Edited version of private advice

Authorisation Number: 1012639258252

Ruling

Subject: Application of Division 7A

Question 1

Is The Trustee of The Trust an associate of Individual A and Individual B?

Answer

Yes

Question 2

Does section 109D or any other section of Division 7A of the ITAA 1936 apply to amounts loaned by The Company to The Trust prior to 30 June 20YY?

Answer

Yes

Question 3

Is it necessary for the Commissioner to exercise his discretion under sec 109RB of the ITAA 1936 to disregard any deemed dividends relating to loans made by The Company to The Trust prior to 30 June 20YY?

Answer

No

Question 4

Is it necessary for The Company to implement a rectification plan for amounts loaned to The Trust prior to 30 June 20YY?

Answer

No

This ruling applies for the following periods:

1 July 1999 to 30 June 2000

1 July 2000 to 30 June 2001

1 July 2001 to 30 June 2002

1 July 2002 to 30 June 2003

1 July 2003 to 30 June 2004

1 July 2004 to 30 June 2005

1 July 2005 to 30 June 2006

1 July 2006 to 30 June 2007

1 July 2007 to 30 June 2008

1 July 2008 to 30 June 2009

1 July 2009 to 30 June 2010

1 July 2010 to 30 June 2011

1 July 2011 to 30 June 2012

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

The scheme commences on:

1 July 1999

Relevant facts and circumstances

1. The Company is a proprietary limited company.

2. The balance sheet of The Company as at 30 June 20YY shows an amount owing from The Trust as an asset. The majority of this amount was loaned to The Trust prior to 30 June 20VV and relates to expenses paid by The Company on behalf of The Trust.

3. For the entire period since The Trust was settled, a self-managed super fund (The SMSF) has remained the sole unit holder of all the issued units of The Trust.

4. During the period 1 July 20WW to 30 June 20YY the trustee of the SMSF has not been under a legal disability.

5. Individual A and Individual B are the directors and the only members of The Company.

6. Individual A and Individual B are members of the SMSF and are directors of the trustee of the SMSF.

7. The trust distribution minutes for the years ended 30 June 20XX to 30 June 20ZZ show that 100% of the trust profit for The Trust is to be paid, applied or allocated for the benefit of the SMSF.

8. The Trust deed makes the unitholders presently and absolutely entitled to the net income of The Trust.

9. The Trust has not lodged any tax returns for the years ended 30 June 20XX through to 30 June 20YY.

10. The SMSF has lodged all their tax returns for the years ended 30 June 20XX through to 30 June 20YY and the four year amendment period for these returns have all expired.

Relevant legislative provisions

Division 6 of Part III, Income Tax Assessment Act 1936

Section 97, Income Tax Assessment Act 1936

Division 7A of Part III, Income Tax Assessment Act 1936

Section 103A, Income Tax Assessment Act 1936

Section 109D, Income Tax Assessment Act 1936

Section 109RB, Income Tax Assessment Act 1936

Subdivision D of Part III, Income Tax Assessment Act 1936

Section 109K, Income Tax Assessment Act 1936

Section 109L, Income Tax Assessment Act 1936

Section 109M, Income Tax Assessment Act 1936

Section 109N, Income Tax Assessment Act 1936

Section 109NA, Income Tax Assessment Act 1936

Section 109NB, Income Tax Assessment Act 1936

Section 170, Income Tax Assessment Act 1936

Subsection 318(6)(a), Income Tax Assessment Act 1936

Reasons for decision

Issue 1

Question 1

Summary

An associate of an individual is defined broadly to include a trustee of a trust where the individual benefits or is capable of benefiting either directly or indirectly from the trust. As the SMSF is the sole beneficiary of The Trust and Individual A and Individual B are both members of the SMSF they stand to benefit, or are capable of benefiting, from The Trust. As such The Trust is an associate of Individual A and Individual B.

Detailed reasoning

For the purpose of Division 7A of part III the ITAA 1936 an associate of a natural person (referred to as the primary entity) is defined in subsection 318(1)(d) of the ITAA 1936 as:

…. a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;

Subsection 318(6)(a) goes on to state that for the purposes of section 318:

…. a reference to an entity benefiting under a trust is a reference to the entity benefiting, or being capable (whether by the exercise of a power of appointment or otherwise) of benefiting, under the trust, either directly or through any interposed companies, partnerships or trusts ….

Individual A and Individual B are both members The SMSF which in turn is the sole unitholder and beneficiary of The Trust. As a result of this relationship Individual A and Individual B are capable of benefiting from The Trust. Thus The Trust is an associate of Individual A and Individual B.

Question 2

Summary

Broadly section 109D of the ITAA 1936 operates, with some exceptions, to treat a loan made to a shareholder or an associate of a shareholder of a private company during an income year, that has not been repaid by lodgement day (or for loans made before the 2004/05 financial year, that have not been repaid by the end of the current year), as a dividend.

As The Trust is an associate of Individual A and Individual B who are also the sole shareholders of The Company, any loans from The Company to The Trust could trigger the operation of section 109D. As at 30 June 20YY The Company has loaned The Trust various amounts, to which none of the exceptions to Section 109D of the ITAA 1936 apply. Section 109D of the ITAA 1936 would apply to loans made by The Company to The Trust to treat them as dividends paid by The Company to The Trust.

Detailed reasoning

Subsection 109D(1) of the ITAA 1936 provides that:

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 years prior to the 2004/05 financial year, by the end of the current year) 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

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

Private Company

Subsection 103A(1) of the ITAA 1936 defines a private company as a company which is not a public company. The meaning public company is found in the remainder of section 103A of the ITAA 1936. The Company does not fit the meaning of public company as set out in these provisions so it is therefore a private company.

The private company makes a loan to the entity during the current year

The Company has made several loans to The Trust for the years ended 1 July 20XX to 30 June 20YY.

The loan is not fully repaid by the specified time

The balance sheets for The Company show an outstanding loan balance to The Trust at the end of each year from 1 July 20XX to 30 June 20YY.

Application of Subdivision D of the ITAA 1936

Broadly, Subdivision D of the ITAA 1936 specifies that the following sorts of loans are not treated as dividends:

n loans to other companies (section 109K);

n loans that are otherwise assessable (section 109L);

n loans made in the ordinary course of business on ordinary commercial terms (section 109M);

n loans that meet criteria for minimum interest rate and maximum term (section 109N),

n certain loans and distributions by liquidators (section 109NA);

n loans that are for the purpose of funding the purchase of certain ESS interests under an employee share scheme (section 109NB).

There is nothing to indicate that any of the exceptions in Subdivision D of the ITAA 1936 apply to the loans made by The Company to The Trust. In particular the loans have not been placed on commercial terms nor do they meet the minimum criteria as specified in section 109N.

The entity is a shareholder or an associate of a shareholder of the private company when the loan is made

As considered above in question 1, The Trust is an associate of Individual A and Individual B who are shareholders of The Company.

Conclusion

As the conditions contained in subsection 109D(1) of the ITAA 1936 are satisfied with regard to the loans made by The Company to The Trust from 1 July 20XX to 30 June 20YY section 109D would apply.

Question 3

Summary

Any assessment, or amendment of an assessment, to include deemed dividends in the assessable income of The Trust would result in a flow on to the assessable income of The SMSF. As The SMSF has lodged its returns for the years ended 30 June 20XX to 20 June 20YY and the amendment period for these years has ended there are no practical taxation consequences to The Trust or The SMSF. Thus it is not necessary for the Commissioner to exercise his discretion in section 109RB of the ITAA 1936.

Detailed reasoning

Section 109RB of the ITAA 1936 provides the Commissioner with the discretion to disregard a dividend included under section 109D of the ITAA 1936 or allow that dividend to be franked. In order for it to be necessary for the Commissioner to exercise this discretion an amount must have been included, or be able to be included, in the assessable income of the entity who received the dividend.

Section 97 of the ITAA 1936 includes a share of the net income of a trust estate in the assessable income of a presently entitled beneficiary of that trust estate who is not under any legal disability. As such, any amount included in the net income of The Trust as a result of section 109D of the ITAA 1936 will automatically flow to and be included in the net income of The SMSF because:

n the trustee of The SMSF is, or was, not under a legal disability,

n the sole beneficiary of The Trust is The SMSF,

n the deed of The Trust makes the unitholders 'presently and absolutely entitled' to the net income of The Trust, and

n The Trust distribution minutes for the years ended 30 June 20XX to 30 June 20YY show that The SMSF has been allocated 100% of the Trust Profit in each year.

Broadly section 170 of the ITAA 1936 limits the period during which the Commissioner may amend an assessment. This period, with some exceptions, will usually be a two or four year period starting from the day after the day on which the Commissioner gives notice of the assessment to the entity.

You have told us that The SMSF has a four year period of review and that the period during which the Commissioner can amend The SMSF assessments for the years ended 30 June 20XX to 30 June 20YY has expired. Thus any assessment including deemed dividends in the net income of The Trust would not have any practical consequence to The SMSF, as any changes to the net income of The Trust can no longer be included in the assessment of The SMSF.

As there are no practical consequences to either The Trust or the SMSF for the years ended 30 June 20XX to 30 June 20YY it is not necessary for the Commissioner to apply his discretion in section 109RB of the ITAA 1936.

Question 4

Summary

As it is not necessary for the Commissioner to exercise his discretion in section 109RB of the ITAA 1936 it is not necessary for The Company or The Trust to implement a rectification plan at the direction of the Commissioner.

Detailed reasoning

Subsection 109 RB(4) of the ITAA 1936 allows the Commissioner, when exercising his discretion, to impose conditions namely:

(a) a condition that the recipient or another entity must make specified payment to the private company or another entity within a specified time;

(b) a condition that a specified requirement in this Division must be met within a specified time.

The conditions specified in subsection 109RB(4) are often referred to as corrective action or a rectification plan and form part of the matters considered by the Commissioner when exercising his discretion in section 109RB of the ITAA 1936.

In circumstances where the Commissioner is not exercising his discretion in section 109RB of the ITAA 1936 the ability to impose conditions as specified in subsection 109RB(4) would not be enlivened as such there would be no requirement for corrective action, or a rectification plan as a result of the exercise of the Commissioners discretion in section 109RB.

As the discretion in section 109RB is not being applied, subsection 109RB(4) imposing conditions relating to the exercise of the discretion are not enlivened. Because these conditions are not enlivened it is not necessary for The Company or The Trust to undertake any corrective action, including a rectification plan, at the direction of the Commissioner.