Edited version of private advice

Authorisation Number: 1052129530678

Date of advice: 14 June 2023

Ruling

Subject: Division 7A

Question 1

Are loans advanced from the Partnership to Trust A subject to Division 7A?

Answer

Yes.

Question 2

Are overdrawn partner accounts for Person B and Person C in the Partnership's financial statements subject to Division 7A?

Answer

Yes.

Question 3

Are loans owing from Company D to Person B and Person C subject to Division 7A?

Answer

Yes.

Question 4

If the answer to Questions 1, 2, or 3 is 'yes', has the amendment period expired for the Commissioner to make an assessment for any deemed dividend arising out of the relevant transactions?

Answer

No. The relevant entities have a 4-year limited amendment period, and the Commissioner can amend their assessments to include deemed dividends where this period hasn't ended. Furthermore, where the entities applied for this private ruling before the end of a 4-year limited amendment period, then the Commissioner may amend their assessments to give effect to this ruling notwithstanding that this 4-year limited amendment period may have ended. Based only on the facts and information disclosed in this ruling, the Commissioner wouldn't rely on the fraud or evasion exception to amend assessments outside of the 4-year limited amendment period.

Question 5

If the answer to either Question 1, 2, or 3 is 'yes', will the Commissioner exercise the discretion under section 109RB in respect to any Division 7A breaches resulting in deemed dividend assessments within the amendment period?

Answer

The Commissioner will exercise the discretion under section 109RB (to disregard the dividends deemed by Division 7A and dealt with in this private ruling) subject to a condition that Person B, Person C and Trust A each pay to Company D an amount that, in essence, places Company D in the same position it would have been had Division 7A always been complied with.

•                     The amounts on which these payments would need to be calculated are set out in Table 1. The principal amounts would all need to be repaid, plus additional amounts representing interest accrued.

•                     For transactions which happened more than 7 years ago, those payments would need to be made by 30 June XXXX.

•                     Transactions which happened less than 7 years ago may be placed on complying section 109N terms so long as Person B, Person C, and Trust A make appropriate catch-up payments (including interest) by 30 June XXXX.

•                     Amounts representing interest accrued should be calculated using the relevant income year's benchmark interest rate (for the purposes of sections 109E and 109N) and applying that to what the outstanding balance would have been at 30 June in the preceding income year, including any interest already accumulated for previous income years.

For example, if the balance of Trust A loan was $X at 30 June YYYY, for the YYYY+1 income year, Trust A should pay interest on a sum worked out at $X plus the interest that should have accumulated (at benchmark interest rates) since the beginning of the loan.[1]

Table 1: Obligations and outstanding balances

This ruling applies for the following period:

1 July AAAA to 30 June XXXX

The scheme commenced on:

1 July AAAA

Relevant facts and circumstances

In this ruling the Partnership means the partnership formed by Person B, Person C, and Company D.

1.    The Partnership comprises two individuals and one company. The partners are Person B, Person C, and Company D. Each have a 1/3 interest in the Partnership. They don't have a written partnership agreement. The Partnership operates business activities on real property owned by Trust A.

2.    Person B and Person C are shareholders and directors of Company D and have been since AAAA.

3.    Company D had limited functions and activities. It doesn't carry on a separate business activity from the Partnership. It received distributions from Trust E totalling about $X over the AAAA through YYYY income years (stopping in YYYY+1), which were used by the Partnership for working capital.

4.    Person B and Person C are also shareholders and directors of Trust A's corporate trustee.

5.    We have financial reports spanning the period from 1 July BBBB to 30 June YYYY for the Partnership, Company D, and Trust A.

6.    Company D's financial reports and income tax returns for the CCCC through YYYY financial/income years don't disclose any dividends paid to shareholders.

7.    Person B, Person C, and Company D are potential beneficiaries under Trust A. The trust deed contains broad discretions for the trustee to pay or set aside income or capital for any of the trust's beneficiaries. The Schedule to the trust deed lists Person B and Person C, and corporations in which they are directors or shareholders, as general beneficiaries.

8.    Trust A holds property. It owns business land used by the Partnership. It also owns units in a property unit trust. It doesn't carry on business in its own right.

9.    The Partnership made loans to Trust A. The Partnership's accounting records suggest it made loans to Trust A totalling $X before the DDDD income year. It also advanced money to Trust A in the DDDD ($X), EEEE ($X), and FFFF ($X) income years. The DDDD loan was for the trust to purchase real property, while the EEEE loan was to partially repay a bank loan which the trust had incurred to acquire real property. Person B and Person C have said they weren't aware that these transactions were loans payable to the Partnership or that Trust A was required to repay them. Table 2 shows how these loans are recorded in accounting records for both Company D and Trust A.

Table 2 - Loans from Company D to Trust A (accounting records)

10.  Company D made loans directly to Person B and Person C. Company D's accounting records suggest it made a loan to Person B and Person C of $X before the DDDD income year. Company D lent another $X to Person B and Person C during the EEEE income year. These loans didn't involve Person B and Person C withdrawing cash from Company D, because Company D never had a bank account. The applicant suggests that the loan arose as a journal entry made by the former tax agent. Person B and Person C weren't aware that they had received a loan from Company D or that they needed to repay it.

11.  Person B and Person C used the funds from these Partnership loans (to themselves and to Trust A):

•                     to fund business inputs for the business

•                     for living costs

•                     to provide for their children's education, and

•                     to purchase additional real property which is used in the business.

12.  The Partnership's accounting records show balances and movements in each partner's entitlements. Each partners' total entitlement balance is increased by their share of profit each year. However, the balances are also adjusted (increased or decreased) to account for items such as 'partners salary', 'drawings' (including for income tax and superannuation), 'advances', 'capital introduced', 'advances'. All three partners have drawings for income tax - suggesting that the Partnership paid for their tax obligations. The net movements in entitlement balances in the partnership accounts show that:

•                     Person B and Person C have overdrawn their partnership entitlements

•                     Company D has underdrawn its partnership entitlement.

13.  We describe the ending balances and net movements from the CCCC income year through YYYY income years in Table 3. In that table:

•                     negative ending balances mean a total overdrawn balance

•                     positive ending balances mean a total underdrawn balance

•                     negative net movements mean the partner's entitlement has decreased compared to the previous year (in other words, they have made a net overdrawing during the relevant year)

•                     positive net movements mean the partner's entitlement has increased from the previous year (in other words, they have made a net underdrawing during that year).

Table 3: summary of partnership entitlements

14.  The Partnership's accounting records show that Person B and Person C made fresh overdrawings in many years. Person B and Person C overdrew their partnership entitlements in many of the income years from DDDD to YYYY.

•                     DDDD: $X to Person C

•                     EEEE: $X to Person B, and $X to Person C

•                     FFFF: $X to Person B, and $X to Person C

•                     YYYY: $X to Person B, and $X to Person C.

We restate the net underdrawings (positive) and overdrawings (negative) in Table 4.

Table 4: Net underdrawings and overdrawings

15.  Person B, Person C, and Company D didn't have any agreement about repaying overdrawn partner entitlements.

16.  Person B and Person C didn't pay interest on overdrawn entitlements.

17.  Person B and Person C weren't aware their partnership overdrawn entitlements could be considered loans from Company D or the Partnership, or that they needed to repay those overdrawn amounts.

18.  Person B and Person C used the funds from their overdrawn partner accounts for the same purposes as the loans from Company D.

19.  For the transactions described in these facts (both loans from Company D and the Partnership, and overdrawn partner accounts), Person B, Person C, and Trust A didn't:

•                     enter any loan agreements which complied with Division 7A

•                     record any deemed dividends in their tax returns.

20.  Person B and Person C established the arrangements described in these facts on the advice of their former tax agent. Person B and Person C started operating their business in partnership with Company D in July AAAA on the professional advice of that former tax agent. That former tax agent advised them that this was the most appropriate trading structure for their business going forward. The former tax agent also determined the partners' salaries.

21.  Person B and Person C relied on their former tax agent to comply with their tax obligations. Their former tax agent was Tax Agent F. They started engaging Tax Agent F in about HHHH, when Tax Agent was the only chartered accountant in town. Person B and Person C were encouraged by Tax Agent F's client list, which included many established and successful people who they respected. They placed considerable trust in Tax Agent F's abilities and advice. Person B and Person C wanted to be sure they had the best advice that was squeaky clean. Person B and Person C are business people with limited understanding of taxation and relied on Tax Agent F for their group's tax affairs.

22.  Person B and Person C questioned Tax Agent F about the arrangements described in these facts and were reassured by the responses.

•                     Every year, Person B and Person C questioned Tax Agent F about the partnership arrangement and structure to check it complied with tax obligations.

•                     In response, every year, Tax Agent F assured them that the arrangement complied.

•                     Person B and Person C relied on this professional advice.

23.  Tax Agent F never mentioned Division 7A to Person B or Person C. Tax Agent F didn't mention the potential Division 7A implications of their structure including both the inter-entity loans and their partnership accounts. Further, Tax Agent F never gave general advice to Person B or Person C about the legal implications of accessing company money for private purposes or receiving payments from related companies. Person B and Person C were unaware that tax issues may have arisen from the loans from the Partnership, the loans from Company D, or overdrawn partner accounts.

24.  In July YYYY Person B and Person C stopped using Tax Agent F as a tax agent and engaged their present tax agents.

25.  Person B and Person C's present tax agents advised them about Division 7A and how it might apply to the arrangements described in this private ruling.

26.  After receiving this advice, Person B and Person C:

•                     applied for a private binding ruling on XXXX about the tax consequences of these arrangements, and

•                     sought the Commissioner's discretion under section 109RB to disregard any relevant transactions to the extent that Division 7A applied to them.

27.  They now submit that:

•                     they would have made repayments had they known the arrangements described in these facts were loans

•                     a reasonable person would conclude that the purpose of Company D's underdrawn partnership entitlement was to contribute working capital to the Partnership, not to make payments or loans to Person B, Person C, or Trust A.

28.  Person B and Person C have proposed corrective action, conditional on the Commissioner exercising the discretion under section 109RB. That corrective action would be to:

•                     treat any transactions subject to Division 7A as having been converted into loan agreements that comply with section 109N

•                     declare fully franked dividends in the XXXX income year from Company D to Person B and Person C (on a 50/50 basis) to meet shortfall principal and interest repayments up to XXXX

•                     include shortfall interest payments in Company D's income tax return for the XXXX income year

•                     treat the balance of loans as continuing on complying section 109N loans, meeting the minimum yearly repayments in following years.

29.  ATO records show details about recent income years for Person B, Person C, Company D, and Trust A. Those records show assessments issued for Person B, and Person C, and that Company D lodged returns (deemed to be assessments) on certain dates. They also show Trust A lodged returns which didn't result in a trustee assessment on certain dates. We list the relevant dates in Table 5.

Table 5: Lodgment and assessment dates

Former ATO guidance about Division 7A and partnership entitlements

30.  Former ATO web guidance suggested that Division 7A wouldn't ordinarily apply where a partner had overdrawn their partnership entitlement and a private company in the same partnership had an underdrawn entitlement. The ATO website had a document giving answers to frequently asked questions on Division 7A.[2] Questions 79 and 80 addressed whether a private company partners' undrawn partnership profits, or an overdrawing by its shareholders or associates, could be subject to Division 7A. We list the questions and answers in Table 6. That web guidance has been withdrawn and doesn't reflect the ATO's current view.

Table 6: Questions 79 and 80 in former ATO guidance

Relevant legislative provisions

Income Tax Assessment Act 1936 section 6

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 section 109J

Income Tax Assessment Act 1936 section 109K

Income Tax Assessment Act 1936 section 109L

Income Tax Assessment Act 1936 section 109M

Income Tax Assessment Act 1936 section 109N

Income Tax Assessment Act 1936 section 109NA

Income Tax Assessment Act 1936 section 109NB

Income Tax Assessment Act 1936 section 109Q

Income Tax Assessment Act 1936 section 109RA

Income Tax Assessment Act 1936 section 109RB

Income Tax Assessment Act 1936 section 109T

Income Tax Assessment Act 1936 section 109V

Income Tax Assessment Act 1936 section 109W

Income Tax Assessment Act 1936 section 109ZD

Income Tax Assessment Act 1936 section 170

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 section 960-100

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

In these reasons, references to:

•                     the Partnership mean the partnership formed by Person B, Person C, and Company D

•                     un-hyphenated legislative provisions (eg, section 109C) mean those provisions in the Income Tax Assessment Act 1936, except where we specify a provision in the Regulations

•                     hyphenated provisions (eg, section 995-1) mean provisions in the Income Tax Assessment Act 1997, except where we specify another act

•                     'tax acts' mean both the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997 taken together

•                     Division 7A mean Division 7A of the Income Tax Assessment Act 1936

•                     the Regulations mean the Income Tax Assessment (1936 Act) Regulation 2015.

Question 1

Are loans advanced from the Partnership to Trust A subject to Division 7A?

Summary

1.    Yes. Those loans were only possible because Company D never called on its entitlements to partnership income. The controllers of Company D, the Partnership and Trust A are all connected in such a way that Company D would necessarily have been aware of, and acquiesced to, the loans made by the Partnership to Trust A. The Partnership loans wouldn't have been possible without the agreement or acquiescence of Company D. Consequently, Company D provides financial accommodation to Trust A, so Division 7A applies to treat the amounts as dividends from Company D to Trust A.

Explanation

2.    Broadly, Division 7A treats payments, loans, and forgiven debts, where they relate to private companies and their shareholders, as dividends for tax purposes. Operative rules in Subdivision B treat payments, loans, and forgiven debts as dividends where:

•                     the private company is making the payment, loan, or forgiving the debt, and

•                     the recipient of the payment or loan, or the forgiven debtor, is or was a shareholder, or an associate of a shareholder.

There are also rules in Subdivision E which treat transactions made by interposed entities as having been made directly by the private company. Subdivision D has exceptions where Division 7A won't apply.

3.    Before addressing the operative, interposed entity, and excluding rules, we'll briefly discuss some defined terms used in Division 7A.

Applying some defined terms: Company D is a private company; Trust A and the Partnership are both associates of Company D's shareholders.

4.    Section 109ZD says:

•                     'associate' has the meaning given by section 318, and

•                     'entity' has the meaning given by section 960-100.

5.    Associates of entities include:

•                     a partnership in which the entity is a partner: paragraph 318(1)(b), and

•                     the trustee of any trust where the entity benefits under the trust: paragraph 318(1)d.

6.    Section 960-100 says that 'entity' includes individuals, bodies corporate, partnerships, and trusts. For the purposes of both tax acts, 'partnership' includes an association of persons carrying on business as partners. See sections 6 and 995-1.

7.    Broadly, for tax purposes, partnerships calculate their net income but partners declare their share of the profit or loss. The relevant rules are in Division 5 of the Income Tax Assessment Act 1936. Section 91 says a partnership lodges a return but isn't liable to pay tax. Section 92 says each partner includes their share of the partnership's net income in their assessable income and may deduct their share of a partnership loss. Section 90 says that 'net income' is the partnership's assessable income less allowable deductions, calculated as if it was a resident taxpayer.

8.    Broadly, 'private company' is an incorporated company which isn't public.

•                     Section 6 says 'private company' means a company that's a private company for the purposes of Division 7. Section 6 says 'company' takes its meaning from section 995-1.

•                     Section 995-1 says 'company' includes a body corporate. 'Body corporate' isn't defined in either tax act, but ATO guidance says it means an artificial entity with a separate legal existence, and includes entities created under the Corporations Act. See MT 2006/1[3] at paragraphs 30-34.

•                     The effect of section 103A (in Division 7) is that private companies are companies which aren't public companies. Public company loosely means companies which have shares listed on a stock exchange or fall within a short list of other company types (they include government-controlled companies, non-profits, and cooperatives or similar bodies).

9.    We'll briefly apply these definitions to this scenario.

•                     Company D is a private company. It's incorporated as a proprietary listed company under Australian law. It's family controlled, and isn't listed on the stock exchange, or a non-profit.

•                     Person B, Person C, the Partnership, and Trust A are all 'entities' for tax purposes - they're either individuals, a partnership, or a trust.

•                     Trust A is an associate of Company D's shareholders. Person B and Person C are Company D's shareholders. They're both beneficiaries under Trust A, so the trust is their associate.

•                     The Partnership is also an associate of Company D's shareholders. Person B and Person C are partners in the Partnership, so the Partnership is their associate.

The primary operative rules: Subdivision B deems loans and payments from a private company to a shareholder or associate to be dividends.

10.  Payments from private companies to an entity may be taken to be dividends, if made to an entity that's a shareholder (or an associate of a shareholder). Section 109C applies where the payment is to a shareholder (or an associate) when the payment is made, or a reasonable person would conclude the payment was made because the entity has been a shareholder (or associate) at some time. Payment has an extended meaning which covers payments on behalf of, credits, and transfers of property: see subsection 109C(3). But amounts treated as loans under section 109D aren't treated as payments: subsection 109C(3A).

11.  Loans from private companies to shareholders or associates may also be treated as deemed dividends. Section 109D applies if three core elements are met.

•                     First, either the loan recipient is a shareholder (or an associate of a shareholder) when the loan is made, or a reasonable person would conclude the loan was made because the entity was a shareholder (or an associate) at some time.

•                     Second, the loan isn't fully repaid by the lodgment date for the income year.

•                     Third, an exception in Subdivision D doesn't apply. We'll briefly address exceptions to Division 7A at paragraphs Error! Reference source not found. and Error! Reference source not found..

12.  'Loan' for Division 7A purpose has an extended meaning. That meaning covers advances of money, the provision of credit or any other form of financial accommodation, payments where there's an express or implied obligation to repay, or 'in substance' loans. We'll elaborate on this extended meaning by referring to ATO guidance.

•                     The ordinary meaning of loan would normally cover something given for a temporary period, ie, on the condition of being returned: see SMSFR 2009/2 at paragraphs 34 and 35.[4]

•                     'Credit' involves allowing time to pay any debt, not just loans: see TD 2022/11[5] at paragraph 58.

•                     TD 2022/11 suggests 'financial accommodation' has a broad meaning. While this TD focusses on whether unpaid present entitlements are financial accommodation, it makes some points which have more general application. It suggests 'financial accommodation' extends to cases where there's a consensual arrangement between the parties, or an entity with a (trust) entitlement has knowledge of an amount that it can demand and doesn't call for payment. See paragraphs 6 and 62 through 73.

•                     TD 2022/11 says for the purposes of determining whether one entity has extended 'financial accommodation' to another, knowledge can be imputed where both entities are controlled by the same person. See paragraphs 78 through 84.

13.  The same ATO guidance also suggests that the financial accommodation would arise in the following year after the entitlement arose. In the context of unpaid present entitlements, TD 2022/11 at paragraphs 12, 89, and 90 suggests that a private company would usually become aware of its present entitlement to trust income for an income year in the following income year.

14.  For completeness, there are also interposed entity rules which may treat loans and payments made by other entities as having been made by a private company. These rules are in Subdivision E. Broadly, the effect of section 109T is that the interposed entity rules apply where a reasonable person would conclude that the private company made a loan or a payment to an interposed entity as part of an arrangement where the interposed entity on-lent or on-paid to the target entity. Where section 109T applies, then sections 109V (payments) and 109W (loans) treat the private company as having made the payment or loan directly to the target entity for Division 7A purposes. However, the effect of subsection 109T(3) is that the interposed entity rules don't apply if Division 7A would already treat the private company's loan or payment to the interposed entity as a dividend.

The excluding rules in Subdivision D: transactions on arm's length terms, or which are otherwise included in assessable income, won't be deemed dividends.

15.  Broadly, excluding rules in Subdivision D prevent transactions which are on arm's length terms or are already assessable from being treated as dividends. We'll briefly summarise the circumstances where provisions in Subdivision D exclude transactions from Division 7A.

•                     Payments that discharge arm's length obligations: section 109J.

•                     Payments and loans between companies: section 109K.

•                     Payments and loans that are already assessed as income or are excluded from assessable income under a specific provision: section 109L.

•                     Loans made in the ordinary course of business on arm's length terms: section 109M.

•                     Transactions made as or converted into qualifying written loan agreements requiring repayment on specified terms that comply with section 109N.

•                     Liquidator's distributions: section 109NA.

•                     Loans to purchase shares under an employee share scheme: section 109NB.

•                     Demerger dividends: section 109RA.

•                     Transactions where the Commissioner applies a discretion to vary how Division 7A operates. Section 109RB allows the Commissioner to disregard dividends or allow them to be franked if Division 7A because of an honest mistake or inadvertent omission. Section 109Q allows the Commissioner to disregard dividends caused from a failure to make the required minimum yearly repayment under section 109E (where satisfied that the dividend would cause hardship and was triggered by circumstances outside the entity's control).

Division 7A will treat the loan as a direct loan or payment from Company D to Trust A: Company D is consenting to an arrangement under which its partnership entitlements are redirected.

16.  As a preliminary point, we think it's evident from the facts and financial statements that Company D's underdrawn partnership entitlements enabled the loans to Trust A. Here, Company D's and the Partnership's financial statements show Company D's underdrawn entitlement was over $X by 30 June BBBB and had risen to over $X by 30 June DDDD. The Partnership made loans to Trust A totalling $X, of which $X was made after 30 June BBBB.

17.  The loans to Trust A fall within the extended definition of a loan under section 109D. Company D provided Trust A with financial accommodation. This financial accommodation arises as the Partnership was only able to make these loans to Trust A with the acquiescence or agreement of Company D. Those loans wouldn't have been possible had Company D called on its partnership entitlements.

18.  Alternatively, it's possible that Company D's underdrawing could be characterised as payments to Trust A. Person B and Person C have said that they didn't intend any of the relevant transactions to be repaid and didn't appreciate that the transactions needed to be repaid. Conceivably, if there was never any intention for Company D to claim its entitlement, the transactions would be better characterised as payments. Since all entities had common controlling minds, Company D should be treated as having appreciated that in failing to draw on its partnership entitlements, it was consenting to the Partnership redirecting its entitlements to other entities, including to Trust A. While the Partnership may have transferred the relevant funds to Trust A, the arrangement could be characterised as payments by the Partnership at Company D's direction.

19.  Division 7A therefore would treat Company D as having paid dividends to Trust A unless exceptions apply. Company D is a private company. Trust A is an associate of Company D's shareholders. Company D has made loans (or alternatively payments) to Trust A. Section 109D (or alternatively section 109C) would apply to deem dividends unless any of the excluding rules in Subdivision D operate. We don't need to determine whether the transactions are best characterised as payments or as loans, because they will be treated as dividends in either event.

20.  Each loan will be treated as a dividend in the income years when the Partnership made the loans. When all loans were made, Company D's controlling minds would have had constructive knowledge of two things. First, Company D had a substantial underdrawn partnership entitlement. Second, its ongoing failure to demand payment would allow the Partnership to fund the loans. Therefore, the financial accommodation (or payments by direction) would arise in the income years when the Partnership provided the funds to Trust A.

21.  We can see two alternative ways Division 7A could operate here. First, in underdrawing its entitlements, Company D could be characterised as making section 109C payments or section 109D loans to the Partnership. Second, Company D could be treated as having made loans or payments to Trust A under the interposed entity rules.

22.  But we don't think it's appropriate to take either of these approaches on these facts. We think these transactions are best characterised as direct loans or payments to Trust A because all entities were controlled by Person B and Person C. The Partnership is simply an agreement between Company D and Person B and Person C. Since Person B and Person C controlled Company D, it should therefore be taken to have consented to a redirection of its entitlements to Trust A. It's unnecessary to characterise the arrangement as involving loans or payments to the Partnership. Further, we wouldn't need to consider the interposed entity rules where the underlying transactions can be appropriately characterised as direct loans or payments to the target entity.

The excluding rules in Subdivision D won't apply unless the Commissioner exercises a discretion to vary how Division 7A operates.

23.  The excluding rules in Subdivision D won't apply here unless the Commissioner exercises a discretion to vary how Division 7A operates. Most of those rules aren't relevant to this scenario.

•                     Company D hasn't discharged an arm's length obligation; it didn't set-off its entitlement against an obligation or debt it owed to the Partnership.

•                     Company D hasn't transacted with another company.

•                     Trust A didn't include Company D's underdrawing as an amount in its assessable income.

•                     Company D's underdrawing isn't an arm's length loan made in the ordinary course of business. It doesn't carry on any business (such as a money lending business) separate from the Partnership, and an arm's length partner wouldn't have underdrawn its partnership entitlements without requiring repayment plus interest.

•                     The entities didn't enter loan agreements that complied with section 109N.

•                     The rules about liquidation, employee share schemes, and demergers aren't relevant here.

•                     The Commissioner's discretion under section 109Q isn't relevant here because the parties haven't entered loan agreements that comply with section 109N.

•                     Section 109RB is potentially relevant to any situation where Division 7A operates.

Conclusion: Division 7A will apply to treat the Partnership's loans as dividends from Company D to Trust A.

24.  It follows that the operative rules in Division 7A will apply to the loans from the Partnership to Trust A. Company D is a private company. We've concluded that Company D will be treated as having made direct loans, or alternatively payments, to Trust A. The trust is an associate of Company D's shareholders. The elements of section 109D (or alternatively section 109C) are met. The excluding rules in Subdivision D won't apply unless the Commissioner applies the discretion in section 109RB.

Question 2

Are overdrawn partner accounts for Person B and Person C in the Partnership's financial statements subject to Division 7A?

Summary

25.  Yes. Division 7A will treat Person B and Person C's overdrawn partner accounts as dividends. Similar to Question 1, Company D has made loans or payments to Person B and Person C by failing to call on its underdrawn partnership entitlement.

Explanation

26.  Our reasons are similar to why Division 7A applies to loans from the Partnership to Trust A.

•                     Company D's underdrawn partnership entitlement permitted Person B and Person C to overdraw. Company D had an underdrawn entitlement which seems to have exceeded both Person B and Person C's overdrawings and the loans to Trust A.

•                     Company D would have had constructive knowledge about Person B and Person C's overdrawings because Person B and Person C were Company D's controlling minds.

•                     We think Company D was making loans through granting financial accommodation directly to Person B and Person C by consenting to Person B and Person C's overdrawings without demanding payment of its underdrawn entitlement.

•                     Alternatively, Person B and Person C's overdrawings could be characterised as payments by direction from Company D. Company D is tacitly authorising the Partnership to redirect its entitlement to Person B and Person C.

•                     We don't characterise the arrangement as involving Company D making loans or payments to the Partnership for similar reasons to those discussed in Question 1 at paragraph Error! Reference source not found..

•                     The excluding rules in Subdivision D aren't relevant for similar reasons to the ones we gave in Question 1 at paragraph Error! Reference source not found..

•                     It follows that either section 109C or section 109D will apply to treat these transactions as dividends from Company D to Person B and Person C.

Question 3

Are loans owing from Company D to Person B and Person C subject to Division 7A?

Summary

27.  Yes. Division 7A will apply, because these transactions are either loans or payments from a private company to its shareholders. The exceptions to Division 7A aren't relevant.

Explanation

28.  These transactions could be characterised as either loans or payments.

•                     They fit the extended meaning of a loan. The arrangements are recorded as loans in Company D's financial statements. While Person B and Person C have suggested they didn't appreciate the Company D loans needed to be repaid, and they didn't involve cash payments, the transactions would still be described as credits or financial accommodation to Person B and Person C.

•                     Alternatively, if Company D never intended to be repaid, the transactions could be characterised as payments by direction.

•                     We don't need to determine which characterisation is most appropriate on these facts because Division 7A would apply the same way.

29.  The operative rules in Subdivision B will apply to treat the loans from Company D to Person B and Person C as dividends.

•                     Company D is a private company.

•                     Person B and Person C are its shareholders.

•                     Company D has made either loans or payments to Person B and Person C.

•                     The excluding rules in Subdivision D aren't relevant for similar reasons to the ones we gave in Question 1 at paragraph Error! Reference source not found..

•                     It follows that either section 109C or section 109D will apply to treat these transactions as dividends from Company D to Person B and Person C.

30.  Therefore, Company D will be taken to pay dividends to Person B and Person C of:

•                     $X sometime before the EEEE income year, and

•                     $X during the FFFF income year.

Question 4

If the answer to Questions 1, 2, or 3 is 'yes', has the amendment period expired for the Commissioner to make an assessment for any deemed dividend arising out of those transactions?

Summary

31.  No. The relevant entities have a 4-year limited amendment period, and the Commissioner can amend their assessments to include deemed dividends where this period hasn't ended. Furthermore, where the entities applied for this private ruling before the end of a 4-year limited amendment period, then the Commissioner may amend their assessments to give effect to this ruling notwithstanding that this 4-year limited amendment period may have ended.

32.  Based only on the facts and information disclosed in this ruling, the Commissioner wouldn't rely on the fraud or evasion exception to amend assessments outside of the 4-year limited amendment period.

Explanation

The Commissioner generally has a 2 or 4-year period in which to amend assessments, depending on the entity's circumstances, although the amendment period is unlimited in some cases.

33.  Tax laws limit the periods in which the Commissioner may amend assessments. The amendment periods are set by section 170 unless modified by regulations. Very broadly, individuals generally have a 2-year amendment period. Companies and trusts will also have a 2-year amendment period where they are small business entities. However, the effect of Item 4 in the Table in subsection 170(1) is that the amendment period is raised to 4 years where exceptions listed in Items 1, 2, and 3 apply. We summarise in Table 7.

Table 7: Exceptions to the 2-year amendment period

34.  The Regulations extend the amendment period to 4 years in two relevant cases. These are in Items 1 and 2 in the Table in section 14 of the Regulations. Item 1 applies where there's a transaction involving associates who aren't dealing at arm's length and at least one has a 4-year amendment period. Item 2 applies where a private company is taken to pay a dividend under Division 7A and the company has a 4-year amendment period.

35.  However, there's no limit in some circumstances. Many provisions in section 170 allow the Commissioner to amend an assessment at other times, mostly at any time. Two more generally applicable circumstances include:

•                     where the Commissioner is of the opinion there's been fraud or evasion: Item 5 of the Table in subsection 170(1)

•                     to give effect to a private ruling where the taxpayer applied for a private ruling before the end of the amendment period: subsection 170(6).

There are other exceptions in section 170, but most aren't relevant to the transactions and provisions raised by the ruling questions. We won't list them.

36.  The ATO has guidance about the fraud or evasion exception. According to ATO instructions to staff in PS LA 2008/6[7]:

•                     fraud means making false statements knowingly or recklessly to deceive the Commissioner

•                     evasion means a blameworthy act or omission (like taking an incorrect position, or intentionally withholding information)

•                     a blameworthy act or omission lies somewhere between innocent mistake and intention to defraud, and involves culpable conduct

•                     evasion is to be assessed objectively, based on the standard of a reasonable person, and involves conduct that a reasonable person wouldn't engage in

•                     fraud and evasion are serious matters and not to be inferred lightly.

The ATO's Fraud or evasion guidelines[8] at paragraph 66 say that the Commissioner may form a fraud or evasion opinion where the fraud or evasion was committed by an agent on the taxpayer's behalf, rather than by the taxpayer personally.

37.  The ATO treats trustee returns as having a limited amendment period. PS LA 2015/2[9] explains.

•                     In many cases, trust tax returns don't result in an assessment for the trustee.

•                     Strictly, this means the Commissioner has an unlimited period within which to assess the trustee's tax position.

•                     However, this outcome is inconsistent with the purpose for limited amendment periods.

•                     Therefore, the ATO treats returns lodged by trustees as if they resulted in an assessment for the purposes of calculating a trustee's limited amendment period.

The amendment period will be 4 years, except for the 2018 and subsequent income years, where the Commissioner has an unlimited time to give effect to this private ruling decision.

38.  The limited period of review will, unless an exception applies, be 4 years here because the relevant entities are a trustee and beneficiaries of a trust, where that trust doesn't carry on business.

•                     Trust A doesn't run a business, so it won't have a 2-year period of review.

•                     It's possible that Person B, Person C, and Company D could be carrying on a small or medium business as partners, which could potentially mean the amendment period is 2 years.

•                     However, three exceptions apply which extend the amendment period to 4 years.

•                     First, Person B, Person C, and Company D are all potential beneficiaries under Trust A. The Trust A doesn't carry on business, so it can't be a small or medium business entity. The trust beneficiary exception in Items 1(d) and 2(b) of the Table in subsection 170(1) apply.

•                     Second, Person B, Person C, and Company D have had non arm's length dealings. The Partnership (which includes them as partners) has made interest free loans to themselves and a family trust. Those are non arm's length dealings because parties acting at arm's length would pay interest. Trust A has a 4-year period of review. This means the exception in Item 2 of the Table in section 14 of the Regulations would apply.

•                     Finally, Division 7A applies and the private company has a four-year period of review. This means the exception in Item 2 of the Table in section 14 of the Regulations applies.

•                     For completeness, the Partnership wouldn't have a limited amendment period. While it's required to lodge returns, those returns wouldn't result in an assessment. Rather, the issue is whether any adjustment to the Partnership's net income would result in an amended assessment to each partner. That would depend on whether the relevant amendment period for Person B, Person C, and Company D had expired.

39.  While we think there are some factors that might suggest evasion, the Commissioner wouldn't rely on the fraud or evasion exception to extend the amendment period on these facts alone.

40.  The Commissioner may amend assessments to give effect to a decision in this private ruling for transactions taking place in the BBBB and subsequent income years only. Subsection 170(6) allows the Commissioner to amend an assessment if the taxpayer applies for a private ruling before the end of the period, and the Commissioner makes a private ruling because of the application. Here, the applicants applied for a private ruling in XXXX, which was before the limited amended assessment periods for the relevant taxpayers expired for the DDDD income year (in XXXX), or will expire for any subsequent years.

41.  We haven't identified any other exceptions to the extended amendment period that are directly relevant to the provisions and transactions addressed by the questions in this ruling.

42.  It follows that Person B, Person C, and Trust A will have a 4-year amendment period for the relevant transactions. Several of the exceptions to the 2-year amendment period will apply to ensure those entities have a 4-year amendment period. The Commissioner wouldn't rely on the fraud or evasion ground to extend the amendment period based on the facts in this private ruling. The only other exception we think relevant is the one allowing the Commissioner to amend an assessment to give effect to a private ruling.

Question 5

If the answer to either Question 1, 2, or 3 is 'yes', will the Commissioner exercise the discretion under section 109RB in respect to any Division 7A breaches resulting in deemed dividend assessments within the amendment period?

Answer

43.  The Commissioner would exercise the discretion under section 109RB (to disregard the dividends deemed by Division 7A and dealt with in this private ruling) subject to a condition that Person B, Person C and Trust A each pay to Company D an amount that, in essence, places Company D in the same position it would have been had Division 7A always been complied with.

•                     The amounts on which these payments would need to be calculated are set out in Table 1.

•                     The principal amounts would all need to be repaid, plus additional amounts representing interest accrued.

•                     Amounts representing interest accrued should be calculated using the relevant income year's benchmark interest rate (for the purposes of section 109E and 109N) and applying that to what the outstanding balance would have been at 30 June in the preceding income year, including any interest already accumulated for previous income years.

•                     For transactions which happened more than 7 years ago, those payments would need to be made by 30 June XXXX.

•                     Transactions which happened less than 7 years ago may be placed on complying section 109N terms so long as Person B, Person C, and Trust A make appropriate catch-up payments by 30 June XXXX.

44.  For example, if the balance of Trust A loan was $X at 30 June YYYY, for the YYYY+1 income year, Trust A should pay interest on a sum worked out at $X plus the interest that should have accumulated (at benchmark interest rates) since the beginning of the loan. [10]

Explanation

45.  The Commissioner may in some circumstances decide to disregard the operation of Division 7A where the deemed dividend arises out of an honest mistake or inadvertent omission. This power is given to the Commissioner by section 109RB. Subsection 109RB(1) sets threshold conditions.

•                     First, Division 7A must operate to treat an amount as a dividend.

•                     Second, that result must have arisen because of an honest mistake or inadvertent omission by the recipient, the private company, or any other entity whose conduct contributed to that result.

Where those circumstances are met, subsection 109RB(2) says that the Commissioner may make a decision to disregard a deemed dividend, or allow it to be franked.

46.  Subsection 109RB(3) lists relevant considerations for determining that decision. They include

•                     the circumstances leading to the mistake or omission

•                     the extent any entities have tried to correct it, and if so, how quickly

•                     whether Division 7A has applied before

•                     any other matters the Commissioner considers relevant.

47.  The ATO view is that the Commissioner can't consider exercising the discretion where a mistake or omission didn't cause Division 7A to operate. In other words, the mistake or omission must have triggered Division 7A for the discretion to be available. See TR 2010/8[11] at paragraphs 47 through 52 and PS LA 2011/29[12] at Step 1, paragraph 6.

48.  The ATO has a practice statement giving instructions about this discretion to internal staff. PSLA 2011/29 divides those instructions into two steps. Step 1 instructions are about helping staff determine whether Division 7A was triggered by an honest mistake or inadvertent omission. Step 2 instructions are about deciding whether the Commissioner's discretion should be exercised, and if so, how and under what conditions.

49.  We'll briefly summarise how we've applied that two-step approach to these facts.

Step 1: We accept that Division 7A applied because of Person B and Person C's mistake or omission about the tax consequences of these transactions.

50.  Under Step 1, PS LA 2011/29 suggests some considerations that are relevant to determining whether a mistake or omission is honest or inadvertent. We briefly list paraphrase some considerations in Table 8.

Table 8: Step 1 considerations in PS LA 2011/29

51.  While some circumstances may suggest otherwise, on balance, we've decided that Division 7A applied to the relevant transactions because of an honest mistake or inadvertent omission.

•                Person B and Person C relied on their former tax agent's advice and say they would have repaid loans had they been advised about Division 7A.

•                That's both a mistake (about tax law) or an omission (failure to make repayments and enter loan agreements).

•                We recognise that the law about how Division 7A applies to partnership entitlements isn't straightforward, and former ATO guidance may have provided support for the view that Division 7A wouldn't apply to the relevant transactions.

Step 2: The Commissioner should only exercise the discretion if the relevant entities pay Company D all Division 7A amounts, plus appropriate interest, including amounts where the amendment period has expired.

52.  Under Step 2, PS LA 2011/29 gives some instructions for how ATO staff should approach the discretion.

•                     Broadly, the considerations we referenced in Table 8 are also relevant to the decision about whether to exercise the discretion to disregard a dividend (or allow dividends to be franked).

•                     Other considerations include the extent of any corrective action taken or proposed by the relevant entities.

•                     The result of exercising the discretion should restore retained profits to the private company, achieve the correct repayments covering both principal and interest, and ensure the recipient of the loan, payment, or forgiveness is appropriately taxed.

•                     Period of review is also a relevant consideration.

•                     The Commissioner may make his or her decision to exercise a discretion subject to conditions, such as making specified payments, or specified requirements in Division 7A, by specified times.

53.  Here, the Commissioner will only exercise the discretion to disregard dividends if the relevant parties restore Company D, as closely as possible, to the position it would have been had Division 7A been complied with from the beginning.

•                     To comply with Division 7A, Person B, Person C, and Trust A would have had to repay that money, either by lodgment day, or by entering a loan agreement requiring them to make repayments plus interest.

•                     Had they complied with Division 7A from the beginning, all relevant transactions would have been repaid (with interest if not repaid by the relevant lodgment day).

•                     Person B, Person C, and Trust A didn't repay the relevant transactions or enter complying loan agreements under section 109N. Most section 109N loan agreements are unsecured 7-year loans rather than secured 25-year loans.

•                     This means they have had the benefit of accessing funds sourced from Company D's partnership entitlements over many years, without paying tax, repaying the funds, or paying interest on that money.

•                     To approximately return Company D to a Division 7A-compliant position, they will need to repay all Division 7A amounts, plus appropriate interest.

•                     We don't think it's appropriate to permit the taxpayers convert transactions into section 109N complying loan agreements where more than 7 years has passed since the relevant transactions happened. That would effectively reset the transaction as if it had happened some years later, with the effect of allowing the taxpayers interest-free use of the funds for earlier years.

•                     We will permit the taxpayers to convert transactions into section 109N complying loan agreements where less than 7 years have passed since the relevant transactions happened, so long as they make appropriate catch-up payments by 30 June XXXX.

54.  We won't exclude transactions for periods where the amendment period has expired from the necessary corrective action. We think the discretion in section 109RB shouldn't be exercised in a way which would make a taxpayer better off than others who had complied with Division 7A. If other taxpayers in this position had complied with Division 7A from the beginning, they would have had to repay all transactions with necessary interest payments. We don't think the discretion should be exercised in a way which puts taxpayers in a better position than if they had fully complied, or leaves a private company in a worse position, just because amendment periods have expired. Disregarding dividends without requiring full repayment and appropriate interest would have that effect.

[1] See ATO (July 2022), Division 7A - benchmark interest rate | Australian Taxation Office (ato.gov.au), for benchmark interest rates for the 2020 and later income years. Years for the 2019 and earlier income years were published in Taxation Determinations. For example, for the 2019 income year, refer to Taxation Determination TD 2018/14 Income tax: what is the benchmark interest rate applicable for the year of income that commenced on 1 July 2018 for the purposes of Division 7A of Part III of the Income Tax Assessment Act 1936 and how is it used?

[2] ATO (date unknown), Taxation of private company payments, loans and debts forgiven - The most frequently asked questions and answers on Division 7A of Part III of the Income Tax Assessment Act 1936.

[3] Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the morning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number.

[4] Self Managed Superannuation Fund Ruling SMSFR 2009/2 Self Managed Superannuation Funds: the meaning of 'borrow money' or 'maintain an existing borrowing of money' for the purposes of section 67 of the Superannuation Industry (Supervision) Act 1993.

[5] Taxation Determination TD 2022/11 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'?

[6] Very broadly, small (or medium) business entities are businesses with aggregated turnover below certain thresholds. The relevant aggregated turnovers vary depending on the relevant income year. However, those variations aren't relevant to this private ruling. The two-year period of review extended to medium business entities only applies from the 2022 income year. See Schedule 3, item 40(6) of the Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Act 2020 (No. 92 of 2020).

[7] Law Administration Practice Statement PS LA 2008/6 Fraud or evasion.

[8] ATO (July 2018) Fraud or evasion guideline (period of review),accessed at https://www.ato.gov.au (QC 55481) on 5 June 2023, at paragraph 66.

[9] Law Administration Practice Statement PS LA 2015/2 Trustee assessments.

[10] See ATO (July 2022), Division 7A - benchmark interest rate | Australian Taxation Office (ato.gov.au), accessed 9 June 2023.

[11] Taxation Ruling TR 2010/8 Income tax: application of subsection 109RB(1) of the Income Tax Assessment Act 1936.

[12] Practice Statement Law Administration PS LA 2011/29 Exercise of the Commissioner's discretion under section 109RB of Division 7A of Part III of the Income Tax Assessment Act 1936 to either disregard a deemed dividend or to permit a deemed dividend to be franked.