Edited version of your written advice

Authorisation Number: 1051462055062

Date of advice: 13 December 2018

Ruling

Subject: Division 7A Loans

Question 1

Are you taken under section 109T of the Income Tax Assessment Act 1936 (ITAA 1936) to make a notional loan to an associated family trust through an interposed entity where you assign your right to a pre-4 December 1997 debt to an associated private company?

Answer

Yes

Question 2

Will the Commissioner determine the amount of the notional loan to be nil under section 109W?

Answer

Yes

This ruling applies for the following period:

1/07/201X to 30/06/201Y

The scheme commences on:

1/07/201X

Relevant facts and circumstances

1. X entities are associates of each other pursuant to section 318 of the Income Tax Assessment Act 1936 (ITAA 1936).

2. Y of the entities are private companies and the Z others are trusts.

3. According to its financial accounts, one company (the assignor) has an amount receivable from one of the trusts (‘the trust’) and that amount remains outstanding.

4. As the amount receivable was provided by the company to the trust prior to 4 December 1997 and prior to the introduction of Division 7A of Part III of the ITAA 1936, the amount has not been previously treated as a deemed dividend.

5. No written contracts were executed in respect of the arrangement relating to the pre-4 December 1997 amount receivable. There have been no changes to the terms of the arrangement since 4 December 1997.

6. The debt is not statute barred.

7. The assignor proposes to assign its interest in the debt in equal proportions to three assignee companies.

8. The assignment will happen in the 201Y income year.

9. The assignee companies will not demand payment in full by the lodgment day of the income year in which they receive the assignment.

10. No date has been fixed for when the assignee companies will call on payment from the trust.

11. The full amount of the assigned debt will be outstanding at the lodgment day of the income year in which the assignment is made.

12. If payments are not made when called, the assignee companies could issue formal demands and pursue the creditor through recovery proceedings.

13. The terms of the debt will remain the same as stated in the deed of assignment.

14. Express notice of the assignment of the debt will be provided to the trust by 30 June 201Y pursuant to section 134 of the Property Law Act 1958 (X).

15. The purpose of the assignment is to facilitate the liquidation of the assignor company which is considered to be surplus to the group’s requirements.

16. The assignment is to occur before the liquidation of the assignor company.

17. The total consideration that will be paid for the interest in the debt will be the book value of the loans. A valuer has not been engaged.

18. Each assignee company will provide ¹/₃ of the consideration in respect of their interest in the debt.

19. The loans made to date by the assignor, the assignee companies, and the trust, are only to entities controlled by related individuals.

20. It is expected that the assignee will exercise its right to receive payments against the outstanding amount from the entity previously owing the money to the assignor.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Subsection 109D(1)

Income Tax Assessment Act 1936 Subsection 109D(3)

Income Tax Assessment Act 1936 Subsection 109D(3)(b)

Income Tax Assessment Act 1936 Section 109M

Income Tax Assessment Act 1936 Section 109N

Income Tax Assessment Act 1936 Subdivision E

Income Tax Assessment Act 1936 Section 109T

Income Tax Assessment Act 1936 Subsection 109T(1)

Income Tax Assessment Act 1936 Subsection 109T(1)(b)

Income Tax Assessment Act 1936 Subsection 109T(2)

Income Tax Assessment Act 1936 Subsection 109T(3)

Income Tax Assessment Act 1936 Section 109V

Income Tax Assessment Act 1936 Section 109W

Property Law Act 1958 (X) Section 134

ATO view documents

Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements

Other references (non ATO view)

Corporate Initiatives Pty Ltd & Ors v. Federal Commissioner of Taxation [2005] FCAFC 62; 142 FCR 279; 219 ALR 339; 59 ATR 351; 2005 ATC 4392

Eldersmede Pty Ltd & Ors v. Federal Commissioner of Taxation [2004] AATA 710; 56 ATR 1179; 2004 ATC 2129

Re Montgomery Wools Pty Ltd as trustee for Montgomery Wools Pty Ltd Super Fund and Federal Commissioner of Taxation [2012] AATA 61; 2012 ATC 10-233; (2012) 87 ATR 282 Spellson v. George (1992) 26 NSWLR 666; [1992] NSWCA 254

Reasons for decision

Question 1

Are you taken under section 109T of the ITAA 1936 to make a notional loan to an associated family trust through an interposed entity where you assign your right to a pre-4 December 1997 debt to an associated private company?

Summary

You will be taken to make a notional loan in accordance with section 109T of the ITAA 1936 where you assign your right to a pre-4 December 1997 debt to an associated private company.

Detailed reasoning

1. Subsection 109T(1) provides that a private company will be taken to make a payment or loan to 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.

2. The test in paragraph 109T(1)(b) is approached from the perspective of a reasonable person and applies having regard to the prevailing circumstances at the time when the interposed entity makes the payment or loan to the target entity.

3. Paragraph 109T(1)(b) makes no reference to there being any purpose or intent of avoiding Division 7A. It merely requires that a reasonable person would conclude that a payment or loan from the private company to the interposed entity was made as part of an arrangement involving a payment or loan to the target entity. Nonetheless, such a purpose or intent may help establish such a reasonable conclusion.

4. Subsection 109T(2) makes it clear that it does not matter whether the interposed entity made the payment or loan to the target entity before, after or at the same time that the first interposed entity received the payment or loan from the private company; or 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.

5. Subsection 109T(3) provides an exclusion if the payment or loan to the first interposed entity is treated as a dividend under subdivision B of Division 7A.

6. You are being wound up as you are considered to be surplus to the group’s requirements. The winding up necessitates you to take some action in respect of the debt owed by the trust. The action chosen is the assignment of the debt to the assignee companies.

7. Upon execution of the deed of assignment in 201Y income year, you (assignor) assign your interest in the debt to each of the assignee companies (interposed entities). The transfer of your interest in the debt is a transfer of property by you to the assignee companies which amounts to a payment as defined by subsection 109C(3)(c) and a payment to an interposed entity for the purposes of subsection 109T(1)(a).

8. Paragraph 109D(3)(b) includes within the meaning of a Division 7A loan 'a provision of credit or any other form of financial accommodation'.

9. Paragraph 96 of Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements explains what amounts to financial accommodation for the purposes of subsection 109D(3):

In the Commissioner's view, the statutory context in which the phrase appears limits what amounts to financial accommodation under this definition to:

● the supply or grant of some form of pecuniary aid or favour (as suggested by the ordinary meaning of this term - see paragraphs 90 to 92 of this Ruling);

● under a consensual arrangement (similarly to Radilo ); and

● where a principal sum or equivalent is ultimately payable (similarly to Radilo).

The supply or grant of some form of pecuniary aid or favour

10. Paragraphs 98-102 of TR 2010/3 provides further explanation on when an entity is taken to provide a benefit. In summary paragraphs 101-102 of TR 2010/3 state:

101. In Eldersmede and Corporate Initiatives a beneficiary was taken to have provided a benefit to the trustee of a related trust directly as a result of that beneficiary's inaction. The beneficiary provided that benefit to the trustee by failing to either:

● call for payment of its UPE; or

● call for the trustee to invest the amount of that UPE at a commercial return for its (the beneficiary's) benefit.

102. The findings of the AAT and comments by the Full Federal Court indicate that there would be a similar provision of a benefit by an unrelated beneficiary not calling for payment of funds distributed to it if it has knowledge of the UPE and authorises, or with this knowledge acquiesces to, the trust's continued use of those funds for trust purposes.

11. Under section 134 of the Property Law Act 1958 (X), where the assignor makes an absolute assignment in writing of a debt of which express notice is provided to the debtor, the assignment shall be and shall be deemed to have been effectual in law to pass and transfer legal right to the debt and all legal and other remedies.

12. The assignment will be executed in writing via a deed of assignment in which you will assign absolutely all of your right title and interest in the debt to the assignee companies as tenants in common. You will provide express notice to the trust of the assignment by 30 June 201Y pursuant to section 134 of the Property Law Act 1958 (X).

13. When you assign your right title and interest in the debt to the assignee companies and provide express notice to the trust, the assignee companies will have a legal right to call on payment of their interest in the debt from the trust.

14. Accordingly, by not calling for payment of their interest in the debt from the trust, the assignee companies authorise, or acquiesce to, the trust's continued use of those funds for trust purposes. In allowing this to continue the assignee companies provide a benefit to the trust in the form of pecuniary aid in the amount of funds owed to them from the assignment of the interest in the debt.

Under a consensual arrangement

15. You and the assignee companies will consent to the assignment of the debt as signatories to the deed of assignment.

16. Whilst the trust is not a signatory to the deed of assignment, the corporate trustee of the trust, shares common directors with each of the assignee companies and you.

17. In Spellson v. George (1992) 26 NSWLR 666; [1992] NSWCA 254 the Supreme Court of New South Wales had cause to consider what would amount to the consent of a beneficiary to the actions of a trustee in the context of a claim by the beneficiary that there had been a breach of trust. In his judgment, Handley JA, observed:

Consent may take various forms. These include active encouragement or inducement, participation with or without direct financial benefit, and express consent. Consent may also be inferred from silence and lack of activity with knowledge.

18. In Re Montgomery Wools Pty Ltd as trustee for Montgomery Wools Pty Ltd Super Fund and Federal Commissioner of Taxation [2012] AATA 61; 2012 ATC 10-233; (2012) 87 ATR 282 the AAT held that consent could be inferred where there was a common controlling mind:

85. … In Radilo Enterprises, the Full Court considered the meaning of "the provision of credit or … financial accommodation" in the context of another legislative provision and found that the provision of credit or financial accommodation "implies a consensual transaction". In the case where Mr Montgomery was the controlling mind of both Montgomery Wools and Warwick Wools and was aware of the sale of Pearl Street, the distribution of income to the MWS Fund and the proposed payment to the CBA for the benefit of the MFT rather than to the MWS Fund, the Tribunal can infer there was a consensual arrangement. It would be artificial to suggest otherwise…

87…The arrangement was consensual because it was approved by Mr Montgomery, who was the controlling mind of both trustees. It does not matter that Mr Montgomery did not specifically turn his mind to the legal effect of this or the specific nature of the transactions. He approved and intended to approve the sale and payment of the proceeds for the benefit of the MFT, knowing the MWS Fund was entitled to those proceeds

19. As there are common controlling minds between the trustee of the trust and the companies that are party to the assignment, it will be taken that the trust will have knowledge of the assignment and it will be inferred they have consented to the arrangement.

Where a principal sum or equivalent is ultimately payable

20. As per the draft deed of assignment, ‘the terms of the debt were never reduced to writing however it is understood that the debt is interest free unless otherwise agreed and repayable at the demand of the assignor’.

21. When you assign all of your right title and interest in the debt to the assignee companies and provide express notice to the trust pursuant to section 134 of the Property Law Act 1958 (X), the assignee companies will have a legal right to call on payment of their interest in the debt from the trust.

22. Upon execution of the deed of assignment, the assignee companies will be providing pecuniary aid to the trust by not calling on a debt that is ultimately payable to them. As there are common controlling minds it will be inferred all parties have consented to the arrangement.

23. The trust is an associate of your shareholder in accordance with section 318. Accordingly, the assignee companies will be providing financial accommodation to the trust and be taken to have made a loan to the trust for the purposes of Division 7A when they are assigned the interest in the debt and do not call for payment in full, being during the 201Y income year.

Reasonable person test

24. The reason for assigning the debt is to facilitate your winding up. The debt is being assigned in equal shares to three companies.

25. If the interest in debt was not assigned before winding up, you would be required to demand repayment.

26. The sum of the debt owed by the trust is roughly equivalent to the sum of unsecured loans that the trust has made to related parties. Approximately 50% of the unsecured loans have been made to Y related persons, who are also the Y directors of the trustee of the trust. The related persons are also directors of you or the assignee companies.

27. The trust has no other substantial assets to fund repayment of the debt.

28. Other alternatives would be for you to forgive the debt which may have tax consequences or the loan could be distributed in specie as part of a liquidator’s distribution.

29. The financial accommodation provided by the assignee companies to the trust only arises as a result of you choosing to assign them the debt and the assignee companies failing to demand payment.

30. As there are common controlling minds between you, assignee companies and the trust it will be inferred that each will have knowledge before the assignment occurs that no date has been fixed for when the assignee companies will call on payment from the trust. It will also be inferred that they will each have knowledge that the assignee companies will not demand payment by the assignee companies’ lodgment date for the year in which the assignment occurs.

31. Based on the facts, a reasonable person would conclude the main purpose of you in assigning the debt to the assignee companies was to allow for the continued use of the funds for an indeterminate time after you are wound up.

32. This conclusion is informed by factors including the similarity in the quantum of assigned debt to the unsecured loans owed to the trust by related parties, the lack of other liquid assets held by the trust to fund repayment of the debt, the common controlling minds between the parties and the shared knowledge that the debt will continue to remain unpaid for an indeterminate time.

33. The exclusion in subsection 109T(3) would not apply as the payments to each of the interposed entities (the assignee companies) are company to company payments and would therefore be excluded from being treated as a dividend under section 109C due to the operation of section 109K.

34. Where section 109T applies, the amount of the payment or loan taken to have been made by the private company to the target entity is determined by the Commissioner taking into account the factors described in sections 109V and 109W respectively.

35. The transaction between the assignee companies (interposed entities) to the trust (target entity) is a loan as defined in subsection 109D(3).

36. Section 109W operates to treat the private company as making a loan to the target entity where an interposed entity loans an amount to the target entity. The timing of the notional loan will be when the interposed entity made the loan to the target entity.

37. You will be taken to make a notional loan to the trust when the assignee companies are assigned the debt and do not call for payment in full.

Question 2

Will the Commissioner determine the amount of the notional loan to be nil under section 109W?

Summary

The Commissioner will determine the amount of the notional loan to be nil under section 109W.

Detailed reasoning

38. Taxation ruling TD 2011/16 Income tax: Division 7A - payments and loans through interposed entities - factors the Commissioner will take into account in determining the amount of any deemed payment or notional loan arising under section 109T of the Income Tax Assessment Act 1936 outlines the factors the Commissioner will consider. These factors, and their application to the proposed arrangement are detailed as follows:

a) the amount that an interposed entity loaned or paid the trust (target entity)

● Where the assignee companies fail to call on the debt, the amount of financial accommodation (being a loan for the purposes of Division 7A), by the assignee companies will be equal to the assigned debt.

b) how much of the amount loaned to the trust by an interposed entity under the arrangement the Commissioner believes represented arm's length consideration payable to the trust by the private company or an interposed entity for anything (other than its right to receive repayment of the loan and any relevant interest)

● Not applicable. The amount is a loan and does not represent consideration payable to the trust for anything.

c) the extent to which any actual loans made as part of the arrangement have been repaid by that time

● No amount will be paid in the 201Y income year and no fixed date for payment has been determined.

d) the extent to which any loan or payment made from the private company to an interposed entity as part of the arrangement meets the criteria set out in section 109N

● The terms of the debt as stated in the deed of assignment do not meet the conditions in section109N.

e) the extent to which any actual loans made as part of the arrangement would be covered by section 109M (loans in the ordinary course of the private company's business made on its usual terms applicable to arm's length parties)

● Not applicable. The only loans made by you and assignee companies are to related parties, and are therefore not in the ordinary course of business.

f) the extent to which the above factors reflect genuine transactions that are not designed to avoid the application of Subdivision E otherwise than as envisaged within the scheme of Division 7A

● Not applicable.

39. In addition to the relevant factors above, the Commissioner may, in appropriate cases, consider (having regard to the intended purpose of Division 7A) the extent to which tax is otherwise payable because of the structure used in the arrangement. (See paragraph 81 of Tax Determination TD 2018/13 Income tax: Division 7A: can section 109T of the Income Tax Assessment Act 1936 apply to a payment or loan made by a private company to another entity (the 'first interposed entity') where that payment or loan is an ordinary commercial transaction?).

40. The assignee companies will be taken to pay a dividend to the trust under subsection 109D(1) where the debt assigned to them is not fully repaid by the lodgment day of the tax return for the year the assignment and subsequent loan is made (201Y tax return).

41. Based on the above factors outlined in TD 2011/16 and that the amount of the notional loan from you to the trust will also be assessable to the trust as a deemed dividend from the assignee entities, the Commissioner would determine the notional loan amount from you to the trust as nil.