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Edited version of private advice
Authorisation Number: 1051616720252
Date of advice: 4 December 2019
Ruling
Subject: Division 7A private company loan
Question 1
Does the transfer of $X from Company A to Company B attract the operation of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?
Answer
No
Question 2
Does the transfer of $X from Company A to Company B as trustee for the Z Trust attract the operation of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?
Answer
Yes
This ruling applies for the following period
Year ended 30 June 20XX
The scheme commences on
1 July 2016
Relevant facts and circumstances
Z Trust
The Z Trust was established by a Deed of Settlement dated in YYYY. Company B is the corporate trustee.
The Z Trust is a discretionary trust, with the trustee having the power to exercise its discretion in relation to the distribution or accumulation of any net income of the trust in accordance with the Deed.
The primary beneficiaries are defined within the Deed to mean Beneficiary 1 and Beneficiary 2. Other beneficiaries are defined in Clause 1 of the Deed by their relationship to Beneficiaries 1 and 2.
Company A
Company A (the Company) is an Australian company whose share capital was held prior to the share sale in the 2017 financial year by:
· Person W
· Company C atf the W trust
· Beneficiary 1
Share Sale Agreement
On a specific date in the 20XX financial year, Person W and Company C (the sellers) and Company B as trustee for the Z Trust (the buyer) entered into a Share Sale Agreement for the sale and purchase of shares in the Company.
The total purchase price was agreed to be $Y (payable in instalments by way of Vendor Finance) plus an amount equal to the value of the debit loan account of Person W in the Company at settlement (being approx. $X).
At settlement the buyer must pay the amount equal to the loan account together with the first instalment.
Steps in the transaction in relation to the loan
On a specific date in the 20XX financial year, the Company transferred, by way of book entry, $X to Company B as trustee for the Z Trust (Trustee).
On the same date, the Trustee drew a Bill of Exchange of $X, made payable to Person W.
On the same date, Person W endorsed the Bill of Exchange to the Company, in order to repay their debit loan account with the Bill of Exchange.
Treatment of loan in financial statements
The 20XX and 20XX Balance Sheets of the Company shows loan balances to the Z Family Trust as at financial year end of 20XX and 20XX.
The Income Statements of the Company records interest received from The Z Trust in the 20XX financial year.
The Income Statements of the Z trust records interest paid to the Company in the 20XX and 20XX financial years.
The applicant advised that no written loan agreement was entered into in respect of the loan and no repayments of the loan have been made.
Relevant legislative provisions
Section 109D of the Income Tax Assessment Act 1936
Section 109K of the Income Tax Assessment Act 1936
Section 109M of the Income Tax Assessment Act 1936
Section 109N of the Income Tax Assessment Act 1936
Section 109Y of the Income Tax Assessment Act 1936
Section 202-45 of the Income Tax Assessment Act 1997
Section 318 of the Income Tax Assessment Act 1997
Reasons for decision
Question 1
The Share Sale Agreement provided shows that the transfer occurred between Company A and Company B as trustee for the Z Trust.
As Company B was acting in its capacity as trustee, there was no transfer to Company B in its own capacity, and therefore there can be no application of Division 7A of the ITAA 1936 for the company.
Question 2
Summary
The Share Sale Agreement provided shows that the transfer occurred between Company A and Company B as trustee for the Z Trust.
Division 7A of the ITAA 1936 applies to the loan made on in the 20XX financial year from Company A to Company B as trustee for the Z Trust. As the loan was drawn from Company A to the Z Trust and all the conditions of a subsection 109D loan are met the loan will be a deemed dividend to the Z Trust. It will be included in the income of the Z Trust for the 20XX income year.
Requirements of a section 109D loan
Under subsection 109D(1) of the ITAA 1936:
A private company is taken to pay a dividend to an entity at the end of one of the private company's years of income (the current year) if:
(a) the private company makes a loan to the entity during the current year; and
(b) the loan is not fully repaid before the lodgment day for the current year; and
(c) Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and
(d) either:
(i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or
(ii) a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time.
Each of these elements will now be considered against the facts of this transaction.
Subsection 109D(1)(a)
A loan is defined for the purposes of Division 7A in subsection 109D(3) of the ITAA 1936 as including:
(a) an advance of money; and
(b) a provision of credit or any other form of financial accommodation; and
(c) a payment of an amount for, or on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and
(d) a transaction (whatever its terms or form) which in substance effects a loan of money.
In this case, it is clear that there has been a loan under the definition. The Company clearly entered into a transaction with the Trustee to provide a form of credit or financial accommodation, by lending the Trustee an amount that enabled it to fulfil its obligations under the sale contract to pay an amount equal to the value of the debit loan account of Person W.
This transaction resulted in the Trustee owing $X to the Company.
Subsection 109D(1)(b)
The loan was made from the Company in the 20XX financial year and was not fully repaid by the lodgement date of the Company's 20XX income tax return.
Subsection 109D(1)(c)
Subdivision D of Division 7A of the ITAA 1936 sets out exclusions for loans that will not be treated as dividends for the purposes of subsection 109D(1).
None of these exclusions apply to the loan made by the Company to the Trustee. More specifically:
· Section 109K provides a company to company exclusion. This exclusion does not apply in situations where the loan is made to a company acting in its capacity as trustee, as is the case here.
· Section 109N requires that there must be a written loan agreement, and that agreement must specify a rate of interest payable that equals or exceeds the benchmark interest rate, and the term of the loan, which must not exceed the maximum term allowable. In this case, there is no written loan agreement in respect of the loan.
Subsection 109D(1)(d)
The Trustee was an associate of the Company's shareholder Beneficiary 1 when the loan was made.
Timing of the loan
Whilst the applicant contends that the loan was made prior to the Trustee becoming a shareholder, because it was done prior to settlement of the sale contract, the Commissioner does not accept this argument as the transactions were all done on the same day, essentially as one arrangement causing the Trustee to become a shareholder.
The shareholder
Beneficiary 1 was a shareholder of the Company at the time of the transaction.
An associate of such a shareholder
|
The interpretation of 'associate' is found in subsection 318(6) of the Income Tax Assessment Act 1997 (ITAA 1997) which provides: |
For the purposes of this section:
(a) a reference to an entity benefiting under a trust is a reference to the entity benefiting, or being capable (whether by the exercise of a power of appointment or otherwise) of benefiting, under the trust, either directly or through any interposed companies, partnerships or trusts; ....
Beneficiary 1 is a primary beneficiary named in the Z Trust Deed, and is capable of benefitting from the trust. As such the Z Trust is and was an associate of Beneficiary 1 at all times pertinent to the relevant transactions.
Therefore, paragraph 109D(1)(d) of the ITAA 1936 is satisfied as the Trustee was an associate of a shareholder at the time the loan was made.
Conclusion
As all of the conditions in subsection 109D(1) of the ITAA 1936 are met, the loan will be a deemed dividend to the Trustee in the 20XX income year, subject to Company A's distributable surplus in that year in accordance with section 109Y of the ITAA 1936.
The deemed dividend is an unfranked dividend in accordance with section 202-45 of the ITAA 1997.