Edited version of private advice

Authorisation Number: 1052177663868

Date of advice: 6 October 2023

Ruling

Subject: Division 7A

Question

Will the in-specie distribution of the Property by the trustee of the Trust to the Individual Beneficiary result in an amount included as a deemed dividend in the Individual Beneficiary's assessable income under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

Relevant facts and circumstances

The Trust holds a property (the Property).

The Trustee is planning to transfer the Property to Individual Beneficiary by way of an in-specie distribution on a non-contingent basis (the Distribution).

The terms of the Trust's deed allow the Trustee to make the Distribution to Individual Beneficiary.

The Distribution is not in satisfaction of a right to income or capital from the Trust.

The Trust will derive a capital gain as a result of the Distribution.

The capital gain arising from the Distribution will be included in the net income of the Trust.

The Trust has a pre-16 December 2009 unpaid present entitlement (UPE) owing to a private company.

The UPE is held on separate account in the financial records.

Individual Beneficiary is a shareholder and an associate of a shareholder of a company.

The financial statements of the Trust do not include a revaluation reserve.

When the Trust purchased the Property, it did not anticipate making the Distribution.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Section 109T

Income Tax Assessment Act 1936 Section 109XA

Income Tax Assessment Act 1936 Section 109XB

Reasons for decision

Division 7A of the ITAA 1936 contains a number of provisions that can result in deemed unfranked dividends arising for recipients of certain advances from a private company or an interposed entity.

Section 109C can apply to payments made from private companies. As the Trust is not a private company, section 109C, in and of itself, does not apply to the Distribution.

However, other provisions of Division 7A of the ITAA 1936 may apply which enable section 109C to apply as if a private company made a payment to an entity. One such provision is section 109T, which enables payments or loans made through interposed entities to be treated as payments or loans from a private company, therefore enabling section 109C or D to apply. In this case, the relevant UPE arose prior to 16 December 2009 and will not be treated as a loan for the purposes of Division 7A. Thus, this UPE does not give rise to a loan to an interposed entity to which section 109T can apply.

The provisions within subdivision EA of Division 7A of the ITAA 1936 are relevant to this ruling application.

Subdivision EA of Division 7A of the ITAA 1936 contains the rules for determining whether a shareholder of a private company (or an associate of the shareholder) will, by virtue of Division 7A, be treated as having received an assessable dividend as a result of obtaining a financial benefit in the form of a loan, payment or a forgiven debt through a trust.

Section 109XA of the ITAA 1936 sets out the conditions where certain payments made by trustees, including transfers of property, are treated as deemed dividends in accordance with section 109XB.

Subsection 109XA(1) of the ITAA 1936 provides:

Payments. Section 109XB applies if:

(a) a trustee makes a payment to a shareholder or an associate of a shareholder of a private company (except a shareholder or associate that is a company) (the actual transaction); and

(b) the payment is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain; and

(c) either:

(i) the company is presently entitled to an amount from the net income of the trust estate at the time the actual transaction takes place, and the whole of that amount has not been paid to the company before the earlier of the due date for lodgement and the date of lodgement of the trustees return of income for the trust for the year of income of the trust in which the actual transaction takes place; or

(ii) the company becomes presently entitled to an amount from the net income of the trust estate after the actual transaction takes place, but before the earlier of the due date for lodgement and the date of lodgement of the trustees return of income for the trust for the year of income of the trust in which the actual transaction takes place, and the whole of the amount has not been paid to the company before the earlier of those dates.

A 'payment' for the purposes of Division 7A of the ITAA 1936 is defined in subsection 109C(3) and includes a transfer of property to the shareholder, or an associate of the shareholder.

A present entitlement will be attributable to an amount that is an unrealised gain, within the meaning of paragraph109XA(1)(b) of the ITAA 1936 where the trust deed empowers the trustee to declare present entitlement to an amount representing the unrealised gain, and the trustee has declared present entitlement to that amount.

There is no definition of the term 'present entitlement' in the ITAA 1936 or the Income Tax Assessment Act 1997 (ITAA 1997); therefore, it is necessary to establish its ordinary meaning given by the courts. The principal cases concerning the concept of present entitlement are the High Court decisions of FC of T v. Whiting (1943) 68 CLR 99 and Taylor v. FC of T (1970) 119 CLR 444.

The main principles that emerged from these cases are:

•         The income must be legally available for distribution to the beneficiary. It does not matter whether the amount of income has been precisely ascertained.

•         The beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent; the beneficiary must have the right to demand immediate payment (or would have had the right to demand payment had they not been under a legal disability).

Unrealised gain is defined in subsection 109XA(7) of the ITAA 1936 and provides:

Unrealised gain, in relation to a trust estate and an actual payment, means any unrealised gain, whether of a capital or income nature, but does not include an unrealised gain to the extent that it has been or would be included in the assessable income of the trust, apart from this Division, for:

(a) a year of income before the year in which the actual payment was made;

(b) the year of income in which the actual payment was made; or

(c) the year of income following the year in which the actual payment was made.

Further, the Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 1) Bill 2004provides at paragraph 8.13:

....the term 'unrealised gain' is intended to apply very broadly. It is defined to mean any unrealised gain whether of a capital or income nature. For the purposes of these rules, realisation will be taken to have occurred when a gain converts into a recoverable debt.

Application of subsection 109XA(1) of the ITAA 1936

The rules in subsection 109XA(1) of the ITAA 1936 are only applicable to payments that are wholly or partly attributable to an amount that is an unrealised gain.

Specifically, paragraph 109XA(1)(b) of the ITAA 1936 requires that the payment by the trustee to the shareholder (or associate of the shareholder) be one that discharges or reduces the present entitlement of the shareholder, and the present entitlement arose from amounts attributable to unrealised gains.

The payment will not be a discharge of a reduction in a present entitlement of the shareholder that is wholly or partly attributable to an amount that is an unrealised gain.

Based on the facts provided, the Distribution will trigger a CGT event, resulting in a taxable capital gain for the Trustee, which will be included in the net income of the Trust. As the distribution of the Property is a realisation of that asset, it is not within the meaning of "unrealised gain" as set out in subsection 109XA(7) of the ITAA 1936. Further, it is not proposed that the Trustee will make any beneficiary presently entitled to unrealised gains on that Property. Therefore the requirement in subsection 109XA(1)(b) of the ITAA 1936 is not met.

Therefore, subsection 109XA(1) of the ITAA 1936 does not apply to treat the Distribution as a deemed dividend to Individual Beneficiary under section 109XB.