Edited version of private advice

Authorisation Number: 1051944048652

Date of advice: 27 January 2022

Ruling

Subject: Division 7A

Question

Will the Commissioner exercise discretion under subsection 109G(4) of the Income Tax Assessment Act 1936 (ITAA 1936) to not treat the forgiven loans as dividends?

Answer

No.

This private ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The individual is the sole director and shareholder of the company.

The company was quite successful until the Covid 19 pandemic occurred and the company received very little in Jobkeeper subsidies.

The individual's spouse has been suffering from a serious medical condition which has limited their ability to work.

The individual has remained the main earner within the family unit, and has to pay for mounting travel and medical bills relating to their spouse's illness.

As their personal income reduced, the individual regularly withdrew funds from the company bank account to pay for such expenses and normal day to day living expenses. Amounts were withdrawn in the 20XX, 20XX and 20XX financial years.

The money withdrawn was not used to purchase assets.

The individual has minimal funds in the bank as does the company.

The individual does not have any assets to liquidate.

The company intends to forgive the debt.

When the individual incurred the debt they were receiving dividends from the net profit derived by the company.

The individual did not make payments on the loan or put loan agreements in place over the 20XX, 20XX and 20XX financial years.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109D

Income Tax Assessment Act 1936 subsection 109D(3)

Income Tax Assessment Act 1936 subsection 109D(6)

Income Tax Assessment Act 1936 Section 109F

Income Tax Assessment Act 1936 subsection 109F(6)

Income Tax Assessment Act 1936 subsection 109G(4)

Income Tax Assessment Act 1936 Section 109Y

Reasons for decision

Division 7A of Part III of the ITAA 1936 applies to payments and loans from companies to shareholders or their associates.

Under section 109D a loan from a private company to a shareholder or their associate may be treated as a Division 7A dividend unless, by the lodgement day of the company tax return for the year the loan was taken to have arisen, the loan is:

•         a complying loan for Division 7A purposes, or

•         repaid.

Section 109Y limits the total amount of dividends taken to have been paid by a private company under this Division to the company's distributable surplus.

An associate for Division 7A purposes has the meaning given by section 318 of the ITAA 1936 and generally includes your relatives; a partnership that you are a partner in; a trustee of a trust that you, or your associate, are a beneficiary of; or a company that you, or your associate, control or influence.

A 'loan' is defined in subsection 109D(3) to include the provision of credit or any other form of financial accommodation.

In accordance with subsection 109D(6) lodgment day for a private company's year of income is the earlier of the due date for lodgment of the private company's income tax return for the year and the date of lodgment of the private company's income tax return for the year.

Under section 109N all the following conditions must be satisfied for a loan to be a complying loan and therefore excluded from being a Division 7A dividend:

•         A written loan agreement must be in place before the company's lodgement day for the income year in which the loan amount was paid to the shareholder or associate.

•         The loan interest rate for each year of the loan must at least equal the Division 7A - benchmark interest rate.

•         The term of the loan must not exceed 7 years for an unsecured loan.

Where a loan agreement is made for the purposes of Division 7A, minimum yearly repayments must be made in the subsequent income years. To be effective, minimum yearly repayments of loans must be made by 30 June of the income year in which the repayment is due.

Debt forgiveness

Section 109F of the ITAA 1936 details that 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 as a shareholder or associate at some time

The amount of the dividend equals the amount of debt forgiven.

Debt forgiveness is not treated as a dividend where:

•         a private company forgives a debt owed to it by another company, unless the other company owed the debt in its capacity as trustee

•         the debt is forgiven because the shareholder or their associate became bankrupt or because of Part X of the Bankruptcy Act 1996

•         the debt that has been forgiven results from a loan from a private company that has been treated as a dividend under Division 7A (or section 108 of the Income Tax Assessment Act 1936) in the current year or a previous year

•         the Commissioner of Taxation exercises his discretion not to treat the debt forgiveness as a dividend.

Application to the circumstances

In this case, the individual withdrew funds from the company in the 20XX, 20XX and 20XX financial years. The individual did not make any repayments of principle or interest and no complying loan agreements were in place between the parties.

Given the absence of repayments and a complying loan agreement, the amounts withdrawn would have been treated as dividends in the relevant years. Therefore, forgiveness of the amounts would not give rise to a dividend and the Commissioner is unable to exercise discretion.