Edited version of your private ruling

Authorisation Number: 1012496293695

Ruling

Subject: Division 7A - loans

Question and answer

Will the leasehold interest in land held by the trustee of an Investment Trust satisfy the requirements of subsection 109N(3)(a)(i) of the Income Tax Assessment Act 1936?

Yes.

This ruling applies for the following periods

1 July 2012 to 30 June 2015

Relevant facts and circumstances

Company 3 acts as trustee of the Trust, a discretionary trust.

The Trust is sole unit holder of the units in a unit trust, Trust 2.

The trustee of Trust 2 is the Company.

Trust 2 has been a granted long term leasehold interest in land (the ground lease).

The lessor in respect of the land is an entity that is related to Trust 2 (in that they share common control), however, the terms of the ground leases have been struck on an arm's length basis, with commercial rent being payable, supported by the advice of an independent expert.

The ground lease is set for a term longer than 100 years.

Under the terms of each of the ground leases, Trust 2 is empowered to undertake the redevelopment of the land.

Trust 2 has commenced doing so, demolishing the previous building on the land (which was in a quite dilapidated state) and is in the course of undertaking a significant new development.

The capital construction cost of this development is expected to be in the millions, which will obviously add significant value to the land and the leasehold interest in it held by Trust 2.

The intention of Trust 2 is to hold the leasehold interest long term and expects to derive significant annual rental from the improvements.

The funding of the development costs for this development is being provided by way of loan from a related company, Company 2 to the Trust.

The Trust then provides this funding as subscribed unit capital to Trust 2 to fund the capital expenditure that is being incurred by Trust 2 in respect of the improvements being constructed on the land.

Company 2 is a private company that has considerable cash reserves and a significant "distributable surplus" for the purposes of section 109Y of Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

The Trust, as the borrower, is an associate of a shareholder of Company 2 for the purposes of Division 7A. Accordingly, the loan from Company 2 to the Trust will be impacted on by Division 7A.

The Trust is seeking to ensure that the loan from Company 2 is put on terms that comply with Division 7A, such that a deemed dividend does not arise.

The loan funding provided to the Trust by Company 2 has ultimately been applied in the construction of significant and valuable capital Improvements to a long term leasehold interest held within Trust 2, a unit trust that is 100% owned by the Trust, the borrower.

The objective is to secure the value of the loan from Company 2 to the Trust by a registered mortgage ever the leasehold Interest held by Trust 2, with a view to making the loan compliant with the Division 7A requirements applicable to a 25 year loan.

You have confirmed with legal advisers and also with the relevant State's Lands Titles Office that a leasehold interest is able to be mortgaged and that such a mortgage is able to be registered in that state.

Relevant legislative provisions

Income Tax Assessment Act 1936 section109N

Income Tax Assessment Act 1936 subsection 109N(1)

Income Tax Assessment Act 1936 subsection 109N(3)

Income Tax Assessment Act 1936 subsection 109N(3)(a)(i)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not considered the application of Part IVA to the arrangement you asked us to rule on.

Reasons for decision

Section 109N of the Income Tax Assessment Act 1936 (ITAA 1936) sets out the conditions in which loans from a company to a shareholder or associate will not be deemed to be dividend paid to the entity.

Subsection 109N(1) of the ITAA 1936 sets out three conditions for the loans:

(a) The loan is made under a written agreement;

(b) The rate of interest payable on the loan for years of income after the year in which the loan is made equals or exceeds the benchmark interest rate for the year; and

(c) The term of the loan does not exceed the term (the maximum term) for that kind of loan worked out under subsection (3).

The maximum term of the loan is as per subsection 109N(3) of the ITAA 1936:

(a)   25 years for a loan if:

(i)   100% of the value of the loan is secured by a mortgage over real property that has been registered in accordance with a law of a State or Territory; and

(ii)   when the loan is first made, the market value of that real property (less the amounts of any other liabilities secured over the property in priority to the loan) is at least 110% of the amount of the loan; and

 

(b)   7 years for any other loan.

 

Paragraph 109(3)(a)(i) will not apply if 100% of the value of the loan is not secured by mortgage registered in accordance with a law of a State or Territory.

The words registered and accordance in sub-paragraph 109(3)(a)(i) of the ITAA 1936 are not defined and therefore adopt their ordinary meanings.

The Macquarie Dictionary, provides the following definitions in the relevant context:

 registered 1. recorded, as in a register or book;

- accordance 1. agreement; conformity.

 

The phrase, registered in accordance with a law of a State or Territory therefore literally means recorded in a register in conformity with a law of a State or Territory.

 Tax Laws Amendment (2009 Measures No. 4) Act 2009 at paragraph 5.6 it states the following;

Putting beyond any doubt that 'taxable Australian real property' in the context of Division 855 of the Income Tax Assessment Act 1997 (ITAA 1997), relating to the types of assets known as 'taxable Australian property' on which foreign residents pay capital gains tax (CGT), extends to a lease over land…

Although the above is in reference to capital gains tax (CGT), it is also relevant to subsection 109N(3)(a)(i) of the ITAA 1936. Division 7A of the Act was inserted by Taxation Laws Amendment Act (No. 3) 1998. The explanatory memorandum to Taxation Laws Amendment Bill (No. 3) 1998 does not indicate sub-paragraph 109N(3)(a)(i) of the ITAA 1936 should be read narrowly to restrict qualifying registration to cases under a deeds registration statute or Torrens statute of a State or Territory.

Application to your circumstances 

You advised you have confirmed with legal advisers and also with the relevant State's Lands Titles Office that a leasehold interest is able to be mortgaged and that such a mortgage is able to be registered in that state.

Therefore, the mortgage over leasehold property, registered with the relevant State's Lands Titles Office would satisfy the requirements of subsection 109N(3)(a)(i) of the ITAA 1936.