Edited version of your written advice

Authorisation Number: 1012663876419

Ruling

Subject: Division 7A

Question 1

Will section 109C in Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) deem the private company to have paid a dividend to the trustee of a trust established to provide loans to its employees where the private company makes a payment to the trustee of that trust?

Answer

No, insofar as the payment is made when; neither the trustee nor any of its associates are shareholders in the private company; and no reasonable person would conclude that the payment is made because the trustee or any of its associates was a shareholder in the private company at some earlier time.

Question 2

Will section 109D in Division 7A of the ITAA 1936 deem the private company to have paid a dividend where it:

• makes a payment to the trustee of a trust established to provide loans to its employees, and

• that trustee loans an amount to an employee of the private company?

Answer

No, insofar as the loan is made when; neither the employee nor any of their associates are shareholders in the private company; and no reasonable person would conclude that the loan is made because the employee or any of their associates was a shareholder in the private company at some earlier time.

This ruling applies for the following period:

Financial year ending 30 June 2015.

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.

1. The private company is a private company and a resident of Australia.

2. The private company wishes to establish an arrangement to provide share based benefits to its employees via a trust (herein referred to as the share trust).

3. The only entities that will benefit under the share trust are employees of the private company.

4. The private company will settle by way of a single lump sum payment of cash an amount of capital on the share trust for the benefit of its employees as a general class. This is called the cash contribution. No further contributions will be paid to the trustee of the share trust.

5. The trustee of the share trust will use the cash contribution to make loans to the employees of the private company. Employees of the private company will apply the loan funds from the trustee of the share trust to subscribe for units in the share trust.

6. Neither the trustee of the share trust, nor any of its associates, will be a shareholder in the private company when the private company pays the cash contribution.

7. No employee of the private company, nor the associate of any such employee, will be a shareholder in the private company when the private company pays the cash contribution.

8. The trustee of the share trust will not be a shareholder in the private company when that trustee makes loans to the employees of the private company.

9. No employee of the private company, nor the associate of any such employee, will be a shareholder in the private company when the trustee of the share trust makes loans to the employees of the private company.

10. The trustee of the share trust will apply the subscription monies received from the employees to acquire ordinary shares in the private company.

Assumptions

1. No reasonable person would conclude that the cash contribution payment to the trustee of the share trust is made because that trustee, an employee of the private company, or an associate of either was at some time a shareholder in the private company.

2. No reasonable person would conclude that the trustee of the share trust made an employee loan because the employee or their associate was at some time a shareholder in the private company.

Relevant legislative provisions

Division 7A of the ITAA 1936

Section 109C of the ITAA 1936

Section 109D of the ITAA 1936

Section 109T of the ITAA 1936

Section 109W of the ITAA 1936

Section 318 of the ITAA 1936

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the private company.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Division 7A

1. The purpose of Division 7A of the ITAA 1936 is to ensure private companies cannot make tax-free distributions of profits to shareholders (and their associates) in the form of payments or loans. It ensures amounts lent or paid are treated as dividends and are assessable income of the shareholder or associate.

Question 1

2. Section 109C of the ITAA 1936 deals with payments. It deems payments by a private company to a shareholder in the private company (and to the shareholder's associates) to be dividends.

3. Neither the trustee of the share trust, nor any of its associates, will be a shareholder in the private company when the cash contribution is paid. Consequently, section 109C of the ITAA 1936 will not apply to deem the payment of the cash contribution to be a dividend.

4. Elaborating on the above, when the private company pays the cash contribution, the associates of the trustee of the share trust will include:

• every employee of the private company, and

• the associates of every employee of the private company (including the trustees of any trust that an employee benefits under).

Employees of the private company are associates of the trustee of the share trust

5. Section 318 of the ITAA 1936 sets out the meaning of associates. The associates of a trustee include any entity that is capable (whether by the exercise of a power of appointment or otherwise) of benefiting under the trust.

6. The circumstances under which an entity is capable of benefitting under the trust are very broad. The Commissioner's view on this issue was explained in Taxation Ruling TR 1999/5, and this view is unchanged despite the withdrawal of that ruling. The Commissioner there expressed his view in the following terms:

13. The expression 'capable of' is not a technical term and will, therefore, take its ordinary meaning. Where a trust is established for the benefit of employees, on a literal construction, the fact that a person is an employee means that prima facie they fall within a class of persons who are 'capable of benefiting' under the trust.

…

16. It is considered that the expression 'capable of ... benefiting under the trust' is not limited to circumstances where a person is a present beneficiary. The use of the words 'whether by exercise of a power of appointment or otherwise' [emphasis added] clearly indicates that a person need not be an existing beneficiary under the trust.

17. It is considered that the power to issue units in a unit trust constitutes a power of appointment, as it creates beneficial interests in property.

18. Prima facie, an employee is 'capable ... of benefiting under the trust' if the employee is within a class, the members of which constitute the objects of a power of appointment.

7. Applying this view, every employee of the private company will be an associate of the trustee of the share trust. The share trust will be established for the benefit of the private company's employees as a general class. Therefore, all of the private company's employees will be capable of benefitting under the share trust.

Associates of employees are also associates of the trustee of the share trust.

8. The associates of the trustee of a trust include the associates of every natural person who benefits or is capable of benefitting under that trust.

9. The employees of the private company will be natural persons capable of benefitting under the share trust. Consequently, their associates will also be associates of the trustee of the share trust.

10. A natural person's associates include the trustees of trusts under which they benefit or are capable of benefitting. Therefore, a natural person employee of the private company will be an associate of the trustee of each trust under which they benefit or are capable of benefitting.

11. As a result, included amongst the associates of the trustee of the share trust will be the trustees of each other trust under which an employee of the private company is capable of benefitting.

Question 2

12. Section 109D of the ITAA 1936 deems amounts lent by a private company to a shareholder or shareholder's associate to be dividends. It may also apply where an amount is paid to an interposed entity as part of an arrangement to make a loan to a shareholder or shareholder's associate.

13. The private company and the trustee of the share trust will not make any loan to a shareholder in the private company or to the associate of such a shareholder. Consequently, section 109D of the ITAA 1936 will not apply.

14. As discussed in question one above, the associates of every natural person employee of the private company will also be associates of the trustee of the share trust. In any scenario where section 109C of the ITAA 1936 applies to the cash contribution by the private company to the trustee of the share trust, then section 109D of the ITAA 1936 will not apply to a subsequent and corresponding loan.