Edited version of your written advice

Authorisation Number: 1013003841177

Date of advice: 4 May 2016

Ruling

Subject: Division 7A and Foreign Hybrid Entities

Question 1

How is Australian sourced income derived by the U LLC treated for Australian tax law purposes?

Answer

Australian sourced income derived by the U LLC is treated for Australian tax law purposes as partnership income under Division 830 of the Income Tax Assessment Act 1997 (ITAA 1997)

When the income of the U LLC becomes Australian sourced;

a. The U LLC will continue to be treated for taxation purposes as a partnership or flow through entity.

b. The income will have an Australian source

c. 80% of the income (or the amount that represents the Australian Hybrid Unit Trust's portion) will be taxable as its share of Australian sourced income flowing from a partnership.

d. 20% of the income (or the amount that represents the foreign shareholders interest in the U LLC) will be Australian sourced income assessable in Australia to a non-resident.

Question 2

Does Division 7A apply to the loan from A Pty Ltd to the U LLC?

Answer

Yes. Division 7A will apply to the loan from A Pty Ltd to the U LLC.

The ITAA1936 Pt III Division 7A treats loans from a private company to a shareholder or an associate of a shareholder as deemed dividends unless conditions are satisfied for their exclusion. The client has indicated the intention is for the payment to be a loan.

Associate has the meaning from ITAA36 s 318. It includes entity associates of natural persons, companies, partnerships and trustees. The ruling applicant has informed The Commissioner that all parties or entities in the group are associates.

The loan satisfies the requirements of Division 7A. None of the exemptions are available.

Question 3

Does Division 7A apply to the loan from the Corporate Beneficiary to A Pty Ltd to the U LLC?

Answer

Yes. Division 7A will apply to the loan from the Corporate Beneficiary to A Pty Ltd to the U LLC.

The loan offshore to the U LLC is to a flow through partnership. For tax purposes we look to the partners as being the taxpayers for the transactions of the U LLC. All parties are associates as defined in s318 of the ITAA 1936.

A loan is made from the Australian Corporate Beneficiary Company Pty Ltd to A Pty Ltd (the Australian Holding Company) and a further loan is then made from A Pty Ltd to the U LLC.

Section 109T of the ITAA 1936 ensures Division 7A is not avoided by using interposed entities. It extends to loans as part of an arrangement involving a loan to another entity (the "target entity"). It operates as if the private company made the loan direct to the target entity.

On present facts:

• The loan by Australian Corporate Beneficiary Company Pty Ltd to A Pty Ltd; under section 109K of the ITAA 1936, as an inter-company loan, this loan is not treated as a dividend.

• The loan by A Pty Ltd to the U LLC; A Pty Ltd is taken to have paid a dividend to the U LLC capped at the company's distributable surplus.

• The notional loan taken to be made by Australian Corporate Beneficiary Company Pty Ltd to the U LLC; subsection 109T(1) of the ITAA 1936 is satisfied. There is an arrangement in which Australian Corporate Beneficiary Company Pty Ltd has made a payment to A Pty Ltd as part of an arrangement involving a loan to the U LLC.

Division 7A of the ITAA 1936 operates as if Australian Corporate Beneficiary Company Pty Ltd made a loan to the U LLC as described in section 109W(1) of the ITAA 1936.

This ruling applies for the following period:

1 July 2016 to 30 June 2019

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.

Group structure

1. FP LLC and IM LLC both trade in the foreign country and are owned by the U LLC, which in turn is owned 80% by Hybrid Unit Trust, an Australian entity and, 20% by H Plains LLC, a U entity owned by the foreign country citizens.

2. The Australian Hybrid Unit Trust controls 80% of the voting rights in U LLC and the U LLC is, other than for Division 830 of the ITAA 1997, a CFC for Australian tax purposes with an attribution percentage.

3. FP LLC markets products and IM LLC manufactures them.

4. IM LLC has a Permanent Establishment in the foreign country. FP LLC uses the premises of IM LLC to trade.

5. The unit holders in Australian Hybrid Unit Trust are B Unit Trust (BT) 80%, C Family Trust (CFT) 10%, and E Family Trust (EFT) 10%.

6. The Unit Holders of EFUT are E Family Trust, D Family Trust, and D Family Trust (all discretionary family trusts). The beneficiaries of these are family members plus a common corporate beneficiary for D and D Family Trusts. E Family Trust only has natural persons as beneficiaries.

7. The beneficiaries of CFT and EFT are family members. Each has a corporate trustee.

8. All parties are associates. They are either shareholders or associates of shareholders within the group structure.

9. The role of A Pty Ltd;

A Pty Ltd is the Australian head of the corporate group for all Australian trading entities. Hybrid Unit Trust is the Unit Trust that has an investment (80%) in the U LLC. A Pty Ltd has no investment in the foreign country entities. The shareholder of A Pty Ltd is AA Pty Ltd with shareholders being the respective family trusts mentioned earlier.

Scheme for the Commissioner to rule on

10. Increasingly marketing activities are being conducted from Australia for FP LLC, although contracts are finalised by FP LLC staff in the foreign country.

11. If the facts continue to evolve it could be that FP LLC's income will be Australian sourced.

12. The U LLC's have not elected to be treated as a company for the foreign country taxation purposes, instead are treated as a "flow through" entities.

13. FP LLC and IM LLC are growing entities in the foreign country and further investment is likely.

14. Funds are expected to flow from Hybrid Unit Trust to the following beneficiary's in proportion to their unit holdings;

a. 80% B Unit Trust

b. 10% C Family Trust

c. 10% E Family Trust

15. Then from B Unit Trust to B Trust, D Trust, and D Trust (the last 3 being discretionary family trusts) in proportion to their unit holdings and then to discretionary objects of B Trust, D Trust and D Trust.

16. C Family Trust would distribute to discretionary objects in accordance with its deed.

17. E Family Trust would distribute to discretionary objects in accordance with its deed.

18. In order to provide investment capital for the U LLC's in the future, profit distributions to the discretionary trusts in Australia would be further distributed to corporate beneficiaries for re-investment into the U LLC.

19. The Lender is proposed to be the corporate beneficiary (who is the end beneficiary) and the U LLC the borrower.

20. As another variant the corporate beneficiaries would loan funds to A Pty Ltd (the Australian business holding company) which would then lend the funds to the U LLC.

21. The following steps occur:

Step 1 A loan is made from the final Australian Corporate Beneficiary Company Pty Ltd to the Australian Holding Company A Pty Ltd and;

Step 2 A loan is then made from the Australian Holding Company A Pty Ltd to the U LLC.

22. The loans would be interest bearing at commercial rates.

23. There are no unpaid present entitlements from any of the trust distributions. Loans will be physically paid to the U LLC's.

24. A Pty Ltd (the Australian business holding company) which lends the funds to the U LLC has a distributable surplus.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-1,

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 6-10,

Income Tax Assessment Act 1997 Section 10-5,

Income Tax Assessment Act 1997 Section 830-1,

Income Tax Assessment Act 1997 Section 830-5,

Income Tax Assessment Act 1997 Section 830-15,

Income Tax Assessment Act 1997 Section 830-20,

Income Tax Assessment Act 1997 Section 830-25,

Income Tax Assessment Act 1997 Section 830-30,

Income Tax Assessment Act 1997 Section 830-45,

Income Tax Assessment Act 1936 Section 92,

Income Tax Assessment Act 1936 Section 109D,

Income Tax Assessment Act 1936 Section 109J,

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 109P,

Income Tax Assessment Act 1936 Section 109Q,

Income Tax Assessment Act 1936 Section 109T,

Income Tax Assessment Act 1936 Section 109V,

Income Tax Assessment Act 1936 Section 109W,

Income Tax Assessment Act 1936 Section 109X,

Income Tax Assessment Act 1936 Section 318,

Income Tax Assessment Act 1936 Section 340,

Income Tax Assessment Act 1936 Division 5,

Income Tax Assessment Act 1936 Part X,

International Tax Agreements Act 1953 Section 3AAA and

International Tax Agreements Act 1953 Section 3AAB.

Reasons for decision

Question 1

How is Australian sourced income derived by the U LLC treated for Australian tax law purposes?

Detailed reasoning

25. The U LLC satisfies subsection 830-15(1) of the ITAA 1997. It is a foreign hybrid company and will be treated as a partnership under section 830-20 of the ITAA 1997.

26. Australian Hybrid Unit Trust, being a member of the U LLC, is deemed to be a partner of the partnership under section 830-25 of the ITAA 1997 and will have an interest in the partnership net income equal to its entitlement to the profit of the LLC under section 830-30 of the ITAA 1997. Thus Hybrid Unit Trust must include as assessable income its share of the LLC's net partnership income.

27. This will be Australian sourced partnership income it will declare in its Australian tax return.

28. The income may flow via the U LLC but this flow through entity does not change the income from having an Australian source. It does however change the nature of the income. Now, instead of being trading income derived directly by the Hybrid Unit Trust, it will be assessable as a share of a partnership income.

29. The 20% foreign country shareholder of the U LLC will also lodge an income tax return in Australia. Its Australian income tax return will include its share of partnership income. It will be subject to the payment of tax in Australia as a foreign resident deriving Australian sourced partnership income.

30. Under the ITAA 1997 assessable income consists of ordinary income and statutory income paragraph 6-1(1). The income derived will be Australian sourced statutory income.

31. Hybrid Unit Trust is an Australian resident trust. If you are an Australian resident your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year; ITAA 1997 6-5(2).

32. The 20 % the foreign country shareholder of the U LLC is a foreign resident. As a foreign resident, their assessable income includes:

a. the ordinary income derived directly or indirectly from all Australian sources during the income year; and

b. other ordinary income that a provision includes in assessable income for the income year on some basis other than having an Australian source. ITAA 1997 6-5(3)

33. Assessable income also includes statutory income under paragraph 6-10 of the ITAA 1997. This is included in your assessable income by provisions about assessable income (making them be called statutory income).

34. Hybrid Unit Trust is an Australian resident trust. As an Australian resident its assessable income includes statutory income from all sources, whether in or out of Australia, paragraph; 6-10(4) of the ITAA 1997.

35. The 20 % the foreign country shareholder of the U LLC is a foreign resident. Under paragraph 6-10(5) of the ITAA 1997 if you are a foreign resident your assessable income includes:

(a) your statutory income from all Australian sources; and

(b) other statutory income that a provision includes in your assessable income on some basis other than having an Australian source.

36. Section 10-5 of the ITAA 1997 contains a table list of provisions about assessable income.

37. The provisions operate to include in a taxpayers assessable income amounts that are not ordinary income but are included by way of provisions of the ITAA 1997 as well as provisions of the Income Tax Assessment Act 1936 (ITAA 1936).

38. The table includes in a taxpayers assessable income a partners share in the net income of a partnership under subsection 92(1) of the ITAA 1936.

39. Subsection 92(1) of the ITAA 1936 provides as follows: The assessable income of a partner in a partnership shall include:

(a) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident; and

(b) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was not a resident and is also attributable to sources in Australia.

40. Subsection 92(1)(a) of the ITAA 1936 is applicable to the Hybrid Unit Trust. It will be assessable on its 80% interest in the net income of the partnership attributable to the period when it is a resident.

41. Subsection 92(1)(b) of the ITAA 1936 is applicable to the 20% the foreign country partner. It will be assessable on its 20% interest in the net income of the partnership attributable to sources in Australia even though it is not a resident.

42. Subsection 92(2) of the ITAA 1936 outlines how partnership losses incurred by a partnership in a year of income are allowable as a deduction to a partner in the partnership however these are subject to section 830-45 of the ITAA 1997.

Foreign Hybrid Provisions

43. The ITAA 1997 has been amended to treat foreign hybrids as partnerships for purposes of Australian income tax law; section 830-1 of the ITAA 1997.

44. These entities would otherwise be treated as flow-through entities for the purposes of foreign tax, but treated as companies for Australian income tax purposes.

45. Australian Taxpayers are therefore treated as having a partnership interest where they have an interest in a foreign hybrid.

46. The expression 'foreign hybrid' is defined in section 830-5 of the ITAA 1997 to mean a foreign hybrid limited partnership or a foreign hybrid company and includes the foreign country limited liability companies taxed on a partnership basis in their home country; subsection 830-15 of the ITAA1997.

47. Subsection 830-15(1) of the ITAA 1997 sets out the requirements for a foreign hybrid company: A company is a foreign hybrid company in relation to an income year if:

(a) at all times during the income year when the company is in existence, the partnership treatment requirements for the income year in subsection (2) or (3) are satisfied; and

(b)  at no time during the income year is the company, for the purposes of a law of any foreign country that imposes *foreign income tax on entities because they are residents of the foreign country, a resident of that country; and

(c)  at no time during the income year is the company an Australian resident; and

(d)  disregarding this Division, in relation to the same income year of another taxpayer:

(i)  the company is a *CFC at the end of a *statutory accounting period that ends in the income year; and

(ii)  at the end of the statutory accounting period, the taxpayer is an *attributable taxpayer in relation to the CFC with an *attribution percentage greater than nil.

* denotes a term defined in section 995-1 of the ITAA 1997.

48. The U LLC satisfies the requirements in subsection 830-15(1) of the ITAA 1997 and is therefore regarded as a foreign hybrid company. Paragraph 830-15(1)(a) of the ITAA 1997 is satisfied because subsection 830-15(2) of the ITAA 1997 is satisfied. Subsection 830-15(2) requires that a company, being a LLC formed in the foreign country, be treated as a partnership for the foreign country tax purposes. The LLC in this case was formed in the foreign country and has elected to be treated as a partnership for the foreign country tax purposes.

49. Paragraph 830-15(1)(b) of the ITAA 1997 is satisfied because the LLC is not treated as a resident for the purposes of the tax laws of any foreign country.

50. Paragraph 830-15(1)(c) of the ITAA 1997 is satisfied because the LLC is not an Australian resident at any time during the income year.

51. Paragraph 830-15(1)(d) of the ITAA 1997 is satisfied because the LLC is (disregarding this division) a Controlled Foreign Company (CFC) and the taxpayer is an attributable taxpayer of the LLC under Part X of the ITAA 1936 with an attributable percentage. The LLC is a CFC under section 340 of the ITAA 1936.

52. Having satisfied subsection 830-15(1) of the ITAA 1997, the LLC is a foreign hybrid company and will be treated as a partnership under section 830-20 of the ITAA 1997.

53. Section 830-20 of the ITAA 1997 provides that if a company is a foreign hybrid company in relation to an income year it is treated as a partnership for the purposes of Australian income tax law. The partners in the partnership are the shareholders in the company (section 830-25 of the ITAA 1997).

54. The taxpayer, being a member of the U LLC, is deemed to be a partner of the partnership (section 830-25 of the ITAA 1997) and will have an interest in the partnership's net income equal to its entitlement to the profit of the LLC (section 830-30 of the ITAA 1997). Thus the taxpayer must include as assessable income its share of the LLC's net partnership income. The relevant share is determined by the percentage of the taxpayer's entitlement to the LLC's profit (section 830-30 of the ITAA 1997).

55. Hybrid Unit Trust, an Australian taxpayer, is a member of the U LLC and controls 80% of the voting rights in the U LLC.

56. As a result of the foreign hybrid company being treated for taxation purposes as a partnership "flow-through" taxation treatment of Partnerships under Division 5 of the ITAA 1936 applies. Tax is levied directly on the partner themselves. The foreign hybrid company is not treated as a CFC.

The effect of the foreign country convention

57. In determining the liability of an Australian resident to Australian tax on international transactions, it is necessary to also consider the applicable tax treaty or other agreement defined in section 3AAA or 3AAB of the International Tax Agreements Act 1953. The relevant agreement in this case is the Convention between the Government of Australia and the Government of the Foreign Country for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income ATS 16 (the foreign country convention).

58. The foreign country convention will not affect the outcomes in this case. As U LLC is fiscally transparent in the foreign country, any foreign country income tax is imposed at the level of the members of U LLC. A fiscally transparent entity is an entity that is taxed on a look-through basis, such that the participants in the entity are liable to tax on the income or profit derived by the entity, rather than the entity itself.

59. Since U LLC qualifies as a foreign hybrid company under Division 830 of the ITAA 1997, the Australian resident members of U LLC are treated as partners in a partnership under Australian income tax law.

60. The income received by U LLC is treated for Australian (and the foreign country) tax law purposes as Australian sourced income of Australian residents (being the members of U LLC), and the foreign country convention does not disturb Australia's taxing right.

Question 2

Does Division 7A apply to the loan from A Pty Ltd to the U LLC?

Detailed reasoning

61. The ITAA1936 Pt III Division 7A (s109B to 109ZE) treats loans from a private company to a shareholder or an associate of a shareholder as deemed dividends unless conditions are satisfied for their exclusion. Division 7A applies where the recipient of the loan is a shareholder or an associate of a shareholder.

62. Under subsection 109D(3) a loan includes: an advance of money, a provision of credit or any form of financial accommodation, a payment of an amount for another entity if there is an obligation to repay the amount and a transaction which in substance effects a loan of money.

63. Information provided in the ruling application indicates the payment to the U LLC will be a loan. The client has indicated the intention is for the payment to be a loan.

Is the loan to a Shareholder or Associate?

64. Under section 109D of the ITAA 1936 a loan that may be treated as a dividend includes a loan to a shareholder of the private company or to an associate of a shareholder of the private company when the loan is made, sub section 109D(1)(d).

65. Associate has the meaning from ITAA36 s318. It includes entity associates of natural persons, companies, partnerships and trustees.

66. A Pty Ltd is the Australian head of the corporate group for all Australian trading entities.

67. To determine who associates are for Division 7A purposes it is necessary to identify the shareholders of A Pty Ltd. The shareholder of A Pty Ltd is AA PL with shareholders being the respective family trusts.

68. The lender in Australia will be A Pty Ltd lending to the U LLC as borrower.

69. U LLC is 80% owned by the Australian Hybrid Unit Trust.

70. As previously established the borrower U LLC is treated as a Partnership for Australian tax law purposes.

71. As a partner in the partnership, Hybrid Trust is an associate of the partnership under ITAA 1936 sub section 318(4)(a) where associates of a partnership include a partner in the partnership.

72. As the loan offshore to the U LLC is a loan to a flow through partnership entity for tax purposes we look to the partners as being the taxpayers for transactions of the U LLC.

73. Prior to funds being sent offshore to the U LLC, beneficiaries have received distributions from the trusts. Under ITAA 1936 sub section 318(3)(a) associates of a trustee include any entity that benefits under the trust.

74. Sub section 318(6) provides the interpretation for this section:

(a) a reference to an entity benefiting under a trust is a reference to the entity benefiting, or being capable of benefiting, under the trust, either directly or through any interposed companies, partnerships or trusts; and

(b) a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); and

(c) an entity or entities hold a majority voting interest in a company if the entity or entities are in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be cast at a general meeting of the company.

75. As the Shareholders of the lending Company (A Pty Ltd) and the discretionary trusts are all part of the same group the ruling applicant was informed the Commissioner will need the trust deeds to determine who the beneficiaries are.

76. Further, to determine if an associate relationship exists, the Commissioner may have required the trust deeds for the Hybrid Trust.

77. We informed the ruling applicant we needed this information to determine if U LLC is either a shareholder or associate of a shareholder of the A Pty Ltd to determine if Division 7A applies.

78. Application of the provisions to establish the recipient of the loan is a shareholder or an associate of a shareholder is not required for this ruling. The ruling applicant, having been made aware of section 318 of the ITAA 1936, has informed The Commissioner for inclusion in the facts that all parties or entities in the group are associates as defined in s318 of the ITAA 1936.

79. This assisted in addressing the Division 7A shareholder associate sections of the ruling application as an alternative to providing trust deeds and company documents.

80. As all entities in the group are associates Division 7A will apply to the loan from A Pty Ltd to the U LLC.

Does any exclusion apply?

81. Some situations where loans are not treated as dividends under Division 7A include;

• a payment of a legitimate debt under s 109J

• a payment or loan to from one private company to another company, s109K

• a payment or loan otherwise included in the entity's assessable income or specifically excluded from assessable income under s109L

• a loan made in the ordinary course of business on the ordinary commercial terms which the private company makes loans to parties at arms-length basis, s109M

• amalgamated loans, under s109P or s109Q

82. A U LLC can elect to be treated as a company for the foreign country tax law purposes instead of being treated as a "flow through" entity or partnership. Had the U LLC made such an election to be considered a company then the loan to from one private company to another may have been exempt under s109K. This does not have to be determined as the status of these U LLCs for the foreign country tax law purposes is confirmed by the ruling applicant as an entity disregarded as being separate from its owners i.e. they have not elected to be treated as taxable entities but to remain as "flow through" entities. For this reason they are considered a partnership for Australian tax law and not a company. The exemption under s109K for a loan to from one private company to another company is therefore not available.

83. The ruling applicant has said "The loans would be interest bearing at commercial rates." Had the Australian private companies making the loans done so in the ordinary course of the private company's business the exemption in s109M may have applied. However as lending money is not the ordinary course of the private company's business no exemption under this sub-section is available.

84. None of the exemptions are available.

Does Division 7A apply to the loan?

85. None of the exemptions are available and the loan satisfies the requirements of Division 7A. The loan will be subject to Division 7A.

Question 3

Does Division 7A apply to the loan from the Corporate Beneficiary to A Pty Ltd to U LLC?

86. This extends the proposition in Question 2. Many of the legislative provisions referenced in question 2 although not all repeated here are relevant to question 3.

87. To aid understanding 'the Corporate Beneficiary' is referred to as 'Australian Corporate Beneficiary Company Pty Ltd'. This is a yet to be incorporated entity. The term is used to aid understanding of the type of entity being referred to.

88. As previously established in question 2;

a. The ITAA1936 Pt III Division 7A deems loans from a private company to a shareholder or their associate as dividends.

b. The client has indicated the intention for this to be a loan.

Detailed reasoning

Is the loan to a Shareholder or Associate?

89. Associate has the meaning from ITAA 1936 s318. It includes entity associates of natural persons, companies, partnerships and trustees.

90. A Pty Ltd is the Australian head of the corporate group.

91. The intermediary lender in Australia will be A Pty Ltd lending to the U LLC as borrower.

92. To determine associates for Division 7A purposes the shareholders of the lender A Pty Ltd need to be identified.

93. The shareholder of A Pty Ltd is AA Pty Ltd with shareholders being the respective family trusts.

94. U LLC is 80% owned by Hybrid Unit Trust.

95. U LLC is treated as a partnership for Australian tax law purposes. As a partner in the partnership, Australian Hybrid Trust is an associate of the U LLC partnership under ITAA 1936 sub section 318(4)(a).

96. The loan offshore to U LLC is to a flow through partnership. For tax purposes we look to the partners as being the taxpayers for transactions of U LLC.

97. Prior to funds being sent offshore to U LLC a chain of distributions occur. Funds flow from Hybrid Unit Trust to the following beneficiary's in proportion to their unit holdings;

• 80% to the B Unit Trust

• 10% to the C Family Trust

• 10% to the E Family Trust

98. From B Unit Trust funds flow to B Trust, D Trust, and D Trust (the last 3 being discretionary family trusts) in proportion to their unit holdings and then to the discretionary objects of those trusts (E Family Trust, D Trust, and D Trust).

99. C Family Trust and E Family Trust distribute to discretionary objects in accordance with their deeds.

100. In order to provide investment capital for the U LLC's in the future, profit distributions to the discretionary trusts in Australia will be further distributed to a corporate beneficiary for re-investment into the U LLC

101. The following steps occur in this process:

Step 1 A loan is made from the final Australian Corporate Beneficiary Company Pty Ltd to the Australian Holding Company A Pty Ltd and;

Step 2 A loan is then made from the Australian Holding Company A Pty Ltd to the U LLC

102. The Australian Corporate Beneficiary Company Pty Ltd who receives distributions from the Trust is an associate of the Trust under ITAA 1936 sub section 318(3)(a) where associates of a trustee include any entity that benefits under the trust. Sub section 318(6) provides the interpretation for this section:

(a) a reference to an entity benefiting under a trust is a reference to the entity benefiting, or being capable of benefiting, under the trust, either directly or through any interposed companies, partnerships or trusts;

103. Shareholders of the (as yet unincorporated) Australian Corporate Beneficiary Pty Ltd are likely to be the discretionary trusts. To determine if an associate relationship exists, the Commissioner informed the ruling applicant he would need to provide the trust deeds for the Australian Hybrid Trust and the discretionary trusts, company details for the entity not yet incorporated (the Australian Corporate Beneficiary Pty Ltd Company) and shareholder details for A Pty Ltd.

104. We informed the ruling applicant we needed this information to determine if the loan recipient (U LLC) is either a shareholder or associate of a shareholder of A Pty Ltd and if A Pty Ltd is either a shareholder or associate of a shareholder of the Australian Corporate Beneficiary Pty Ltd company in order to determine if Division 7A applies.

105. The ruling applicant was made aware of section 318 of the ITAA 1936 (meaning of associate). As an alternative to providing trust deeds and company documents (including details for the entity not yet incorporated) the ruling applicant informed us, for inclusion in the facts, that all the parties are associates as defined in s318 of the ITAA 1936. Application of the legislative provisions by the Commissioner to establish the recipients of the loans as shareholders or associates of shareholders is therefore not required for this ruling.

106. The Shareholders of the lending companies both (Australian Corporate Beneficiary Company Pty Ltd and A Pty Ltd) and the trusts are all part of the same group. They are associates for the purposes of this ruling, for the reasons provided by the applicant and detailed above.

Division 7A and interposed entities

107. Special rules ensure that Division 7A is not avoided by using interposed entities. The provisions apply if an entity is interposed between the private company and the target entity: ITAA 1936 s109T(1).

108. This extends the operation of Division 7A to loans made by a private company to an interposed entity where a reasonable person would conclude the payment or loan was made solely or mainly as part of an arrangement involving a payment or loan to another entity (the "target entity"). The private company can be treated as having made the loan directly to the target entity.

109. In a situation where;

• Australian Corporate Beneficiary Company Pty Ltd has significant cash reserves and a distributable surplus

• A Pty Ltd has no distributable surplus.

• Australian Corporate Beneficiary Company Pty Ltd loans an amount to A Pty Ltd

• A Pty Ltd loans an amount to the U LLC; and

• Division 7A would otherwise apply to the loan, for example no repayments of the loan have been made by the U LLC before the private company's lodgment day for the relevant year of income.

110. In this case section 109T of the ITAA 1936 can operate to treat the Australian Corporate Beneficiary Company Pty Ltd as having made a payment or loan to a shareholder or an associate of a shareholder (the target entity). It can apply where the interposed entity (A Pty Ltd) is also a shareholder or associate of the private company provided the conditions in subsection 109T(1) of the ITAA 1936 are satisfied.

111. Subdivision E of Division 7A of the ITAA 1936 allows a private company to be taken under Subdivision B of the ITAA 1936 to pay a dividend to a shareholder or an associate of a shareholder (the target entity) if an entity interposed between the private company and the target entity makes a payment or loan to the target entity under an arrangement involving the private company.

112. If the conditions in subsection 109T(1) of the ITAA 1936 are satisfied then, subject to subsection 109T(3) of the ITAA 1936, Division 7A of the ITAA 1936 operates as if the private company made the payment or loan direct to the target entity. Section 109T of the ITAA 1936 relevantly provides:

109T(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.

109T(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.

109T(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.

113. Section 109V, subsection 109W(1) and sub-subsection 109X(1)(a) of the ITAA 1936 are also relevant and can apply in circumstances where the amount paid by the private company is via an interposed entity. These provisions provide:

Section 109V - Amount of private company's payment to target entity through one or more interposed entities

109V(1) Private company taken to pay if target entity is paid.

If the target entity is paid an amount by the interposed entity, this Division operates as if the private company had paid the amount (if any) determined by the Commissioner to the target entity when the interposed entity paid the target entity.

109V(2) Determining the amount of the private company's payment.

In determining the amount of the payment the private company is taken to have made, the Commissioner must take account of:

(a) the amount the interposed entity paid the target entity; and

(b) …

109W(1)  Private company taken to lend if target entity receives loan.  

If the target entity is lent an amount by the interposed entity, this Division operates as if the private company had made a loan (the notional loan) of the amount (if any) determined by the Commissioner to the target entity when the interposed entity made the loan to the target entity.

109X(1) 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 treating the private company as making a payment or loan to an entity (the target entity ), even if:

(a) the private company is treated that way because it makes a payment or loan to an entity that is a company interposed between the private company and the target entity; or

(b)….

114. On present facts the Commissioner is asked to rule upon the operation of Division 7A of the ITAA 1936 is considered in respect of:

1. The loan by Australian Corporate Beneficiary Company Pty Ltd to A Pty Ltd

2. The loan by A Pty Ltd to the U LLC; and

3. Any notional loan taken to be made by Australian Corporate Beneficiary Company Pty Ltd to the U LLC.

The loan made by Australian Corporate Beneficiary Company Pty Ltd to A Pty Ltd

115. Due to the operation of section 109K of the ITAA 1936 the inter-company loan is not treated as a dividend. 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.

The loan made by A Pty Ltd to the U LLC

116. A Pty Ltd is taken to have paid a dividend to the U LLC under section 109D of the ITAA 1936, where the loan is not fully repaid before the lodgement day for the current year, but the amount of the dividend is capped at the company's distributable surplus.

117. If the amount of distributable surplus is $nil the amount of the dividend that A Pty Ltd is taken to have paid to the U LLC is $nil.

The notional loan taken to be made by Australian Corporate Beneficiary Company Pty Ltd to the U LLC

118. On the present facts subsection 109T(1) of the ITAA 1936 is satisfied. There is an arrangement in which Australian Corporate Beneficiary Company Pty Ltd has made a payment to A Pty Ltd as part of an arrangement involving a loan to the U LLC.

119. As subsection 109T(3) of the ITAA 1936 has no application, Division 7A of the ITAA 1936 can operate as if Australian Corporate Beneficiary Company Pty Ltd made a loan to the U LLC as described in section 109W(1) of the ITAA 1936.

120. All entities in the group are associates. Division 7A will apply to the loan.

ATO view documents

ATO ID 2006/18

ATO ID 2011/104

ATO ID 2012/70

Other references (non ATO view)

Convention between the Government of Australia and the Government of the Foreign Country for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income ATS 16 (the foreign country convention).