Edited version of your written advice

Authorisation Number: 1013134448733

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This edited version has been found to be misleading or incorrect. It does not represent the ATO’s view of the relevant law.

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Date of advice: 2 December 2016

Ruling

Subject: Division 7A of Part III of the Income Tax Assessment Act 1936

Question 1

Will section 109XA and 109XB of the Income Tax Assessment Act 1936 (ITAA 1936) operate to treat the loan from Trust 1 to Trust 2 as a dividend?

Answer

No

Question 2

Will Division 7A of Part III of the ITAA 1936 apply to treat the payment by the Company to Trust 2 as a dividend under section 109C?

Answer

No

Question 3

Will Part IVA of the ITAA 1936 apply to the scheme?

Answer

No

This ruling applies for the following period:

Income year ending 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Family A has an existing group of trusts and companies

Family A received capital proceeds

Family A settled the capital proceeds in Trust 1

Trust 1 owns all shares in the Company

Family A establish Trust 2

The Company will be the sole beneficiary of Trust 2

Trust 1 will loan funds to Trust 2

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Section 109J

Income Tax Assessment Act 1936 Section 109XA

Income Tax Assessment Act 1936 Section 109XB

Income Tax Assessment Act 1936 Section 109XI

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177CB and

Income Tax Assessment Act 1936 Section 318

Reasons for decision

Question 1

Detailed reasoning

Subsection 109XA(2) of the ITAA 1936 provides that section 109XB of the ITAA 1936 will apply if:

(a) a trustee makes a loan (including a loan through an interposed entity as described in section 109XG) to a shareholder or an associate of a shareholder of a private company (except a shareholder or associate that is a company) (the actual transaction); and

(b) either:

(i) the company is presently entitled to an amount from the net income of the trust estate at the time the actual transaction takes place, and the whole of that amount has not been paid to the company before the earlier of the due date for lodgment and the date of lodgment of the trustee's return of income for the trust for the year of income of the trust in which the actual transaction takes place; or

(ii) the company becomes presently entitled to an amount from the net income of the trust estate after the actual transaction takes place, but before the earlier of the due date for lodgment and the date of lodgment of the trustee's return of income for the trust for the year of income of the trust in which the actual transaction takes place, and the whole of the amount has not been paid to the company before the earlier of those dates.

Subsection 109XB(1) of the ITAA 1936 states that:

(1) An amount is included, as if it were a dividend paid by the company at the end of the year of income of the company in which the actual transaction took place, in the assessable income of the shareholder or associate referred to in subsection 109XA(1), (2) or (3) if:

(a) had the actual transaction been done by a private company (the notional company ); and

(b) had the shareholder or associate been a shareholder of the notional company at the time the actual transaction took place;

an amount (the Division 7A amount ) would have been included in the shareholder's or associate's assessable income because of a provision of this Division outside this Subdivision.

Subsection 109XI (1) of the ITAA 1936 states

(1) For the purposes of paragraphs 109XA(1)(c), (2)(b) and (3)(b), a private company is taken to be or to become entitled to an amount from the net income of a trust estate (the target trust ) if:

(a) the company is or becomes presently entitled to an amount from the net income of another trust estate (the first interposed trust ) that is interposed between the target trust and the company; and

(b) a reasonable person would conclude (having regard to all the circumstances) that the company is or becomes so entitled solely or mainly as part of an arrangement involving an entitlement to an amount from the target trust; and

(c) either:

(i) the first interposed trust is or becomes presently entitled to an amount from the net income of the target trust; or

(ii) another trust interposed between the target trust and the company is or becomes presently entitled to an amount from the net income of the target trust.

Trust 1 proposes to make a loan to Trust 2. Trust 1 is the sole shareholder of the Company, which will be the sole beneficiary of Trust 2. Trust 2 and Trust 1 will be associates as defined in section 318 of the ITAA 1936 (section 109ZD of the ITAA 1936).

Sections 109XA and 109XB of the ITAA 1936 will only apply to treat the proposed loan as a dividend if the Company has a direct or indirect present entitlement to the net income of Trust 1. Trust 1 has not conferred present entitlement to trust income on any company or trust. If a company is made presently entitled to the net income of Trust 1 (directly or indirectly), the present entitlement will be paid prior to the tax return lodgement date for the trust (as required by paragraph 109XA(b)(ii)).

As there is no present entitlement to the net income of Trust 1, the requirements of section 109XA of the ITAA 1936 are not satisfied and 109XB of the ITAA 1936 will not apply to treat the loan as a dividend.

Question 2

Detailed reasoning

Subsection 109C(1) of the ITAA 1936 provides:

(1) A private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or

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

The Company will make a payment to Trust 2. The payment will be a payment to an associate of a shareholder for the purposes of section 109C of the ITAA 1936.

Section 109J of the ITAA 1936 states that:

A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment:

(a) discharges an obligation of the private company to pay money to the entity; and

(b) is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length.

The term 'obligation' is not defined for the purposes of section 109J of the ITAA 1936 and therefore adopts its ordinary meaning. The Macquarie Dictionary 2003 rev. 3rd edn, The Macquarie Library Pty Ltd, NSW defines 'obligation' as follows:

a binding requirement as to action; the binding power or force of a promise, law, duty, agreement, etc. ; a binding promise or the like.

The Company will be under an obligation to make the payment to Trust 2.

The payment will be a discharge of an obligation for the purposes of paragraph 109J(a) of the ITAA 1936.

Paragraph 109J(b) requires that the amount of the discharge be no more than would have been required had the parties been dealing at arm's length.

It is accepted that the obligation (payment) will be an arm's length amount.

As such, section 109J of the ITAA 1936 will apply to prevent section 109C of the ITAA 1936 from operating, and the payment will not be treated as a dividend.

Question 3

Detailed reasoning

Part IVA of the ITAA 1936 will apply where:

● there is a scheme as defined in section 177A of the ITAA 1936; and

● a tax benefit, as defined in section 177C of the ITAA 1936, would be or might reasonably be expected to be obtained in connection with the scheme, but for subsection 177F(1) of the ITAA 1936; and

● having regard to the factors in section 177D of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies.

Scheme

Section 177A of the ITAA 1936 provides the following meaning of 'scheme':

“scheme" means:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

The proposed arrangement includes the following steps:

● Family A settle the capital proceeds into Trust 1.

● Trust 2 is executed with the Company as the sole beneficiary.

● Trust 1 loans funds to Trust 2.

● Trust 2 uses the funds.

● Trust 2 distributes income to the Company.

● The Company pays franked dividends to Trust 1.

These steps are considered to be a scheme under section 177A of the ITAA 1936 and the relevant scheme for the purposes of section 177D.

Tax benefit in connection with a scheme

Subsection 177C(1) of the ITAA 1936 provides that a tax benefit obtained by a taxpayer in connection with a scheme includes:

(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or

(ba) a capital loss being incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer during the year of income if the scheme had not been entered into or carried out; or

…

(bb) a foreign income tax offset being allowable to the taxpayer where the whole or part of that foreign income tax offset would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out; …

In deciding whether any of the above benefits would have occurred or might reasonably be expected to have occurred had the scheme not been entered into or carried out, section 177CB of the ITAA 1936 requires consideration be given to the following:

…

(2) A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme).

(3) A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme.

(4) In determining for the purposes of subsection (3) whether a postulate is such a reasonable alternative:

(a) have particular regard to:

(i) the substance of the scheme; and

(ii) any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of this Act); but

(b) disregard any result in relation to the operation of this Act that would be achieved by the postulate for any person (whether or not a party to the scheme).

Under the proposed scheme, capital proceeds will be settled in Trust 1 and then loaned to Trust 2. Trust 2 will receive income which will be distributed to the Company each year. The Company will declare and pay fully franked dividends to its shareholder (Trust 1), which will then distribute the fully franked dividends to members of Family A.

Under subsection 177CB(2) of the ITAA 1936, the scheme will be annihilated, and it is necessary to consider the tax benefit that would have occurred based on the actual circumstances that happened or existed.

Family A has an existing group of trusts and companies. If it is postulated that the proposed scheme does not occur, the capital proceeds would be invested using existing entities. This would result in a similar tax effect as that under the proposed scheme.

Under subsection 177CB(3) a postulate, that is a reasonable alternative to the scheme, must be considered to determine whether a tax benefit might reasonably be expected to have occurred.

The purpose for entering the proposed scheme is to create a long-term family investment structure for Family A which addresses asset protection considerations and enables the acquisition of future investment assets for the benefit of current and future generations across many decades.

The substance and result of the proposed scheme is to provide a structure for the long term investment of family wealth for the benefit of several generations.

As an alternative, Family A could personally invest the capital proceeds, with the income from the investments assessable to them. However, taking into account subsection 177CB(4) of the ITAA 1936, this postulate is not considered reasonable as it will not achieve the result of providing a structure for the long-term investment of wealth for the whole family.

Another alternative, would involve Family A contributing the capital proceeds into another trust in the group. This would achieve the substance and result of the scheme (long term investment of family wealth - although not in a new structure), and is considered a reasonable alternative for the purposes of subsection 177CB(3) of the ITAA 1936. This would result in a similar tax outcome as that under the proposed scheme.

The postulates in subsection 177CB(2) and subsection 177CB(3) of the ITAA 1936 will give rise to a tax effect that is essentially the same as the tax effect that will arise under the proposed scheme.

As the tax effect of the postulates under subsections 177CB(2) and (3) of the ITAA 1936 is in essence the same as the tax effect under the proposed scheme, there is no tax benefit for the purposes of section 177C of the ITAA 1936, and Part IVA of the ITAA 1936 will not apply to the proposed scheme.