Edited version of your written advice

Authorisation Number: 1012539978544

Ruling

Subject: Loans to Associated Entities

Question 1:

Would, as a result of the:

a. Loan from Company X to Company A;

b. the Application of the Funds by Company A;

there be an amount taken to be a dividend to Entity 3 pursuant to Division 7A of the Income Tax Assessment Act 1936 and included in their assessable income pursuant to section 44 of that Act?

Answer

No

This ruling applies for the following periods:

1 July 2011 - 30 June 2015

The scheme commences 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.

Background

Company X was one of several entities involved in a business founded by Entity 1 and Entity 2.

The directors of X are Entity 1 and Entity 2. Entity X has issued capital of a number of shares, some of which are held by Entity 1 and the remainder by Entity 2. Entity 1 and Entity 2 are associated with Entity 3.

Entity 1 and Entity 2 intend that the relevant Entity will ultimately benefit from their wealth.

Entity 1 and Entity 2 have decided to provide a share of capital to Company A.

The Company

Company A is incorporated. That entity has issued capital of ordinary shares owned jointly by Entity 1 and Entity 2.

The sole director of Company A is Entity 3.

The Loan to Company A

$ was advanced from Company X to Company A. The Loan Agreement states that the parties agree the Loan Principal is not repayable until called upon by Company X.

The Loan Principal is $ and no further amounts are intended to be advanced although there are provisions to do so in certain circumstances.

Under the Loan Agreement, Money Owing includes the Loan Principal and other amounts, including interest.

The Loan Principal was advanced interest free, except in certain circumstances unless a Default Event occurs, even then it may be discretionary.

Company X can issue an Interest Notice seeking interest or it can see repayment of the Loan Principal and all other Money Owing.

Interest can be payable from the Advance Date, which means the date upon which any part of the Loan Principal was first advanced to Company A. The Interest Period is from the Advance Date until Default Date determined by the Lender where appropriate.

The Application of the Funds

Company A

Company A applied the funds advanced to it to savings accounts and term deposits.

This is referred to in this ruling as the "Application of the Funds by Company A".

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Section 109B

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Section 109CA

Income Tax Assessment Act 1936 Section 109K

Income Tax Assessment Act 1936 Section 109N

Income Tax Assessment Act 1936 Section 109T

Income Tax Assessment Act 1936 Section 109Y

Income Tax Assessment Act 1936 Section 109Z

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Subsection 109D)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Both Company X and Company A are each a "company" within the meaning provided by subsection 6(1) of the ITAA 1936 and subsection 995-1(1) of Income Tax Assessment Act 1997 (ITAA 1997). Further, relevantly, Company X is a "private company" within the meaning of section 103A(1) of the ITAA 1936..

The application of Division 7A

Section 109B explains that Division 7A of the ITAA 1936 "treats 3 kinds of amounts as dividends paid by a private company: …" including, relevantly, "amounts lent by the company to a shareholder or shareholder's associate". That section also explains that "[t]his treatment makes the amounts assessable income of the shareholder or associate". Certain exceptions also exist.

In this instance, the proposed loan is a loan within the meaning of section 109D(3). At a minimum, it is both "an advance of money" and "a payment of an amount for … an entity," with "an express or implied obligation to repay the amount", within paragraphs (a) and (c) of that subsection.

Section 109D(1) of Division 7A relevantly provides that:

109D Loans treated as dividends

Loans treated as dividends in year of making

(1) 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 makes a loan to the entity during the current year; and

(b) the loan is not fully repaid before the lodgment day for the current year; and

(c) Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and

(d) either:

(i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or …

Some aspects of section 109D(1) of the ITAA 1936 are clearly satisfied. For instance, Company X, a private company, is to make a loan to Company A. However, it is not necessary to consider the requirements of section 109D in detail, as paragraph 109D(1)(c) of ITAA 1936 cannot be satisfied. The result of one of the requirements of section 109D(1) not being satisfied is that Company X is not taken to pay a dividend under that section.

Paragraph 109D(1)(c) recognises that Subdivision D may "prevent the private company from being taken to pay a dividend because of the loan". Subdivision D, entitled 'Payments and loans that are not treated as dividends', includes section 109K, which provides:

109K Inter-company payments and loans not treated as dividends

A private company is not taken under section 109C or 109D to pay a dividend because of a payment or loan the private company makes to another company.

Note: This does not apply to a payment or loan to a company in its capacity as trustee. (See section 109ZE.)

The loan is a loan that a private company, Company X, makes to another company, Company A. Section 109K of the ITAA 1936 will be satisfied unless an exclusion applies.

There is an exclusion to the exception provided by section 109K that needs to be considered. Subdivision E, which is entitled 'Payments and loans through interposed entities', contains section 109X. That provision relevantly provides that:

Despite sections 109K and 109L, a private company may be taken under section 109C or 109D to pay a dividend as a result of this Subdivision …

That provision, amongst other things, acknowledges that Subdivision E of the ITAA 1936 excludes the operation of section 109K. However, the exclusions do not apply in this instance.