Edited version of private advice

Authorisation Number: 1051705944220

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Date of advice: 31 August 2020

Ruling

Subject: Division 7A loans of deceased shareholder

Question 1

Will a deemed dividend arise under section 109F of the Income Tax Assessment Act 1936 (ITAA 1936) to the Estate of a deceased person if ABC Pty Ltd (the Company) will forgive the pre-existing Div7A loans before the Grant of Probate to the Executor of the Estate?

Answer

No

Question 2

Will a deemed dividend arise under section 109F of the ITAA 1936 to the Estate of a deceased person if the Company will forgive the current year loans before the Grant of Probate to the Executor of the Estate?

Answer

No

Question 3

If the Company will forgive the pre-existing Div7A and current year loans, will a deemed dividend arise under section 109F of the ITAA 1936 to an individual associate of the deceased person and a shareholder in the Company?

Answer

No

Question 4

Will the commercial debt forgiveness rules in Division 245 of the Income Tax Assessment Act 1997 apply to the Estate of a deceased person if the Company will forgive the pre-existing Div7A and current year loans which the Company provided to that person prior to death?

Answer

No

Question 5

Will a deemed dividend arise under section 109D of the ITAA 1936 to the Estate of a deceased person if the pre-existing Div7A and current year loans are not forgiven by the Company and the Estate is unable to meet the minimum repayment terms?

Answer

No

This ruling applies for the following period:

Year ending 30 June XXXX

The scheme commences on:

21 December XXXX

Relevant facts and circumstances

The Deceased and the Will

The Deceased suddenly died due to an accident, leaving a will (the Will).

The Executor named in the Will is the spouse of the Deceased.

The alternate Executor named in the Will is a relative of the Deceased, if the spouse is unable or unwilling to act as Executor.

The Deceased has children from previous marriage.

Under the Will the Executor acts as sole director of the Company and may propose to sell the business sometime in the future.

The Will provides that the Deceased's shares in the Company are to be held on trust for the benefit of the children in equal shares as tenants in common until such children reach a certain age and thereafter to them absolutely.

The Company and the Loans

ABC Pty Ltd (the Company) is an Australian resident company.

The Deceased was actively involved in the running of the company business being the sole director of the Company and was the key decision maker in the business prior to death.

The Deceased owned 100% of the ordinary shares in the Company and the spouse holds 1 share of a different class.

There had been a history of loans made by the Company to the Deceased, and they were under Division 7A complying loan agreements. These are referred to as pre-existing Div7A loans. The loans are unsecured and have a maximum term of 7 years. The required minimum interest and repayments were made, ordinarily by declaring fully franked dividends.

The pre-existing Div7A loans have been predominantly used for private purposes by the Deceased and no deduction for interest has been claimed.

Additional funds were drawn by the Deceased in the current year. These are referred to as current year loans. The funds were used to acquire personal assets in the name of the Deceased person and to purchase a property with the spouse as joint tenants.

It is submitted that all decisions regarding the withdrawal of the funds from the Company's bank accounts were made solely by the Deceased being the only person who had access to the bank accounts of the Company while alive.

It is also submitted that the current year loans had not been documented as Div7A loans prior to the Deceased's death. As such, there is no written Div7A loan agreement between the Company and the Deceased shareholder.

Status of the Estate of the Deceased

Probate has not yet been granted as the Executor is still in the process of seeking Estate Law advice on the administration of the Estate.

The Executor is placed in a difficult situation dealing with a blended family and the Estate not having enough cash to fund the repayment of the loans owed by the Deceased to the Company.

The assets of the Estate are not readily able to be converted into cash so there is no capacity for the Executor to repay the loans.

There is a risk that any decision the Executor makes regarding the administration of the Estate of the Deceased may be challenged.

For those reasons the Executor has not applied for Probate until Estate Law advice is sought to have a clear understanding of the Executor's powers in order to avoid personal liability.

The administration of the Estate has been further delayed by the Executor falling ill following the death of the spouse.

Relevant legislative provisions

Income Tax Assessment Act 1936

Division 7A

Subdivision D

section 109D

section 109F

section 109R

Income Tax Assessment Act 1997

section 8-1

Division 245

section 245-10

section 245-35

subsection 960-100(1)

subsection 995-1(1)

Taxation Administration Act 1953

Schedule 1

subsection 260-140(2)

Probate and Administration Act 1898 (NSW)

section 61

Other references

TR 94/30

ATO ID 2012/77

PCG 2018/4

Reasons for decision

Questions 1 & 2

All legislative references are to the Income Tax Assessment Act 1936 unless otherwise stated.

Section 109F - Forgiven debts treated as dividends

Subsection 109F(1) provides a private company is taken to pay a dividend to an entity at the end ofthe private company's year of income if all or part of a debt the entity owed the private company isforgiven 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.

Subsection 109F(2) provides the amount of the dividend is equal to the amount of debt forgiven subject to the private company's distributable surplus as determined under section 109Y.

Subsection 109F(7) provides that where a private company forgives an amount of debt resulting from a constituent loan that is taken into account in working out the amount of an amalgamated loan pursuant to subsection 109E(3), the private company is taken to forgive the same amount ofdebt resulting from the amalgamated loan.

The death of a shareholder borrower does not, of itself, trigger an automatic forgiveness of a loan.

Subsection 109F(3) provides that an amount of a debt is forgiven for the purposes of Division 7A if

and when the amount would be forgiven under the commercial debt forgiveness rules in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997).

Relevantly, section 245-35 of the ITAA 1997 provides a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full.

An issue arises as to whom the potential dividend will arise under section 109F where a loan ismade to a shareholder who dies before the loan is repaid.

For a deemed dividend to arise under subsection 109F(1) in respect of a forgiven debt, the entity atthe time the debt is forgiven must be:

• a shareholder in the private company, and

• it owes the debt.

When a person dies, the legal personal representative such as an executor named in the Will of the deceased, 'stands in the shoes of the deceased person' regarding the outstanding tax-related liabilities of the deceased - subsection 260-140(2) of Schedule 1 to the Taxation Administration Act 1953.

PCG 2018/4: Income tax - liability of a legal personal representative of a deceased person explainsthat an executor who has obtained probate of a deceased person's Will is required to provide taxreturns and other information that the deceased was required to provide to the ATO. The executoris also liable to pay any outstanding tax-related liabilities of the deceased person up to the value ofthe deceased's assets that come into the hands of the executor.

Relevantly, subsection 995-1(1) of the ITAA 1997 defines a legal personal representative to mean an executor or administrator of an estate of an individual who has died.

TR 94/30: Income tax: capital gains tax implications of varying rights attaching to shares explainsthat a share in a company is a chose in action and is personal property - paragraphs 24 and 33 ofthe Ruling.

Broadly, Australian property law provides that there cannot be a lapse in the chain of property ownership. When a person dies and prior to the Grant of Probate, the property of the deceased person will immediately vest in either the Public Trustee or in the named Executor depending on the jurisdiction and whether the person dies testate or intestate.

For example, in NSW the property (real and personal) of a deceased person will vest in the Public Trustee - section 61 of the Probate and Administration Act 1898 (NSW) (the Probate Act).

ATO ID 2012/77 explains that section 109F applies to deem a private company to have paid a dividend to a deceased's legal personal representative in circumstances where a private company is taken to have made an amalgamated loan to a shareholder who dies before the amalgamated loan is repaid, and the private company forgives that loan while the shareholder's estate is in administration.

Section 109D - Loans treated as dividends

Subsection 109D(1) provides for loans treated as dividends in year of making. The subsection is covered under the detailed reasoning in question 5 below.

Application to your facts and circumstances

Pre-existing Div7A loans

The pre-existing Div7A loans (the Loans) made by the Company to the deceased shareholder met the conditions in subsection 109E(3). As such, the Loans are taken to be amalgamated loans for the purposes of Division 7A.

The Company has sufficient distributable surplus at the time the forgiveness of the pre-existing Div7A loans is proposed to occur for the purposes of subsection 109F(2).

Based on the Probate Act, the shares in the Company which were owned by the Deceased just before death, have vested in the Public Trustee at the time of the Deceased's death and prior to the Grant of Probate.

Accordingly, prior to the Grant of Probate, the Public Trustee would be deemed to be the relevant shareholder of the Company for the purposes of subsection 109F(1).

However, the Public Trustee is not expected to apply for Probate considering the Deceased died testate. In the Will, an Executor of the Estate is named. Hence, it is the Executor who must apply for Probate to prove the Will.

The Grant of Probate by the Court will confirm the Executor's title to the shares giving the Executorrecognition of their standing to deal with the shares. The Grant will make the Executor accountablefor the administration of the Estate of the Deceased.

Based on PCG 2018/4, the Executor will assume the obligation to repay the debts of the Deceased following the Grant of Probate. This is consistent with the view expressed in ATO ID 2012/77.

Prior to the Grant of Probate nobody assumes the obligation to repay the debts of the Deceased. Both the Public Trustee and the Executor will not be taken to owe the debts (the Loans) being forgiven prior to the Grant of Probate. As such one of the conditions in subsection 109F(1) will not be satisfied because no entity is taken to owe the Loans being forgiven.

Therefore, a deemed dividend will not arise under section 109F to the Estate of a deceased person if the company will forgive the pre-existing Div7A loans during the period between the time of death and prior to the Grant of Probate.

Current year loans

For reasons explained above, a deemed dividend under section 109F will also not arise to the Estate of a deceased person if the Company will forgive the current year loans during the period between the time of death and prior to the Grant of Probate.

There is no written Div7A loan agreement between the Company and the Deceased shareholder for the current year loans. This is because the Deceased died suddenly due to an accident. As such, an issue arises as to whether section 109D has application to the Estate of the Deceased. This issue is dealt with in question 5.

Question 3

As explained above, for a deemed dividend to arise under subsection 109F(1) in respect to a forgiven debt, the entity at the time the debt is forgiven must be a shareholder in the private company, and it owes the debt.

Application to your facts and circumstances

The individual is a shareholder of the Company and an associate of the Deceased shareholder. As such, the one condition in subsection 109F(1) which requires the entity must be a shareholder of the Company is satisfied.

However, the pre-existing Div7A loans and the current year loans (the Loans) were not provided by the Company to the individual. The facts indicated the Loans were provided to the Deceased while alive. Accordingly, the individual does not owe the debt (the Loans) to the Company. As such, the one condition in subsection 109F(1) which requires the entity must owe the debt is not satisfied.

Therefore, a deemed dividend will not arise under section 109F to the individual who is a shareholder of the Company and an associate of the Deceased shareholder, if the Company will forgive the Loans.

Question 4

The commercial debt forgiveness rules in Division 245 of the ITAA 1997 will apply to the forgiveness of a loan if the loan is considered a commercial debt.

Section 245-10 of the ITAA 1997 provides that a debt is a commercial debt if:

(a)  the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

(b)  interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

(c)   interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2) (a), (b) and (c)) that has the effect of preventing a deduction.

Note: Paragraphs 8-1(2) (a), (b) and (c) prevent deductions for capital, private or domestic outgoings and for outgoings relating to exempt income or non-assessable non-exempt income.

Application to your facts and circumstances

The pre-existing Div7A and current year loans (the Loans) have been predominantly used for private purposes and no deduction for interest has been claimed. As such, the Loans are not considered commercial debts within the meaning of section 245-10.

Therefore, the commercial debt forgiveness rules in Division 245 will not apply to the Estate of the deceased person if the Company will forgive the Loans.

Question 5

Subsection 109D(1) provides 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 lodgement 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.

Subdivision D refers to payments and loans that are not treated as dividends. Some repayments cannot be counted for the purpose of subsection 109D(1) - see section 109R referring to some payments relating to loans not taken into account.

Subsection 960-100(1) of the ITAA 1997 provides a definition of an 'entity' to include an individual, a body corporate, a body politic, a partnership, any other unincorporated association or body of person, a trust, and a superannuation fund.

'Individual' is defined in subsection 995-1(1) of the ITAA 1997 as a natural person.

Relevantly, the wording in subsection 109D(1) indicates that section 109D only operates in respect of the entityto which the relevant loan was made in the year. That is, it cannot apply to an entity other than the original recipient of the loan.

Application to your facts and circumstances

The original recipient of the pre-existing Div7A and current year loans (the Loans) was the deceased person as an individual shareholder, an entity defined in tax law as a natural person. Whereas, the Estate of the deceased person is a form of a trust which is a different entity. Accordingly, section 109D cannot apply to the Estate as it is not the original recipient of the Loans.

Therefore, a deemed dividend will not arise under section 109D to the Estate of the deceased person if the Loans are not forgiven by the Company and the Estate is unable to meet the minimum repayment terms.