Edited version of private advice

Authorisation Number: 1051986860656

Date of advice: 31 May 2022

Ruling

Subject: Division 7A

Question

Does section 109T(1) of the Income Tax Assessment Act 1936 (ITAA 1936) deem the payment from Company A to the Asset Holding Trust a dividend under section 109C of the ITAA 1936?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A is an Australian resident company.

Company A's director is Person A and shareholders are Company B and Company C. Company B holds its shares in Company A in its capacity as trustee for a trust.

Company B's director and shareholders are Person A and Person .

Company C's director is Person A and shareholders are Company B and Person B.

Company A is an importer and distributor of medical products.

Company A plans to construct its own manufacturing facility in Australia to get better control of the production process, secure its source of supply of product and minimise the company's reliance on external parties in other parts of the world.

Entities associated with Company A (hereafter referred to as the Company A Group) have entered into a contract to acquire a property.

The Company A Group is planning to make a number of improvements to the land, such as, but not limited to roads.

The intention is to construct a manufacturing facility on the property.

The proposed Scheme

From an asset protection and risk mitigation strategy, it is proposed that a separate entity, the Asset Holding Trust (the Unit Trust), will acquire the land and construct the facility.

Once constructed, the Unit Trust will lease the facility at market rates to Company A or a subsidiary of Company A who will operate the manufacturing facility.

The Unit Trust will issue two classes of units:

•         Class A - rights only to income generated by the Unit Trust. That is, they will receive all of the income, by way of rental income generated by the property (at a market rental yield) until the property is eventually sold.

•         Ordinary - rights only to capital of the unit trust whilst there are Class A units on issue. A consequence of this is that they will receive all of the capital gain at the time the property is ultimately sold, but would not receive any other benefit until that point.

The units in the Unit Trust will be issued at market value.

The Class A unit holder will be Company B.

The Ordinary units will be held by Discretionary Trust, whose beneficiaries will be the director of Company A, and their family members.

The initial funding for the acquisition of the property will be:

•         Class A units - Company B will subscribe units at market value.

•         Ordinary units - The Discretionary Trust will subscribe for units at market value.

•         The Unit Trust will borrow from a bank or non-related lender funds in order to fund the settlement of the purchase of the property.

•         If additional funding is required, say to develop the manufacturing facility, the proportions as between the A Class and Ordinary unit holders will always remain the same.

Company A will lend the Class A unit subscription amount to Company B (via a Company A subsidiary entity) to acquire the units in the Unit Trust. The loan will be interest free.

The Director of Company A will lend the ordinary unit subscription amount to the Discretionary Trust to acquire the ordinary units in the Unit Trust.

Construction costs will be funded by the Unit Trust by borrowing from a bank or other external lender or, failing that, make further calls on the partly paid Class A and Ordinary units.

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.

Section 109T of the ITAA 1936 deals with payments and loans made by private companies to another entity through one or more interposed entities. Where Subdivision 109E applies, the private company is taken to be pay a dividend to the target entity.

Section 109T provides that 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.

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).

Application to your circumstances

Section 109T will apply to treat the amount paid from Company A to the Unit Trust (via the Company A Subsidiary and Company B (the interposed entities) as a payment as described in section 109V for the following reasons:

a)    Company A loans an amount to Company B (via the Company A Subsidiary) for the purposes of making a payment to the Unit Trust for the subscription of units.

b)    A reasonable person would conclude that Company A made the loan solely or mainly as part of an arrangement involving a payment or loan to the Unit Trust.

c)    Company B made the payment to the Unit Trust (the target entity).

In determining the amount of the payment, section 109V(2) provides that the Commissioner must take into account:

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

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 Income tax: Division 7A - payments and loans through interposed entities - factors the Commissioner will take into account in determining the amount of any deemed payment or notional loan arising under section 109T of the Income Tax Assessment Act 1936 provides that:

Subsections 109V(2) and 109W(2) do not exhaustively describe the factors which the Commissioner can consider when quantifying the payment or loan. In particular, it is relevant to have regard to the commerciality of the loan from the private company to the interposed entity.

Paragraph 9.86 of the Explanatory Memorandum to the Taxation Laws Amendment Act (No. 3) 1998 provides that:

This provision allows the Commissioner to take into account such things as a payment from the interposed entity which was, in whole or in part, the arm's length consideration for the sale of goods or the provision of services to the interposed entity by the shareholder or associate.

Section 109V(2) provides the Commissioner with broad discretion on what constitutes consideration for anything that may be provided by the target entity and the private company. The above ATO view further states that regard must be had to the commerciality of the loan or payment from the private company to the target entity.

The payment from Company A to Company B, which will be used to subscribe for units in the Unit Trust at market value is commercial in nature for the following reasons:

•         the taxpayers are of the view that ownership of the facility under the operating entity or an entity wholly owned by Company A is not appropriate from an asset protection perspective as the particular medical products being developed and manufactured is a high-risk activity with significant regulatory and commercial risks.

•         the unit subscription fees will be used to acquire land and construct the manufacturing facility.

•         The facility will be leased back to Company A with commercial arms-length lease terms.

•         The rights and obligations under the class A units which hold rights to the income of the Trust are at arms-length.

As the price paid for the subscription of units in the Unit Trust will be at market value, the amount of the payment from Company A to the Unit Trust for the purposes of section 109V(2) will be nil.

Therefore, for the purposes of section 109T, no amount of the payment is deemed to be a dividend under section 109C.