Edited version of private advice

Authorisation Number: 1051862671060

Date of advice: 8 July 2021

Ruling

Subject: Division 7A loan

Question

Does section 109T(1) of the Income Tax Assessment Act 1936 apply and deem the transfer of funds from Company X to Mr and Mrs A as a Loan or Payment pursuant to the provisions of Subdivision E of Division 7A of the ITAA 1936?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2021

Year ending 30 June 2022

The scheme commences on:

1 April 20XX

Relevant facts and circumstances

Company X is an Australian resident private company.

Company X carries on a business of importing and exporting goods. Company X's operations have reduced significantly in the past few financial years.

Company Y is a private company incorporated and domiciled overseas.

Mr and Mrs A, are shareholders of Company X and Company Y.

Mr and Mrs A are Directors of Company Y.

Mr A is the sole Director of Company X.

Company Y lent Company X an amount in the 20XX financial year. A commercial loan agreement was prepared by Australian Solicitors to document the transaction.

The purpose of the loan was to assist Company X to pay outstanding creditors. One of the key creditors is a loan owing by Company X to Mr and Mrs A.

It is proposed that the same amount lent from Company Y will be paid to by Company X to Mr and Mrs A in the 20XX financial year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Section 109J

Income Tax Assessment Act 1936 Section 109T

Income Tax Assessment Act 1936 Section 109V

Income Tax Assessment Act 1936 Subsection 109V(1)

Income Tax Assessment Act 1936 Subsection 109V(2)

Income Tax Assessment Act 1936 Section 109W

Reasons for decision

Division 7A 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). In particular, advances, loans and other payments or credits to shareholders (or their associates) are, unless they come within specified exclusions, treated as assessable dividends to the extent that the private company has a distributable surplus.

Section 109C of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity if the private company pays an amount to the entity during the year and the entity is a shareholder in the private company (or an associate of the shareholder) or it is reasonable to conclude that the payment is made because the entity was a shareholder or associate at some time.

However, section 109J of the ITAA 1936 provides 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.

In the present case, Company X intends to make a debt repayment to Mr and Mrs A and Division 7A would usually not apply to the amount involved due to the operation of section 109J. However, as the amount involved will be first paid to Company X by another private company, Company Y, section 109T of the ITAA 1936 must be considered.

Section 109T of the ITAA 1936 deals with payments and loans made by private companies to other entities through one or more interposed entities. A private company is taken to make a payment or loan to an entity (the target entity) as described in section 109V or 109W of the ITAA 1936 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.

In the present case, Company Y intends to lend funds to Company X (the interposed entity) which will pay this amount to Mr and Mrs A (the target entity) to reduce the loan from Company X.

Therefore, on a straightforward interpretation of section 109T, it can be said that a reasonable person would conclude (having regard to all the circumstances) that the private company, Company Y, will make the loan solely or mainly as part of an arrangement involving a payment or loan to the target entity, Mr and Mrs A.

Subsection 109V(1) of the ITAA 1936 provides that if the target entity is paid an amount by the interposed entity, the Division operates as if the private company had paid the amount (if any) determined by the Commissioner to the target entity when the interposed entity paid the target entity.

Subsection 109V(2) of the ITAA 1936 provides that in determining the amount of the payment the private company is taken to have made, the Commissioner must take account of:

a) the amount the interposed entity paid the target entity; and

b) how much (if any) of that amount the Commissioner believes represented consideration payable to the target entity by the private company or any of the interposed entities for anything (assuming that the consideration payable equals that for similar transactions at arm's length).

Taxation Determination TD 2011/16 sets out some of the factors the Commissioner will take into account in determining the amount (if any) of any deemed payment or loan under sections 109V or 109W. The determination of the amount depends on the circumstances of each particular case. The factors include to what extent the amount involved can be considered to be a genuine transaction such as where a loan is made to an interposed entity that has an intention and capacity to repay the loan.

In determining the amount of the payment Company Y may be taken to make to Mr A and Mrs A under section 109V of the ITAA 1936, the Commissioner considers that whilst Company X does not appear to have the capacity to repay the additional loan amount to Company Y (negative net assets and operations have reduced), the debt will be reduced by the loan amount to Mr A and Mrs A and therefore the total debt will remain the same. The proposed payment from Company X to Mr A and Mrs A is therefore a genuine loan repayment.

Consequently, the amount determined under section 109V of the ITAA1936 will be nil and there will be no application of any of the provisions of Division 7A of the ITAA 1936 to the proposed arrangement.

This decision acknowledges the general rule that debt repayments made by private companies are not treated as dividends under section 109J of the ITAA 1936.