Edited version of private advice

Authorisation Number: 1051533271418

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Date of advice: 20 June 2019

Ruling

Subject: Division 7A - debt forgiveness

Question

Is the outstanding loan from the company a deemed dividend under section 109F of the ITAA 1936?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commenced on:

1 July 2018

Relevant facts and circumstances

The deceased died in the 2019 income year.

The deceased was the sole director of the company.

The company made loans to the deceased.

All loans were complying Division 7A loans.

The company intends on forgiving the loans.

Probate has not yet been granted.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 109D(1)

Income Tax Assessment Act 1936 section 109E

Income Tax Assessment Act 1936 subsection 109F(1)

Reasons for decision

Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates).

Subsection 109D(1) of the ITAA 1936 operates so that a private company is taken to pay a dividend to an entity (a current or former shareholder or their associate) at the end of one of the private company's years of income if:

·         the company makes a loan to the entity during the year,

·         the loan is not fully repaid before the lodgment day for the year, and

·         the loan is not subject to a written loan agreement that satisfies the requirements of section 109N of the ITAA 1936.

In this case, the Company made 5 loans to the deceased during the 2012, 2013, 2014, 2016 and 2017 financial years and the deceased passed away in the 2019 income year.

ATO Interpretative Decision ATO ID 2002/741 Amalgamated Loans and executors of deceased estates provides that where a shareholder to whom a private company has made a loan dies, there can be no deemed dividend payable following the date of death. This is because a deemed dividend can only be taken to be paid to the entity to whom the loan was made, and the deceased shareholder's legal personal representative is a different entity.

Although the view expressed in ATO ID 2002/741 relates to section 109E of the ITAA 1936 (regarding shortfalls in loan repayments), the principal also applies to section 109D of the ITAA 1936 as this section also specifies that the dividend can only be taken to be paid to the entity to whom the loan was made.

Therefore, the amount of the loans the Company made to the deceased in the 2012, 2013, 2014, 2016 and 2017 financial years will not be taken to be a dividend paid to the deceased on or before the date of death.

Will a dividend be payable if the debt is forgiven?

Under subsection 109F(1) of the ITAA 1936 a private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either:

a)    the amount is forgiven 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 amount is forgiven because the entity has been such a shareholder or associate at some time.

ATO Interpretative Decision ATO ID 2012/77 Income tax Division 7A: operation of section 109F of the Income Tax Assessment Act 1936 to forgiveness of amalgamated loan debt by a private company to a shareholders estate while it is in administration provides guidance on the operation of section 109F of the ITAA 1936 specifically in respect to the effect of death following the grant of probate:

• section 44 of the Probate and Administration Act 1898 (NSW ) deems all real and personal property of the deceased (including title to the shares) to have passed to and become vested in the executor as from the death of the individual;
• the deceased's property (including title to the shares) is held absolutely by the legal personal representative for the duration of the administration of the shareholder's estate; and
• the legal personal representative immediately assumes liability to pay the deceased's debts (including the debt owed by the deceased to the private company.

However, on the date of death, the property of the deceased vests in the Public Trustee of NSW until probate is granted.

Consequently, it is only after the grant of probate that the title to the shares in the private company will be taken to have passed to the deceased's legal personal representative as at the date of death.

It follows that prior to the grant of probate, there will be no relevant shareholder for the purposes of subsection 109F(1) of the ITAA 1936.

Therefore, should the company forgive the loan made to the deceased prior to the grant of probate, the company will not be taken to have paid a dividend to the legal personal representative shareholder.