the purposes of Division 7A of Part III of the ITAA 1936, an amalgamated loan is taken to have been made during an income year if a private company makes a constituent loan, or loans, to an entity during the income year which:

· are not fully repaid before the company's lodgment day for the year,

· would cause the company to be taken under section 109D of the ITAA 1936 to pay a dividend to the entity at the end of the year, apart from section 109N of the ITAA 1936, and

· have the same maximum term for the purposes of section 109N of the ITAA 1936 (subsection 109E(3) of the ITAA 1936).

Because the loan made by the private company to the shareholder satisfied the conditions in subsection 109E(3) of the ITAA 1936, it is taken to be an amalgamated loan for the purposes of Division 7A of Part III of the ITAA 1936.

Repayments made in respect of the loan are taken to be repayments made in relation to the amalgamated loan under subsection 109E(4) of the ITAA 1936.

Under subsection 109F(1) of the ITAA 1936 a private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either:

· the amount is forgiven when the entity is a shareholder in the private company, or an associate of such a shareholder; or

· a reasonable person would conclude (having regard to all the circumstances) that the amount is forgiven because the entity has been such a shareholder or associate at some time.

If a private company forgives an amount of debt resulting from a constituent loan taken into account in working out the amount of an amalgamated loan under subsection 109E(3) of the ITAA 1936, the private company is taken to forgive the same amount of debt resulting from the amalgamated loan (subsection 109F(7) of the ITAA 1936).

Under subsection 109F(2) of the ITAA 1936 the amount of the dividend is equal to the amount of debt forgiven, subject to the private company's distributable surplus as calculated under section 109Y of the ITAA 1936.

Following the Grant of Probate of the individual's will, the relevant probate legislation deems all real and personal property of the deceased (including title to the shares) to have passed to and become vested in the executor as from the death of the individual.

The deceased's property (including title to the shares) is held absolutely by the legal personal representative for the duration of the administration of the shareholder's estate (Official Receiver In Bankruptcy v. Schultz [1990] HCA 45; (1990) 170 CLR 306).

Following the Grant of Probate, the legal personal representative immediately assumes liability to pay the deceased's debts (including the debt owed by the deceased to the private company (the amalgamated loan)) (Certoma, GL 2010, The Law of Succession in New South Wales, 4th edn Thomson Reuters, Sydney, p. 304).

As the title to the shares in the private company passed to the shareholder's legal personal representative upon the death of the shareholder, the legal personal representative is the relevant shareholder for the purposes of paragraph 109F(1)(a) of the ITAA 1936.

By forgiving the debt owed by the legal personal representative shareholder, the private company would be taken to have paid a dividend the legal personal representative shareholder in the income year in which the forgiveness occurs.

Note: As the private company has not been taken in any income year to have paid a dividend to the shareholder because all minimum yearly repayments have been made, subsections 109G(3A) and (3B) would have no application. If applicable, these subsections would result in the amount of the dividend taken to have been paid under section 109F being reduced by the amount of dividends the private company is taken to have paid under section 109E at the end of earlier years of income in relation to the loan.

Question 4

For the Forgiveness of Commercial Debts provisions contained in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) to have any consequences in respect of a loan, the loan would have to satisfy the definition of 'commercial debt' as provided for in section 245-10 of the ITAA 1997, as set out below:

Section 245-10 Commercial debts

Subdivisions 245-C to 245-G apply to a debt of yours if:

(a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

(b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

(c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2)(a), (b) and (c)) that has the effect of preventing a deduction.

Note: Paragraphs 8-1(2)(a), (b) and (c) prevent deductions for capital, private or domestic outgoings and for outgoings relating to exempt income or non-assessable non-exempt income.

As the loans borrowed by the shareholder were used for private purposes the interest that was payable on them would not be deductible. Therefore the loans cannot be regarded as commercial debts and as a result the provisions of Division 245 of the ITTAA 1997 have no application.