Edited version of private advice

Authorisation Number: 1052189290864

Date of advice: 3 November 2023

Ruling

Subject: CGT consequences for satisfying an unpaid present entitlement by converting it into a loan

Glossary

Table 1: Terms and symbols in this private ruling and our reasons have the meanings in the glossary.

Question 1

Will the commercial debt forgiveness provisions in Division 245 result in any net forgiven amount for the assignment of loans under the First and Second Assignments?

Answer

No.

Question 2

Will section 109F apply to the assignment of debts under the First and Second Assignments?

Answer

No.

Question 3

Will Division 7A apply to treat any of the loans described in this ruling scheme as dividends?

Answer

No.

Question 4

Will the creditor companies have a capital gain from the First or Second Assignments?

Answer

No.

Question 5

Will the creditor companies have a capital gain when they call on their unpaid present entitlements?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.            <This paragraph has been removed for privacy reasons.>

2.            <This paragraph has been removed for privacy reasons.>

3.            The taxpayers' group has UPEs totalling around $XM, owed by the debtor trusts to the creditor companies. <This paragraph has been modified for privacy reasons.>

4.            <This paragraph has been removed for privacy reasons>.

5.            One of the debtor trusts also owes loans to creditor companies totalling $YM.

Table 1:UPEs and loans

<This table has been removed for privacy reasons>

6.            The taxpayers propose to settle these loans and UPEs through the following steps.

•         The creditor companies will call on their UPEs through converting them into loans.

•         The First Assignment will occur, whereby Trust X will assume from the debtor trusts the obligation to repay the loans to the creditor companies and Trust X will simultaneously receive a right to be paid these same loan amounts by the debtor trusts.

•         The Second Assignment will occur, whereby Company Y will assume from Trust X the obligation to repay the loans to the creditor companies and Company Y will simultaneously receive a right to be paid these same loan amounts by Trust X.

•         Trust X will settle its loan to Company Y by transferring assets with a market value equal to the total of the UPEs and loans ($XM+$YM).

Step 1

7.            The creditor companies will call on their UPEs owed by the debtor trusts.

8.            The debtor trusts don't have enough cash to settle these UPEs.

9.            Therefore, the parties will agree that these UPEs will be met by loans (of equal amounts) from the creditor companies to the debtor trusts.

Diagram 1: Step 1 (converting the UPEs into loans)

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Steps 2 and 3

10.         The creditor companies (lenders) and the debtor trusts (borrowers) will enter two loan assignments. Under the First Assignment, the debtor trusts assign their debt to Trust X (through a three-way agreement with the creditor companies and Trust X). Under the Second Assignment, Trust X assigns its debt to Company Y (through a three-way agreement with the creditor companies and Company Y). The combined effect of these assignments will be that the debtor trusts owe Trust X, Trust X owes Company Y, and Company Y owes the creditor companies.

11.         Each loan will be assigned for the face value of the loan.

Diagram 2: Step 2 (first assignment)

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Diagram 3: Step 3 (second assignment)

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Step 4:

12.         Trust X will settle the loan by transferring investments/securities to Company Y. The loans will be ASX listed (or similar) with a market value of $X-ZM, plus a $ZM loan note with an unrelated third party.

Diagram 4: Step 4 (transfer assets)

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Assumptions

A.            If interest was payable on any loans (Loans 1, 2a, 2b, 3a, and 3b), interest would have been deductible.

B.            The creditor companies didn't pay anything to acquire their UPEs from the debtor trusts.

C.           The creditor companies were made presently entitled to a share of the net income of the relevant trust estates in the years the UPEs arose.

D.           All parties intend to repay their obligations under the loans or reassigned loans and have capacity to repay those obligations.

E.            All obligations are payable on demand.

F.            When the parties enter each agreement (to create, assign, or vary obligations under loan agreements), there won't be any circumstances suggesting otherwise.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 6-25

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-55

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 245-10

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 section 245-36

Income Tax Assessment Act 1997 section 245-37

Income Tax Assessment Act 1997 section 245-55

Income Tax Assessment Act 1997 section 245-65

Income Tax Assessment Act 1997 section 245-75

Income Tax Assessment Act 1936 section 97

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 section 109F

Income Tax Assessment Act 1936 section 109K

Income Tax Assessment Act 1936 section 109R

Income Tax Assessment Act 1936 section 109T

Income Tax Assessment Act 1936 section 109W

Reasons for decision

Question 1

Will the commercial debt forgiveness provisions in Division 245 result in any debt forgiveness amount for the assignment of loans under the First and Second Assignments?

Answer

No.

Summary

13.         The First and Second Assignments will have no practical consequences under the commercial debt forgiveness rules.

•                     Assigning loans under the commercial debt forgiveness rules will be forgiveness events for the original debtor under the assigned debt rule in section 245-36.

•                     The amount assigned to each new creditor will be treated as an amount offset under section 245-65.

•                     The amount offset will be equal to the forgiveness amount, bringing the gross forgiven amount to nil.

•                     Since there's no gross or net forgiven amount, Subdivision 245-E won't apply to reduce losses or other amounts.

Explanation

Brief overview of the commercial debt forgiveness rules: if you have a commercial debt forgiven, you work out a net forgiven amount, which you apply to reduce losses and other items

14.         Very broadly, the commercial debt forgiveness rules eliminate tax benefits where you have had debts forgiven in qualifying circumstances.

•                     The rules (in Division 245) apply to debts that are 'commercial' - in the sense that interest was deductible or would have been deductible if paid.

•                     The debts need to be forgiven for the purposes of Division 245.

•                     There are exclusions - including where amounts are otherwise assessable, or debts are forgiven for natural love and affection.

•                     The rules deem assigned debts to be forgiven in some circumstances.

•                     There are rules for working out the amount of forgiven debts, including where certain amounts can be offset against the forgiven debt to reduce it. Subdivision 245-C works out the gross forgiven amount, and 245-D works out the net forgiven amount.

•                     If the rules apply, Subdivision 245-E applies net forgiven amounts to reduce tax losses, net capital losses, certain deductible amounts, and cost bases of CGT assets.

15.         The effect of section 245-10 is that the commercial debt forgiveness rules may apply to your debts if interest on the debts is deductible or would have been deductible if interest was payable.

16.         We've assumed that interest on all relevant loans would have been deductible if it was payable, which means the commercial debt forgiveness rules apply. We haven't considered or formed an opinion about whether interest would have been deductible to any taxpayers included in this ruling.[1]

Assigning loans will be treated as forgiveness under the assignment rule in section 245-36

17.         Section 245-35 says a debt is 'forgiven' if:

•                     the debtor's obligation to pay the debt is released, waived, or otherwise extinguished other than by repaying the debt in full, or

•                     the debt becomes statute barred.

18.         There's no forgiveness under section 245-35: both the debtor trust (for the First Assignment) and Trust X (for the Second Assignment) will still have an obligation to pay the same amount, merely to a new creditor.

19.         However, assignment can also be forgiveness. Section 245-36 says a debt will also be forgiven if three conditions are met.

•                     The creditor assigns the right to receive payment to a new creditor.

•                     Either the new creditor is the debtor's associate or the assignment occurred under an arrangement to which the new creditor and debtor were parties.

•                     The new creditor didn't acquire their right to receive payment in the ordinary course of trading on a market or exchange.

20.         The assignments will be treated as forgiven because the conditions in section 245-36 are met for both assignments. For the First Assignment, the creditor companies will assign their rights to receive payment to Trust X. For the Second Assignment, the creditor companies will assign their rights to receive payment to Company Y. The assigning creditor, new creditor, and debtor will be parties to both agreements in each case. The assigned rights aren't being sold on a securities market.

The forgiveness amount is equal to the market value of each assigned loan

21.         A debt is generally taken to have its market value, assuming you're solvent. Subsection 245-55(1) says the value of a debt is its market value at the forgiveness time, assuming that you were able to pay all your debts both when you incurred the debt and when it was forgiven.[2] However, subsection 245-55(3) says that rule doesn't apply where the creditor is an Australian resident, you weren't dealing with each other at arm's length, and the debt wasn't a moneylending debt.

22.         ATO guidance suggests 'market value' means the price that fully informed buyers and sellers would reach, if bargaining at arm's length. See TD 2007/1[3] at paragraphs 12 through 14, TD 97/1[4], and the ATO website.[5]

23.         We don't need to determine whether the solvency assumption in subsection 245-55(1) applies because we've assumed that all parties intend to pay and are able to pay their debts.

24.         We've also assumed that all obligations are payable on demand.

25.         It follows that the market values of the relevant obligations would be the same. A fully informed buyer would put the same value on each obligation here. A buyer, acting at arm's length, would pay the same amount for all obligations that had the same face value, whoever was the debtor, because all debtors intend to pay and are able to pay - it wouldn't matter whether the buyer was obtaining an obligation to recover from the debtor trusts, Trust X, or Company Y. We don't need to determine what that market value is (for example, whether there would be any discount on the face value to compensate for transaction costs or any other considerations).

The amount offset will be equal to the forgiveness amount, bringing the gross forgiveness amount to nil

26.         There's an offset rule which allows the gross forgiven amount to be reduced. Section 245-65 says the gross value of a debt will be reduced by an amount worked out in the table. There are six items in the table, but Item 5 is the only relevant one here. Item 5 applies where the debt is assigned under section 245-36, the debt isn't a moneylending debt, and the creditor and new creditor aren't dealing with each other at arm's length in connection with the assignment. Where that rule applies, the amount offset is the market value of the debt at the time of the assignment.

27.         We've considered ATO guidance addressing whether parties are dealing with each other at arm's length. TR 2014/5[6] (at paragraphs 97 through 104) and TR 2006/7[7] (at paragraphs 76 through 78) make the following points:

•                     Determining whether parties deal at arm's length means assessing the way parties conducted their dealing.

•                     The dealing must be consistent with how independent third parties would act, applying their minds and wills to the transaction.

•                     Acting at arm's length means there must be real bargaining.

•                     Determining whether parties deal at arm's length requires measuring what happened against an alternative hypothesis in which parties dealt at arm's length.

•                     The dealing itself is critical, rather than the relationship between the parties.

•                     Parties that aren't at arm's length can deal at arm's length, and parties that are at arm's length can deal in a way that isn't at arm's length.

•                     Influence and control may suggest parties aren't dealing at arm's length, but this isn't decisive.

28.         The conditions in Item 5 are met for both the First and Second Assignments. We concluded at paragraph 20 that the debt was assigned as mentioned in section 245-36. The debt isn't a moneylending debt: none of the relevant entities carry on moneylending businesses. The creditor and new creditor won't be dealing with each other at arm's length under either the First or the Second Assignments. The original creditors are the creditor companies in both cases. The new creditor is Trust X for the First Assignment and Company Y for the Second Assignment. All entities have common controlling minds. Both First and Second Assignments are part of a sequence of transactions to restructure loans within a private group. In both cases, the new creditor is acquiring the original creditor's right to repayment from the debtor but assumes the debtor's obligation to repay the original creditor an identical amount. The terms of the agreements don't give independent parties any advantage that would have been worth bargaining for.

29.         Since Item 5 in section 245-65 applies, the amount offset is the debt's market value for each loan.

30.         Section 245-75 determines the gross forgiven amount of a debt. The gross forgiven amount is:

•                     where the offset rule in section 245-65 doesn't apply, the debt's value: paragraph 245-75(1)(a)

•                     if the offset rule does apply, and the value exceeds the amount offset, the excess: paragraph 245-75(1)(b)

•                     if the offset rule does apply, and debt's value is equal to or less than the amount offset, there's no gross forgiven amount, and the rules about how to work out the net forgiven amount (in Subdivisions 245-D to 245-F) don't apply: subsection 245-75(2).

31.         Here, the forgiveness amount and the amount offset are equal. Both amounts are the market value of the loan.

32.         It follows that there will be no gross forgiven amount. Subsection 245-75(2) will apply because the offset rule in section 245-65 applies and the debt's value is equal to the amount offset.

Conclusion: the debt forgiveness rules don't operate because there's no net forgiven amount

33.         The First and Second Assignments won't have practical consequences under the commercial debt forgiveness rules. Since there's no net forgiven amount, Subdivision 245-E won't apply to the First and Second Assignments to reduce losses, deductible amounts, or cost base.

Question 2

Will section 109F apply to the assignment of debts under the First and Second Assignments?

Answer

No.

Summary

34.         Section 109F doesn't apply. The debts are only forgiven in the sense that they are assigned to third parties. The First and Second Assignments won't be treated as forgiveness for Division 7A purposes because we've assumed all parties can and intend to pay all their debts.

Explanation

Section 109F treats debts from private companies to shareholders or associates as dividends where they're forgiven, or a reasonable person would conclude the creditor won't insist on payment

35.         Division 7A applies to treat amounts from certain forgiveness events as dividends.

36.         The effect of section 109F is that a private company is taken to pay a dividend if it forgives a debt owed to it by a shareholder or associate. Subsection 109F(1) is the operative rule. It says a private company is taken to pay a dividend to an entity if (all or part) of a debt is forgiven, and either:

•                     the amount is forgiven when the entity is a shareholder (or associate of a shareholder), or

•                     a reasonable person would conclude that the amount is forgiven because the entity had been a shareholder (or associate) at some time.

37.         Very broadly, section 109F gives 'forgiven' (for Division 7A purposes) a similar meaning to the commercial debt forgiveness rules:

•                     Subsection 245-35(3) says a debt is forgiven where it would be forgiven (if the commercial debt forgiveness rules applied) under sections 245-35 or 245-37.

•                     Subsection 245-35(5) says debt is forgiven if a private company assigns a debt to a new creditor where two conditions are met. First, the new creditor is either the debtor's associate, or a party to an arrangement with the debtor. Second, a reasonable person would conclude the new creditor won't exercise the assigned right.

•                     Subsection 245-35(6) says a debt is also forgiven if a reasonable person would conclude that the private company won't insist on the entity paying the amount.

38.         Broadly, section 245-37 treats debts as forgiven where a private company debtor repays its debt by allowing a creditor to subscribe for shares.

Section 109F won't apply to the first and second assignments: the debts are assigned, not forgiven, and we've assumed all parties can (and will) pay their debts

39.         The loans assigned under the First and Second Assignments won't be 'forgiven' for Division 7A purposes.

•                     Subsection 245-35(3) won't apply. We concluded in Question 1 at paragraphs 17 to 20 that the commercial debt forgiveness rules will treat the loans as being forgiven under the assignment rule in section 245-36, not section 245-35. Section 245-37 isn't relevant.

•                     Subsections 245-35(5) and (6) aren't relevant on the assumptions we've made. We've assumed all entities intend to pay and are able to pay their debts. Therefore, a reasonable person won't conclude the old or new creditors won't exercise their rights or wouldn't insist on the debtor paying.

40.         It follows that section 109F won't apply to treats loans assigned under the First and Second Assignments as dividends.

Question 3

Will Division 7A apply to treat any of the loans described in this ruling scheme as dividends?

Answer

No.

Summary

41.         Division 7A won't apply to deem loans as dividends in the circumstances of this ruling scheme:

•                     Each step in the sequence would create loans for Division 7A purposes.

•                     The interposed entity rules in Subdivision E will apply to treat fresh loans under the First and Second Assignments as being loans from private companies to other entities.

•                     However, the Commissioner will treat the amount of those notional loans (under section 109W) as 'nil' because they are part of a sequence of transactions which reorganises loans within the group without extracting value from private companies.

•                     All loans in the sequence to which Division 7A could apply will be treated as being repaid by later steps in the sequence.

•                     Those repayments won't be disregarded for Division 7A purposes: section 109R won't apply because the amount of the subsequent reborrowing will be nil.

Explanation

Division 7A treats loans from private companies to shareholders or associates as dividends, where 'loans' includes credit or financial accommodation

42.         Very broadly, Division 7A treats some payments, loans, and forgiven debts involving private companies and their shareholders as dividends.

43.         One of the operative rules - in section 109D - treats loans from private companies to shareholders or associates as dividends. Subsection 109D(1) takes a private company to have paid a dividend to an entity if:

•                     the private company makes a loan to the entity

•                     the loan isn't fully repaid by lodgment day

•                     Subdivision D (with excluding rules) doesn't apply, and

•                     the entity is a shareholder/associate when the loan is made (or a reasonable person would conclude it was made because the entity had been a shareholder at some time).

44.         Subsection 109D(3) gives 'loan' an extended meaning for Division 7A purposes. That extended meaning includes, at paragraph (b), a provision of credit or any other form of financial accommodation.

45.         The ATO view is that 'financial accommodation' extends to situations where a party has knowledge about an entitlement but fails to demand payment: see TD 2022/11[8] at paragraphs 62 through 73.

Under modified rules in Subdivisions D and E, some repayments are disregarded, and payments and loans made through interposed entities are treated as being direct loans from a private company to the end recipient

46.         Subdivision D is broadly about exceptions where loans or payments won't be treated as dividends. One of those exceptions is that company to company loans aren't deemed dividends: see section 109K. Subdivision D also includes section 109R which disregards some repayments for Division 7A purposes. It applies where a reasonable person would conclude that the entity repaid its loan under an expectation that it would get a similar or larger loan from the private company: see subsection 109R(2).

47.         Subdivision E has rules which treats some payments and loans made through interposed entities as direct loans from a private company to the ultimate recipient.

48.         Section 109T broadly treats indirect transactions through interposed entities as having been made by a private company. It applies where:

•                     a private company makes a payment or loan to an interposed entity, and

•                     a reasonable person would conclude that the private company made the first transaction solely or mainly as part of an arrangement to pay or loan money to a target entity, and

•                     the interposed entity makes a payment or loan to a target entity.

49.         However, section 109T doesn't apply if Subdivision B (which includes the operative rule for loans in section 109D) applies directly to take the private company's loan or payment to the interposed entity to be a dividend. See subsection 109T(3).

50.         If section 109T applies, Division 7A applies as if the private company paid an amount to the target entity, with that amount being determined by the Commissioner. Subsection 109W(1) says Division 7A operates as if the private company had made a loan of an amount determined by the Commissioner to the target entity when the interposed entity paid the target entity. Subsection 109W(2) says in determining the amount, the Commissioner must take account of the amount the interposed entity loaned the target entity, and how much the Commissioner believes represented consideration payable to the target entity.

51.         There's ATO guidance about how the Commissioner will determine the amount of a payment or loan under Subdivision E. TD 2011/16[9] lists factors the Commissioner will take into account at paragraph 2. One factor, at paragraph 2(c), is the extent to which any actual loans made as part of the arrangement have been repaid by the company's lodgment date. Another, at paragraph 2(h), is the extent to which the other factors reflect genuine transactions that aren't designed to avoid Subdivision E otherwise than as envisaged within the scheme of Division 7A. TD 2011/16, at paragraph 3, says the Commissioner will take known related facts and circumstances into account when determining the amount of the deemed payment and notional loan.

52.         TD 2011/16 describes Division 7A and Subdivision E as both having an anti-avoidance purpose. Paragraph 24 says Division 7A is an anti-avoidance or integrity provision designed to prevent private companies from making tax-free distributions of profits to shareholders. At paragraph 31, it says Subdivision E is an anti-avoidance provision concerned with back-to-back arrangements. However, paragraph 34 says section 109T doesn't require a purpose or intent to avoid Division 7A.

Section 109D won't deem converting the unpaid present entitlement into loan 1 to be a dividend because it will be fully repaid by lodgment date

53.         Each creditor company is 'lending' to the debtor trust by agreeing to convert the UPEs into loans - which we're (collectively) calling Loan 1.

54.         We've assumed that each debtor trust is an associate of each creditor company's shareholders.

55.         Section 109D would treat Loan 1 as a dividend, unless the loan is fully repaid by lodgment date (we conclude that it will be fully repaid by the First Assignment - see paragraph 58).

The first assignment repays loan 1 and creates loans 2a and 2b

56.         At Step 2, the creditor company and debtor trust make a 3-way agreement with Trust X (which we call the First Assignment) for:

•                     Trust X to assume the debtor trust's obligation to repay the creditor company, and

•                     the debtor trust to promise to pay the same amount to Trust X.

57.         The effect of this First Assignment is to:

•                     extinguish the debtor trust's obligation under Loan 1

•                     create a new loan from the creditor company to Trust X (which we call Loan 2a)

•                     create a second new loan from Trust X to the debtor trust (which we call Loan 2b).

58.         We are treating the First Assignment as repaying Loan 1 because it extinguishes the debtor trust's obligation to pay the creditor company, and the creditor company gets a substitute loan receivable asset from Trust X.

The interposed entity rules recognise a notional loan (loan 2c) from the creditor companies to the debtor trusts - but the Commissioner will determine the amount to be nil in the circumstances of this case

59.         Division 7A will apply to take Loan 2a to be a dividend to Trust X, unless it's fully repaid by lodgment date. The creditor company is making a loan (at least under the extended meaning) through the First Assignment. It's granting credit or financial accommodation through assigning a loan receivable asset (Loan 1) to Trust X, in exchange for a promise that Trust X will pay it the same amount later (Loan 2a). We've assumed that Trust X is an associate of the creditor company's shareholders. But it won't be a deemed dividend if fully repaid by lodgment date - we conclude at paragraph 66 that the Second Assignment will have the effect of repaying Loan 2a.

60.         Section 109T applies to recognise a deemed loan from the creditor company to the debtor trust, which we call Loan 2c.

•                     A reasonable person would conclude that the creditor company lent to Trust X (interposed entity) under Loan 2a to allow Trust X to lend to the debtor trust (target entity) under Loan 2b: see paragraph 109T(1)(b). We think that's self-evident given the ruling scheme involves a rapid sequence of transactions between entities with common controlling minds.

•                     Subsection 109T(3) doesn't prevent section 109T applying because it isn't a section 109D dividend. We treat Loan 2a as being fully repaid by the Second Assignment - see paragraph 66.

•                     Therefore Division 7A operates as if the creditor company makes a loan to the debtor trust (of an amount determined by the Commissioner under section 109W).

61.         Applying TD 2011/16, the Commissioner will determine the amount of Loan 2c notional (section 109T) loan to be 'nil'.

•                     The First Assignment is one step in a sequence of simultaneous transactions with the purpose of redirecting wealth represented by the creditor company/debtor trust's UPE to Company Y.

•                     In the circumstances of this case, we've decided to treat all steps in the transaction as part of the same arrangement.

•                     One of the 'actual loans' in that arrangement is repaid: Trust X transfers assets to Company Y at Step 4.

•                     At the beginning of the sequence, the debtor trusts have had access to company profits from the creditor companies.

•                     At the end of the sequence, another trust in the group (Trust X) pays an equivalent amount to the UPEs to another company in the same group (Company Y) - through Step 4.

•                     Taking the arrangement as a whole, there's no net tax-free distribution of profits from companies in the group. Trusts have accessed company profits through the UPEs, but another trust in the group restores an equal amount to another company.

•                     While Subdivision E generally applies according to its terms, TD 2011/16 gives the Commissioner some discretion when determining the loan amount - and we recognise that this 'back-to-back' arrangement doesn't have the purpose or effect of extracting company profits.

62.         It follows that Division 7A won't apply to take Loan 2c to be a dividend to the debtor trust. There's a loan from a private company to the debtor trust, and we've assumed the debtor trust is an associate of a shareholder. But the amount of the notional loan is nil, so there's no section 109D deemed dividend.

63.         It also follows that Division 7A won't disregard the First Assignment when working out if Loan 1 has been repaid.

•                     Section 109R applies where a reasonable person would conclude that the entity repaid its loan under an expectation that it would get a similar or larger loan from the private company: see subsection 109R(2).

•                     Here, we've treated the debtor trust as having repaid Loan 1 through the First Assignment as explained at paragraph 58.

•                     A reasonable person would conclude that when the debtor trust repaid Loan 1, it expected to get another loan - Loan 2c - from the creditor company. Section 109T applies to recognise a loan 'for the purposes of this Division'. Therefore a reasonable person would recognise Loans 2a and 2b as creating a direct loan from the creditor company to the debtor trust.

•                     However, the amount of Loan 2c is nil, so a reasonable person won't conclude that the debtor trust expected to get a similar or larger loan from the creditor company.

•                     Section 109R won't apply because the conditions in subsection 109R(2) aren't met.

The second assignment repays loan 2a and creates loans 3a and 3b, with loan 3a being repaid by the asset transfer at step 4

64.         At Step 3, the creditor company and Trust X make a 3-way agreement with Company Y (which we call the Second Assignment) for:

•                     Company Y to assume Trust X's obligation to repay the creditor company, and

•                     Trust X to promise to pay the same amount to Company Y.

65.         The Second Assignment seems to:

•                     extinguish Trust X's obligation to repay the creditor company (repay Loan 2a)

•                     create a new loan from the creditor company to Company Y, which we call Loan 3a

•                     create another new loan from Company Y to Trust X, which we call Loan 3b.

66.         As with the First Assignment, we're treating the Second Assignment as repaying Trust X's obligation under Loan 2a. It extinguishes Trust X's obligation to pay the creditor company, but the creditor company gets a substitute loan receivable asset from Trust X.

67.         Section 109D won't apply to treat Loan 3a as a dividend, because company to company loans are excluded under section 109K.

68.         Section 109D also won't apply to treat Loan 3b as a dividend because it will be fully repaid.

•                     Company Y is assuming Trust X's obligation to pay the creditor companies, in exchange for Trust X's promise to pay the same amount to Company Y.

•                     In doing that, it's granting credit or financial accommodation to Trust X.

•                     Therefore Company Y has made a loan to Trust X, which is its shareholder.

•                     However, at Step 4, Trust X will transfer assets of equal value to the loan amount to Trust X, which will repay the loan before lodgment date.

69.         Similar to the First Assignment, section 109T will treat the Second Assignment as also creating a direct loan from the creditor company to Trust X, which we'll call Loan 3c.

•                     A reasonable person would think (given the rapid sequence of transactions between related parties under the scheme) that the creditor company lent to Company Y (Loan 3a) to allow Company Y to lend to Trust X (Loan 3b).

•                     Therefore, subsection 109T(1) treats the creditor company as having made a direct loan to Trust X (Loan 3c).

•                     Subsection 109T(3) won't stop section 109T applying, because Loan 3a isn't a deemed dividend under section 109D.

70.         Following TD 2011/16, the section 109W amount for Loan 3c will be nil. TD 2011/16 says the Commissioner will take into account the extent to which any actual loans were repaid under the scheme. Here, the interposed entity loan (Loan 3b) is fully repaid by lodgment day because Trust X transferred assets to Company Y.

71.         Similar to the First Assignment, section 109R won't apply to disregard the Loan 2a repayment (under the Second Assignment). A reasonable person would recognise that when Trust X repaid Loan 2a, it would get another loan (Loan 3a, or the section 109T notional loan) from the creditor company. But a reasonable person wouldn't conclude that Trust X 'repaid' its loan under the assignment, under the expectation that it would get a similar or larger loan from the creditor company - because the Commissioner will determine that the amount of that notional loan is nil.

Diagram 5: Division 7A consequences of the first and second assignments

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Conclusion: Division 7A won't apply to deem dividends under the scheme

72.         The result is that Division 7A won't apply to deem dividends under the sequence of loans and assignments in this private ruling scheme. We summarise the result in Table 2.

Table 2: Division 7A summary

Question 4

Will the creditor companies have a capital gain from the First or Second Assignments?

Answer

No.

Summary

73.         The creditor companies won't have a capital gain from the First or Second Assignments. Each assignment will trigger a CGT event (either A1 or C2). But the CGT event won't result in a capital gain because the capital proceeds and cost base will be equal.

Detailed reasoning

A brief sketch of the CGT rules: you calculate capital gains from CGT events, by comparing capital proceeds from the event with the asset's cost base

74.         Broadly, the CGT rules calculate capital gains and capital losses from CGT events, net them off against each other, apply relevant discounts, and include any resulting net capital gain in your assessable income. See the guide in Division 100 and the method statement in section 102-5.

75.         There are many CGT events, but for the purposes of this question we'll only address two.

76.         CGT event A1 is about disposals of CGT assets. Subsection 104-10(1) says that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) says that you dispose of a CGT asset if a change of ownership occurs from you to another entity. However, a change of ownership doesn't occur if you stop being the legal owner but continue to be the beneficial owner.

77.         CGT event C2 happens if an intangible asset ends in specified circumstances. Subsection 104-25(1) says that CGT event C2 happens if your ownership of an intangible CGT asset ends in listed circumstances which include being redeemed or cancelled, or being released, discharged, or satisfied.

78.         The time of the event is worked out the same way for both CGT events. For CGT event A1, subsection 104-10(3) says the time of the event is when you enter the contract for the disposal, or when the change of ownership happens if there's no contract. For CGT event C2, subsection 104-25(2) says the time of the event is when you enter the contract for the ending, or when the asset ends if there's no contract.

79.         Capital gains and losses are calculated the same way for both CGT events. For CGT event A1, subsection 104-10(4) says you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. For CGT event C2, subsection 104-25(3) says you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. For both CGT events, you make a capital loss if those capital proceeds are less than the asset's reduced cost base.

80.         Section 108-5 says CGT assets are property, or legal or equitable rights which aren't property, and it lists shares in companies, units in trusts, and debts owed to you as examples.

81.         Intangible CGT asset isn't defined, but the Macquarie Dictionary says an 'intangible asset' is an asset with monetary value but without physical properties.[10]

At least one of CGT events A1 and C2 will happen, but we don't need to determine which one

82.         We'll briefly describe the First and Second Assignments again. In each case, before the assignments, the creditor companies have a right to payment from a debtor - which is a loan receivable asset. After the assignments, a new creditor has a right to payment from the original debtor, and the creditor companies have an equivalent right to payment from the new creditor. We illustrate in Table 3.

Table 3: Rights and obligations under each loan

83.         There's two ways to characterise these transactions. The original creditors could be treated as transferring their right to payment to the new creditor by assignment. Alternatively, the original creditors may be agreeing to end their right to payment from the original debtor, while creating new rights to payment for both the original creditor (from the new creditor) and the new creditor (from the original debtor). Determining which is the best characterisation may depend on the form the agreements take.

84.         In passing, rights to payment are intangible CGT assets. Rights to payment, either under loan agreements, or UPEs, are loan receivable assets in the creditor's hands. They are intangible because they have value but don't have physical form.

85.         Which CGT event happens depends on the characterisation. CGT event A1 happens if the original creditors transfer their existing rights to the new creditor. In that case, there would be a change of ownership of the CGT asset (a right to payment by the original debtor) from the original creditor to the new creditor. But CGT event C2 would happen if the original creditors had their rights end, with new rights to payment created for both original creditors and new creditors. That original right to payment is a CGT asset, and it would end by being discharged under the agreement.

86.         We don't need to determine which CGT event happened because the capital gain or loss would be calculated the same way - see paragraphs 78 and 79.

Capital proceeds are generally the money and market value of property received from a CGT event, with the first element of cost base generally being the money and market value of property you gave to acquire an asset

87.         We need to compare the capital proceeds and cost base (or reduced cost base) to determine whether there's a capital gain or capital loss from the event.

88.         Capital proceeds are usually the money and market value of property received in respect of an event happening: see section 116-20.

89.         Cost base consists of five elements, with the first being money you paid or market value of property you gave in respect of acquiring the asset: see section 110-25.

90.         The only difference between cost base and reduced cost base is the third element: see section 110-55.

91.         TD 2014/26[11] makes some propositions about property. At paragraphs 6 and 7, it says property is a legal relationship with a thing, meaning the degree of power that can be legally exercised over it. There's no single test or determinative factor for identifying proprietary rights, but characteristics include whether a right is definable, identifiable, capable of being assumed by third parties, permanent or stable to some degree, excludable, has commercial value, and is enforceable against third parties.

92.         As mentioned at paragraph 22, ATO guidance suggests market value' means the price that fully informed buyers and sellers would reach, if bargaining at arm's length.

The cost base will be the market value of the original debt, while the capital proceeds will be the value of the substituted debt under each assignment. Both will be the same.

93.         The creditor company will receive property under both the First and Second Assignments. For the First Assignment, it receives a right to be paid by Trust X under Loan 2a. For the Second Assignment, it receives a right to be paid by Company Y under Loan 3a. Those rights are property because they are identifiable, enforceable, and have value.

94.         The creditor companies also gave property to acquire each CGT asset. For the First Assignment, the CGT asset is Loan 1. The creditor company gave up its UPE from the debtor trust to acquire Loan 1. We think a UPE is property in the beneficiary's hands because it has value and can be enforced against the trustee. For the Second Assignment, the CGT asset is Loan 2a. The creditor company acquired Loan 2a by giving up its entitlement to be paid by the debtor trust under Loan 1. The entitlement to be paid under Loan 1 is also property - it's identifiable, enforceable, and has value.

95.         We've assumed that all entities can and intend to pay their obligations under either the UPE or any of the loans, and that all obligations are payable on demand.

96.         It follows that the market values of the relevant obligations would be the same. A fully informed buyer would put the same value on each obligation (for corresponding obligations with the same face value) here for the reasons we gave in Question 1 at paragraph 25. As with Question 1, we don't need to determine what that market value is.

97.         It follows that there will be no capital gain or capital loss for the creditor company from CGT events happening under the First and Second Assignments. The capital proceeds in respect of each event will be the market value of the substituted loan receivable asset they have received. The CGT asset's cost base will also be the market value of the debt they gave up to acquire it. The debts and loans are equal, so the capital proceeds and cost base will also be equal.

98.         Under both agreements, the creditor companies have given (or surrendered) rights to be paid certain amounts. They also receive rights to be paid equal amounts. We think the rights to be paid (which are transferred, surrendered, or acquired under the First and Second Assignments) are property. The market value of those rights would be equal to the market value of the entitlements or obligations. In each case, the amounts given and amounts received will be equal. It follows that the capital proceeds and cost base will be equal, so there will be no capital gain or loss. We describe each in Table 4.

Conclusion: there's no capital gain or loss because the capital proceeds and cost base are equal

99.         The creditor companies won't have capital gains from the First and Second Assignments. CGT events will happen, but in each case the capital proceeds and cost base will be the market value of the relevant loans/debts, which will be the same. Since the capital proceeds and cost base are equal, there will be no capital gain.

Table 4: Capital proceeds and cost base for the CGT events triggered by the first and second assignments

Question 5

Will the creditor companies have a capital gain included in their assessable income when they call on their unpaid present entitlement by converting them into loans?

Answer

No.

Explanation

100.       In these circumstances, the creditor companies won't have a capital gain included in their assessable income. Converting the UPE into a loan would appear to trigger CGT event C2. However, we don't think that the discharge of a UPE should require a beneficiary to have a capital gain from CGT event C2 where Division 6 has operated to include an amount in the beneficiary's assessable income. Division 6 is intended to be the primary taxing point for beneficiaries with entitlements to trust income. The CGT rules are primarily intended to tax realised gains of a capital character which wouldn't have been taxed as income, and aren't intended to tax transactions which have already been dealt with under the trust income provisions.

[1] Broadly speaking, the ATO view is that the deductibility of interest depends on the purpose of the borrowing and the use to which the borrowed funds are put. See Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities at paragraphs 6 and 7.

[2] That rule is modified where there are changes attributable to interest rates or exchange rates: see subsection 245-55(2).

[3] Taxation Determination TD 2007/1 Income tax: consolidation: in working out the market value of the goodwill of each business of an entity that becomes a subsidiary member of a consolidated group, should the value of related party transactions of each business of the entity be recognised on an arm's length basis?

[4] Taxation Determination TD 97/1 Income tax: property development: if land, originally acquired as a capital asset, is later ventured into a business of development, subdivision and sale, how is the market value of the land calculated at the time it is ventured into the business?

[5] ATO (June 2023), 'Capital gains tax: Market valuation of assets' (QC 66067) accessed at www.ato.gov.au on 17 October 2023.

[6] Taxation Ruling TR 2014/5 Income tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate).

[7] Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund, or a pooled superannuation trust in relation to the year of income.

[8] 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'?

[9] 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.

[10] Macquarie Dictionary Publishers (2023), Macquarie Dictionary online, entry for 'intangible asset' accessed at https://www.macquariedictionary.com.au on 22 August 2023.

[11] Taxation Determination TD 2014/26 Income tax: is bitcoin a 'CGT asset' for the purposes of subsection 108-5(1) of the Income Tax Assessment Act 1997?