Edited version of your written advice

Authorisation Number: 1012540081334

Ruling

Subject: Loans to Associated Entities

Question 1:

Would, as a result of the:

a. Loan from Company X to Company B;

b. the Application of the Funds by Company B;

there be:

(i) an amount taken to be a dividend to Trust 3 pursuant to Division 7A of the Income Tax Assessment Act 1936; and,

(ii) as a consequence, an amount included in the 'net income' of the trust estate (of  Trust 3) within the meaning of section 95 as a result of 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 3. 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 4 and Entity 5.

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

Entity 1 and Entity 2 have decided to provide a share of capital to three companies, each of which is controlled by one of the entities.

The Company

Company A is incorporated. That entity has issued capital of ordinary shares:

a. a number of which is held by Entity 3; and,

b. with the remaining held by Trust 3.

The sole director of Company A is Entity 3.

Company 3, is trustee for Trust 3.

Company 3 is incorporated. The sole director and shareholder of Company 3 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

Question 1

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.

Subdivision E of the ITAA 1936 contains section 109T which provides that "This Division operates as if a private company makes a payment or loan to an entity" if certain conditions are met. The section is set out below:

109T Payments and loans by a private company to an entity through one or more interposed entities

(1) This Division operates as if a private company makes a payment or loan to an entity (the target entity) as described in section 109V or 109W if:

(a) the private company makes a payment or loan to another entity (the first interposed entity) that is interposed between the private company and the target entity; and

(b) a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment or loan solely or mainly as part of an arrangement involving a payment or loan to the target entity; and

(c) either:

(i) the first interposed entity makes a payment or loan to the target entity; or

(ii) another entity interposed between the private company and the target entity makes a payment or loan to the target entity.

This section operates regardless of certain factors

(2) For the purposes of this section, it does not matter:

(a) whether the interposed entity made the payment or loan to the target entity before, after or at the same time as the first interposed entity received the payment or loan from the private company; or

(b) whether or not the interposed entity paid or lent the target entity the same amount as the private company paid or lent the first interposed entity.

This section does not operate if the payment or loan to the first interposed entity is treated as a dividend

(3) This Division does not operate as described in subsection (1) (and sections 109V and 109W) if the private company is taken under Subdivision B (as it applies apart from this Subdivision) to pay a dividend as a result of the payment or loan to the first interposed entity.

The provision requires a private company to have made a payment or loan to another entity (the interposed entity) which has also made a payment or loan to another entity (the target entity). Here, although a loan is made from Company X to another entity, Company A, there is no other payment or loan to a target entity.

Rather, the loaned amounts are advanced to Company A and applied in accordance with the Application of the Funds by Company A. None of those involved a loan to Entity 3 within the meaning of subsection 109D(3) of the ITAA 1936. Likewise, none of those involved a payment within the meaning of subsection 109C(3) or section 109CA. Accordingly, section 109T and Subdivision E have no application.

Subsection 109C(3) of the ITAA 1936 relevantly provides that

In this Division, payment to an entity means:

(a) a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and

(b) a credit of an amount to the extent that it is:

(i) to the entity; or

(ii) on behalf of the entity; or

(iii) for the benefit of the entity; and

(c) a transfer of property to the entity.

And subsection 109CA(1) also relevantly provides that "In this Division, payment to an entity includes the provision of an asset for use by the entity."

The Application of Funds by Company A involved the depositing of amounts to bank accounts held in the name of that entity. Accordingly, there was no payment "to an entity" - that is, another entity. Nor was there a credit of an amount to, on behalf of, or for another entity, or a transfer of property to another entity. Likewise, there was no provision of an asset for use by another entity. As such, there was no 'payment' within the meaning of Division 7A.

Further, for the same reasons, there was no payment or loan within the meaning of section 109C of the ITAA 1936 or section 109D from Company A to Entity 3. Accordingly, Division 7A does not apply to deem an amount to be a dividend.