Edited version of private advice

Authorisation Number: 1052195584659

Date of advice: 1 December 2023

Ruling

Subject: Deemed dividend

Question

Will a deemed dividend arise under section 109F of the Income Tax Assessment Act 1936 (ITAA 1936) to the Estate of the deceased if the Company forgives the loans it made to the deceased before the grant of probate to the executor of his will is made?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 2023

Relevant facts and circumstances

1.    The deceased operated a business with the spouse since 20XX.

2.    The business is conducted by the Company.

3.    The deceased and the spouse are directors and shareholders of the Company.

4.    The Company made loans to the deceased during the income year of their death (the Loans).

5.    The Company intends to forgive the Loans before the grant of probate.

6.    The deceased's spouse is the only beneficiary of his will and is also the executor of the will and estate (the Estate).

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(a)

Income Tax Assessment Act 1936 paragraph 6(1)(b)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 former subsection 104(1)

Income Tax Assessment Act 1936 section 109F

Income Tax Assessment Act 1936 subsection 109F(1)

Income Tax Assessment Act 1936 paragraph 109F(1)(a)

Income Tax Assessment Act 1936 subsection 109F(3)

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 subsection 960-100(2)

Reasons for decision

All subsequent legislative references are to the ITAA 1936, unless otherwise indicated.

Summary

The requirements of section 109F will be satisfied and a deemed dividend will arise for the trustee of the Estate if the Company forgives the Loans it made to the deceased prior to the grant of probate of the will. This is on the basis that upon death, the Company is owed a debt by the trustee of the deceased estate who is an 'entity' that is also a 'shareholder' in the Company when the debt is forgiven.

Detailed reasoning

Subsection 109F(1) relevantly provides that:

A private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either:

(a)  the amount is forgiven when the entity is a shareholder in the private company, or an associate of such a shareholder; ...

(Emphasis added)

The elements of subsection 109F(1) (underlined above) that require consideration are:

• determining whether a debt owed by an entity has been forgiven; and
• determining whether that entity was a shareholder or an associate of a shareholder when the debt is forgiven.

As explained below, upon death the Loans became owed by whoever was the trustee of the deceased estate at the time of death. The trustees of the deceased estate from time to time are taken to be a singular 'entity' for income tax purposes.

Furthermore, this entity will be a 'shareholder' in the Company at the time of forgiveness.

Accordingly, the Commissioner considers that the requirements to engage the operation of section 109F will be satisfied in relation to the proposed debt forgiveness before the grant of probate for the deceased.

Debt an entity owed the company is forgiven

In the present case, a debt will be forgiven which is owed by the 'entity' comprising the trustee of the deceased estate for income tax purposes.

For present purposes, a forgiveness can only occur if there is a 'debt' which a debtor has an 'obligation to pay'.[1] A debt that is capable of being forgiven must first be in existence and is therefore necessarily owed by at least one other party (i.e. the debtor, in the debtor-creditor relationship that constitutes the debt).

Such a debt exists in the present case in the form of the Loans. The death of an individual does not extinguish their debts.[2] Rather, the trustee of their estate effectively steps into the shoes of the deceased, undertaking responsibility to call upon the assets of the estate to pay debts and testamentary expenses.[3]

Furthermore, from the time of death, the Estate is taken to be held by a singular 'entity' for income tax purposes, comprising whoever is, or is taken to be, the 'trustee' of the Estate from time to time.[4] This entity will comprise whoever is, from time to time:[5]

• acting in a fiduciary capacity in relation to the estate[6];
• an executor or administrator of the estate[7]; or
• otherwise appointed or constituted trustee of the estate.[8]

Accordingly, while there may be temporal bars to a creditor obtaining satisfaction of a debt incurred by a deceased before there is a grant of probate, such debts remain owing by the trustee of the estate from time to time and are therefore capable of being forgiven.

This recognition of the trustee of a deceased estate as a singular entity from the date of death reflects the application of the tax system to deceased estates generally, including the requirement (subject to exceptions) to lodge income tax returns prior to the grant of probate.[9]

Entity a shareholder or associate of a shareholder at the time of forgiveness

The remaining requirement, specified in paragraph 109F(1)(a), is that the relevant debt forgiveness takes place 'when the entity is a shareholder in the private company'. That is, a trustee of the Estate must be a shareholder in the Company (in that capacity) at the time the proposed transaction takes place (i.e. when the debt is released).

For the reasons described below, the Commissioner considers that the Estate will be a shareholder in the Company for the purposes of section 109F.

Subsection 6(1) provides that the term shareholder, 'includes member or stockholder'.

Patcorp Investments Ltd v Federal Commissioner of Taxation (1976) 140 CLR 247 is authority for the general proposition that a shareholder of a company is a person whose name is entered in the register of members as the holder of shares in it and also includes a person who is entitled as against the company to be registered and whom the company is absolutely entitled to register as a member (i.e. a person to whom a transfer of shares in the company has been approved for registration by its directors, but whose name has not, at the relevant time, actually been entered in the register). Specifically, Jacobs J stated (at [6]):

It appears to me that the question which arises in the present case is whether the meaning of "shareholder'' in the Income Tax Assessment Act is confined to a person whose name appears on the register of members. In my opinion it is not. It also includes a person who is entitled as against the company to be registered and whom the company is absolutely entitled to register as a member of the company.

Gibbs and Jacobs JJ both referred with approval to the earlier decisions of Dixon J in A.L. Campbell & Co Pty Ltd v Federal Commissioner of Taxation (1951) 82 CLR 452 and Dixon CJ in Federal Commissioner of Taxation v Angus (1961) 105 CLR 489. In Campbell, his Honour was concerned with an argument that, in the case where a deceased person remained on the share register, there was no deemed recipient of a hypothetical dividend paid at 30 June for the purposes of calculating undistributed profits tax under former subsection 104(1) of the ITAA 1936. Dixon J's view (at [14]) was that:

I have dealt at length with the foregoing cases because they show, as it appears to me, that when statutory provisions and articles attaching rights or privileges and liabilities or duties to shares employ for the purpose the expressions "member" or "shareholder" they are not to be construed as excluding the shares of a deceased registered member because there is no personal representative who is on the register.

In Angus, the issue before the court was whether amounts received by the daughter of a deceased person whose name remained on the register of a Singaporean company in respect of a life interest were dividends paid by that company. Dixon CJ observed (at [5]) that:

Although they have never been formally placed upon the company's register, it seems that the executors (or trustees) should be regarded as the shareholders for the purpose of payment of dividend and any consequent tax thereon: see Halsbury's Laws of England 3rd ed., vol. 6, pp. 262, 263 and the cases there cited and A.L. Campbell & Co Pty Ltd v Federal Commissioner of Taxation.

Accordingly, in the context of a deceased estate, the meaning of 'shareholder' is not limited to a person who is entered, or absolutely entitled to be registered, on a company's register of members at a particular time - i.e. 'shareholder' can extend to the executors or trustees of a deceased estate. This treatment applies for the purposes of section 109F, in the same way that it applies to the assessment of a 'shareholder' on any actual dividends[10] paid in respect of shares which are part of a deceased estate.

[1] Subsection 109F(3) and subsection 245-35 of the Income Tax Assessment Act 1997 (ITAA 1997).

[2] Union Bank of Australia v Harrison, Jones & Devlin Ltd (1910) 11 CLR 492, 515.

[3] Taxation Ruling IT 2622 Income tax: present entitlement during stages of administration of deceased estates, [2].

[4] Subsection 960-100(2) of the ITAA 1997.

[5] Taxation Ruling IT 2622, [5].

[6] Subsection 6(1), definition of 'trustee', paragraph (b).

[7] Subsection 6(1), definition of 'trustee', paragraph (a).

[8] Subsection 6(1), definition of 'trustee'.

[9] For example, Legislative Instrument LI 2023/16, Table E; c.f. Table O.

[10] Section 44 includes in the assessable income of a 'shareholder' certain dividends paid by the company.