Edited version of private advice

Authorisation Number: 1052256512059

Date of advice: 28 May 2024

Ruling

Subject: Tax integrity measures

Question

Will the loan, or parts thereof, made by the trustee of Trust A to client A and client B be deemed dividends under Division 7A of the Income Tax Assessment Act 1936(ITAA 1936)?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 20YY

Relevant facts and circumstances

Client A and client B are the controlling minds and beneficial owners of a group of related entities, comprising Company A, Trust A and Trust B.

Company A primarily derives its income from Trust B's distributions.

Trust A is a discretionary trust that holds the family group's investment assets.

Trust B is a trading trust that owned and operated a business.

In June 20YY, Trust B sold the business.

Proceeds from the sale of business were transferred by Trust B to Trust A.

Trust A subsequently made a loan to client A and client B (Loan X).

In January 20YY, client A and Client B used the funds in respect of Loan X to purchase property.

As at 30 June 20YY, the following relevant amounts remain outstanding in respect of each of the entities' entitlements and liabilities:

•         $xx loan amount owing by Trust A to Trust B (Loan Y);

•         $xx loan amount owing by Trust A to Company A (Loan Z); and

•         $xx unpaid present entitlement (UPE) payable by Trust B to Company A.

Before the relevant lodgment day:

•         the trustee for Trust A (in the capacity of borrower) executed a loan facility agreement with Company A on complying terms pursuant to section 109N of the ITAA 1936 in respect of Loan Z; and

•         the UPE was converted into a loan from Company A to Trust B and, pursuant to an executed loan facility agreement, was placed on terms compliant with section 109N of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 subsection 109D(1)

Income Tax Assessment Act 1936 paragraph 109D(3)(b)

Income Tax Assessment Act 1936 Subdivision D

Income Tax Assessment Act 1936 section 109N

Income Tax Assessment Act 1936 subsection 109N(1)

Income Tax Assessment Act 1936 subsection 109N(3)

Income Tax Assessment Act 1936 section 109T

Income Tax Assessment Act 1936 Subdivision EA

Income Tax Assessment Act 1936 subsection 109XA(2)

Income Tax Assessment Act 1936 section 109XB

Income Tax Assessment Act 1936 section 318

Reasons for decision

All subsequent legislative references are to the ITAA 1936.

Summary

Loan X, or parts thereof, made by Trust A to client A and client B will not be deemed as dividends under Division 7A.

Detailed reasoning

Division 7A is a specific anti-avoidance measure designed to prevent private companies from making tax-free distributions of profits to shareholders or their associates[1] in the form of payments, loans or debts that are forgiven.

Subsection 109D(1) 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:

•         the private company makes a loan to the entity;

•         the loan is not fully repaid before the lodgment day;

•         the loan is not excluded by Subdivision D; and

•         either:

o   the entity is a shareholder in a private company (or its associate) at the time when the loan is made; or

o   a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time.

One of the circumstances under Subdivision D pursuant to which section 109D does not apply to a loan is where the loan meets the criteria set out in section 109N.

Subsection 109N(1) provides that a private company that makes a loan to its shareholder (or its associate) is not taken under section 109D to pay a dividend if, before the lodgment day for the year of income:

•         the loan agreement is in writing;

•         the interest payable is at least equal to the 'benchmark interest rate' for the year; and

•         the term of the loan does not exceed the maximum term provided for under subsection 109N(3).

Section 109T extends the operation of Division 7A as if a private company makes a payment or loan to a target entity (i.e. shareholder and/or its associate) where:

•        the private company makes a payment or loan to an interposed entity between the private company and target entity;

•         a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment or loan solely or mainly as part of an arrangement involving a payment or loan to the target entity; and

•         a payment or loan is made by the interposed entity to the target entity.

Broadly, Subdivision EA operates such that a deemed dividend may arise where a private company is presently entitled to income of a trust but that income has not been paid and the trustee shifts value from the trust to a shareholder of a private company (or its associate) in the form of a payment, loan or forgiven debt.

Of relevance, subsection 109XA(2) under Subdivision EA sets out the conditions under which a loan will be deemed as a dividend in favour of the shareholder (or its associate) under section 109XB. They are:

•         a trustee makes a loan (including through an interposed entity) to a shareholder of a private company (or its associate); and

•         either, at the time or after the actual transaction, the company is, or has become, presently entitled to an amount from the net income of the trust estate, but that entitlement has not been satisfied before the earlier of the due date for lodgment and the date of lodgment of the trustee's return of income for the trust for the year of income of the trust in which the actual transaction takes place.

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'? explains that where a private company is presently entitled to income of a trust[2] and has knowledge of an amount that it can demand immediate payment of, but by arrangement, understanding or acquiescence, consents to the trustee retaining that amount for trust purposes and does not demand payment, the company will be taken to have provided 'financial accommodation'[3] for the purposes of section 109D.

Paragraph 11 of TD 2022/11 states:

If the private company beneficiary and the trustee have the same directing mind and will, the private company beneficiary is taken to have knowledge of the amount that it can demand immediate payment of from the trustee when the trustee does.

Application to the taxpayer's circumstances

Section 109D does not apply to loans made by a trust. The loan made to client A and client B by Trust A is not taken to be a dividend paid by Trust A.

For completeness, the following is also noted:

1.            For the purposes of section 109T, to the extent that a reasonable person would conclude, having regard to all the circumstances, that Company A made Loan Z to Trust A solely or mainly as part of an arrangement involving Loan X, the loan taken to have been provided by Company A to client A and client B (shareholders) would be nil on the basis that the loan made by Company A to Trust A (as the interposed entity) as part of the arrangement meets the criteria set out in section 109N before the relevant lodgment day (see Taxation Determination 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).

2.            While Company A's UPE from Trust B was a loan pursuant to paragraph 109D(3)(b), the conditions in subsection 109XA(2) will not be satisfied, and (to the extent that a reasonable person would conclude, having regard to all the circumstances, that Trust B made Loan Y to Trust A solely or mainly as part of an arrangement involving Loan X) section 109XB under Subdivision EA cannot apply to treat Loan Y by Trust B (through Trust A as the interposed entity) to client A and client B as a dividend, on the basis that the whole of the UPE was converted into a loan before the relevant lodgment day.

[1] The term 'associate' is given a wide meaning in section 318, as relevantly, to include relatives (i.e. spouse and children) and a trustee of a trust.

[2] Other than a sub-trust as described in paragraphs 13 to 19 of TD 2022/11.

[3] Paragraph 109D(3)(b) defines a 'loan' to mean a provision of credit or any other form of financial accommodation.