Edited version of private advice

Authorisation Number: 7910152492401

Date of advice: 21 October 2022

Ruling

Subject: Division 7A deemed dividends

Question 1

Does Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)[1] apply to the loan provided by the Cattle Company Pty Ltd (the Company) to Yellow, Orange, Mrs Blue and Mr Blue, trading as the Colourful Partnership (the Partnership) to deem the loan as an unfranked dividend in the year ended 30 June 20XX?

Answer

Yes.

Question 1(a)

Following Question 1, will the Partnership be assessed on the deemed dividend in the year ended 30 June 20XX?

Answer:

No.

Question 2

If the answer to Question 1(a) is no, will the partners in the Partnership be required to include the deemed dividends in their assessable income on a proportionate basis?

Answer

Yes.

Question 3

If the answer to either Question 1 or Question 2 is 'yes', whether the Commissioner is authorised to amend the Partners' assessments for the years ended 30 June 20XX pursuant to section 170?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background:

1.         Mr and Mrs Blue are the parents of Yellow. Mr and Mrs Blue passed away in the early 20XXs.

2.         Yellow's spouse is Orange.

The Colourful Partnership (the Partnership):

3.         In 20XX, a partnership known as the Yellow, & Orange & Mrs Blue and Mr Blue Partnership, trading as the Colourful Partnership (the Partnership), commenced between Yellow, Orange, Mrs Blue and Mr Blue, (the Partners). Each of the Partners had a 25% interest in the Partnership.

4.         At all times after forming, the Partnership carried on a primary production business.

5.         Each of the Partners had limited understanding of complex tax law, such as Division 7A. Consequently, they relied entirely on the advice of their previous tax agent in relation to their tax affairs.

6.         The Partnership was dissolved in the year ended 30 June 20XX.

Cattle Company Pty Ltd:

7.         Cattle Company Pty Ltd (the Company) is a private company. The sole shareholder of the company is Yellow.

Loans from the Company to the Partnership:

8.         Recently, Yellow appointed a new tax agent to manage the tax affairs of their entities. While undertaking this review, the new tax agent discovered the existence of a $XXX loan (the Loan) from the Company to the Partnership which arose sometime in the year ended 30 June 20XX.

9.         The Loan was not placed on a complying Division 7A loan agreement and none of the Partners were aware of the tax consequences from this non-compliance. Consequently, no deemed dividends were included in the Partners income tax returns for the year ended 30 June 20XX or subsequent years.

Issue dates of the assessments for the year ended 30 June 2008:

10.      The Partnership lodged its income tax return on or around 15 May 200z.

11.      The Partners assessments for the year ended 30 June 200x were issued on the following dates:

Assumption:

12.      For the purposes of this ruling the Commissioner has no evidence that the partners' behaviour constitutes fraud or evasion in the year ended 30 June 20XX.

Relevant legislative provisions

Section 90 of the Income Tax Assessment Act 1936

Section 91 of the Income Tax Assessment Act 1936

Section 92 of the Income Tax Assessment Act 1936

Division 7A of the Income Tax Assessment Act 1936

Section 170 of the Income Tax Assessment Act 1936

Reasons for decision

Question 1:

Does Division 7A apply to the loan provided by the Company to the Partnership to deem the loan as an unfranked dividend in the year ended 30 June 200x?

DISTRIBUTIONS TO ENTITIES CONNECTED WITH A PRIVATE COMPANY - DEEMED DIVIDENDS

13.      Broadly, Division 7A of Part III of the ITAA 1936[2] (Division 7A) is an integrity measure aimed at ensuring that profits of a private company are not effectively received by its shareholders in non-dividend form. The general provisions of Division 7A[3] apply to treat amounts paid, lent, or debts forgiven, by a private company to a shareholder of a private company, or an associate of such a shareholder, as unfranked dividends, unless they come within specified exclusions.

Definition of a 'private company'

14.      A private company is defined in subsection 103A(1) as a 'company [that] is not a public company in relation to the year of income.' According to subsection 103A(2), a public company includes:

a.         a company whose shares were listed for quotation on a stock exchange at the last day of the income year

b.        a co-operative company, mutual life assurance company or friendly society dispensary

c.         a company that has not been carried on for the purpose of profit or gain to its members and was prohibited by its constitution from making a distribution to its members

d.        a government body or a company controlled by a government body, and

e.        a subsidiary of a public company.

Application to your circumstances

15.      The Company is not a public company as it does not satisfy the requirements of subsection 103A(2) of the ITAA 1936. Consistent with this, the Company therefore satisfies subsection 103A(1).

16.      As the Company is a private company, Division 7A may apply to treat as dividends amounts paid or lent, or debts forgiven by the company to shareholders or shareholders' associates.

Payments, loans and debt forgiveness treated as dividends

17.      Subdivision B of Division 7A provides for payments, loans and debt forgiveness by private companies to be 'treated' as dividends.

18.      With regards to loans, subsection 109D(1) provides that:

A private company is taken to pay a dividend to an entity at the end of one of the private company's years of income (the current year) if:

a.         the private company makes a loan to the entity during the current year; and

b.         the loan is not fully repaid before the lodgment day for the current year; and

c.         Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and

d.         either:

(i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or

(ii) 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.

Note 1: Some repayments cannot be counted for the purpose of this subsection. See section 109R.

Note 2: A private company is treated as making a loan to a shareholder or shareholder's associate if an interposed entity makes a loan to the shareholder or associate. See Subdivision E.

19.      In order for subsection 109D(1) to apply, the private company must be the entity which provides the loan to the shareholder or associate.

Meaning of the term 'associate'

20.      Subsection 995-1(1) of the ITAA 1997 provides that the meaning of the term 'associate' is that provided by subsection 318(1). Specifically, subsection 318(1) provides that an associate of a natural person includes:

a)    a relative of the primary entity;

b)        a partner of the primary entity or partnership in which the primary entity is a partner;

c)         if a partner of the primary entity is a natural person other than in the capacity of trustee - the spouse or a child of that partner;

d)        a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;

e)        a company where:

(i)        the company is sufficiently influenced by:

(A)      the primary entity; or

(B)      another entity that is an associate of the primary entity because of another paragraph of this subsection; or

(C)      another company that is an associate of the primary entity because of another application of this paragraph; or

(D)      2 or more entities covered by the preceding sub-subparagraphs; or ...

Application to your circumstances

1.        Yellow is the sole shareholder of the Company and, as they are a partner of the Partnership, the Partnership will satisfy the definition of associate pursuant to paragraph 318(1)(b).

2.        Mr and Mrs Blue are Yellow's mother and father, thereby also satisfying paragraph 318(1)(b) and are Yellow's associates. Similarly, Orange is Yellow's spouse and also satisfies the definition of Yellow's associate pursuant to paragraph 318(1)(b).

Meaning of the term 'entity'

3.        Section 109ZD provides that the meaning of 'entity' is that pursuant to section 960-100 of the ITAA 1997. Section 960-100 of the ITAA 1997 states that an entity includes an individual, a body corporate, a body politic, a partnership, any other unincorporated association or body of persons, a trust, a superannuation fund or an approved deposit fund.

4.        Subsection 995-1(1) of the ITAA 1997 defines a partnership as:

(a)       an association of persons (other than a company or a limited partnership) carrying on a business as partners or in receipt of ordinary income or statutory income jointly; or

(b)       a limited partnership.

Application to your circumstances

5.        As the Partnership was carrying on a primary production activity and was an association of persons carrying on a business as partners, it meets the definition of 'partnership' in subsection 995-1(1). Consequently, the Partnership satisfies the definition of the term 'entity' pursuant to section 960-100 of the ITAA 1997.

Division 7A compliant loans:

6.        As noted above, section 109D broadly provides that loans given by a private company to an entity will be treated as dividends unless exclusions are satisfied.

7.        The relevant exclusions are provided in Subdivision D which prevent amounts from being deemed to be dividends. One such exclusion is subsection 109N(1), commonly known as "Division 7A compliant loans", which provides that:

109N(1) Criteria A private company that makes a loan to an entity in one of the private company's years of income is not taken under section 109D to pay a dividend at the end of the year of income because of the loan if, before the lodgment day for the year of income:

(a) the agreement that the loan was made under is in writing; and

(b) the rate of interest payable on the loan for years of income after the year in which the loan is made equals or exceeds the benchmark interest rate for the year; and

(c) the term of the loan does not exceed the term (the maximum term) for that kind of loan worked out under subsection (3).

8.        Subsection 109N(2) sets the benchmark interest rate by reference to bank variable housing loans interest rate set by the Reserve Bank and subsection 109N(3) sets the maximum term as 25 years for secured loans and 7 years for unsecured loans.

Application to your circumstances:

9.        The Loan from the Company to the Partnership was recently discovered by Yellow's newly appointed tax agent. The Loan did not meet any of the criteria in section 109N and therefore was not placed on Division 7A compliant terms. This exclusion is not available in the current circumstances.

Amount of the deemed dividend

10.      In general, subsection 109D(1) provides that unrepaid loans made by a private company to a shareholder, or their associate, will be deemed to be a dividend in the company's current year. Similarly, loans made by an interposed entity to a shareholder of a private company, or their associate, are also deemed to be a dividend in the private company's current year pursuant to Note 2 of subsection 109D(1).

a.         Subsection 995-1(1) of the ITAA 1997 states that 'current year' means 'the income year for which you are working out your assessable income and deductions'.

11.      Section 109D(1AA) provides that where Division 7A is applied to loans made to a shareholder or their associate, the amount of the dividend taken to have been paid '... is the amount of the loan that has not been repaid before the lodgment day for the current year, subject to section 109Y of the ITAA 1936'. Subsection 109D(6) provides that the lodgment day is the earlier of the due date for lodgment of the private company's return of income for the year of income and the actual date of lodgment.

12.      Subsection 109Y(1) limits the sum of all of the dividends a private company is taken to have paid under Division 7A to the company's distributable surplus for the year of income. A company's distributable surplus is calculated in accordance with subsection 109Y(2) as follows:

Net assets - non-commercial loans - paid up share value - repayments of non-commercial loans

13.      Where the sum of all of the dividends a private company is taken to have paid under Division 7A is greater than the company's distributable surplus, a proportionate reduction of dividends is calculated using the formula at subsection 109Y(3):

14.      Paragraph 202-45(g)(i) of the ITAA 1997 provides that if an amount is taken to be a dividend pursuant to Division 7A, the amount will not be franked.

Application to your circumstances

15.      Pursuant to section 109D, the amount of dividends taken under Division 7A to have been paid to the Partnership directly from the Company are the amount of the loans (being the notional loans in your circumstances) that have not been repaid before the lodgment day for the relevant years, subject to section 109Y. As none of the loans were repaid, the amount of the deemed dividend is $XXX. Consistent with paragraph 202-45(g)(i) of the ITAA 1997, the deemed dividend will not be franked.

16.      The amount of the Company's distributable surplus for the year ended 30 June 200x is unknown. If the loan to the Partnership was greater than the company's distributable surplus, the formula explained in paragraph 20 will need to be applied in order to calculate the provisional dividend pursuant to subsection 109Y(3).

Question 1(a)

17.      Following Question 1, will the Partnership be assessed on the deemed dividend which arises as a result of Division 7A in the year ended 30 June 20XX?

LIABILITY OF PARTNERS

18.      Section 91 provides that partnerships are required to lodge income tax returns however, no tax is levied on the partnership.

19.      Rather, subsection 92(1) broadly provides that the assessable income of a partner in a partnership includes the partner's interest in the net income of the partnership.

20.      The term 'net income' in relation to a partnership means the assessable income of the partnership, calculated as if the partnership were a resident taxpayer, less allowable deductions[4] in accordance with section 90.

Application to your circumstances:

21.      The Partnership lodged its income tax return for the year ended 30 June 200x on or around 15 May 200y but did not include the amount of the unfranked deemed dividend in this return.

22.      As each of the individual partners held a 25% interest in the Partnership, they are each required to include their 25% share of the net income of the Partnership, which should have included the unfranked deemed dividend, in their assessable income for the year ended 30 June 200x in accordance with subsection 92(1). Consequently, it is the partners, and not the Partnership, that are assessed in relation to the loan from the Company.

Question 2

If the answer to Question 1(a) is no, will the partners in the Partnership be required to include the deemed dividends in their assessable income on a proportionate basis?

Answer

Yes.

LIABILITY OF PARTNERS

Application to your circumstances

23.      As explained in paragraphs 29 and 30, although the Partnership is required to include the unfranked deemed dividend in its tax return for the year ended 30 June 200x, it is the partners that must include their 25% share in their assessable income for the year in accordance with subsection 92(1).

Question 3

If the answer to either Question 1 or 2 is 'yes', is the Commissioner is authorised to amend the Partners' assessments for the years ended 30 June 2008 pursuant to section 170?

Answer

No.

COMMISSIONER'S AUTHORITY TO AMEND ASSESSMENTS

24.      Section 170 allows the Commissioner to amend an assessment, subject to the limitations in the section. Relevantly, item 1 of the table in subsection 170(1) broadly provides that the Commissioner may amend the assessment of an individual who is a partner in a partnership that carries on a business and is a small or medium business entity within 2 years of the issue date of the assessment. Where the individual is a partner in a partnership that carries on a business that is not a small or medium business entity, the Commissioner is permitted to amend their assessment within a four-year period in accordance with item 4. However, where the Commissioner has formed the opinion that there has been fraud or evasion, item 5 of subsection 170(1) provides that the Commissioner can then amend an assessment at any time.

Application to your circumstances

25.      The following table outlines the date upon which the Commissioner issued assessments to the partners of the Partnership:

26.      The individuals are all partners in a partnership that carried on a business. However, you have not explained whether the Partnership was a small or medium business entity in the year ended 30 June 200x. As such, the Commissioner in unable to determine whether the 2 or 4 year period in which to amended their assessments would apply. Despite this, the period of time in which the Commissioner can amend their assessments has lapsed by a number of years unless he has determined that there has been fraud or evasion.

27.      In this case, no evidence that fraud or evasion occurred has been provided to the Commissioner. Consequently, in accordance with subsection 170(1) the Commissioner is out of time to amend the assessments of the Partners for the year ended 30 June 20XX.

[1] All future references to the legislation are to the Income Tax Assessment Act 1936, unless otherwise stated.

[2] all future legislative references are to the ITAA 1936, unless otherwise indicated.

[3] at Subdivision B, comprising of sections 109B to 109F.

[4] Except deductions allowable under section 290-150 or Division 36 of the Income Tax Assessment Act 1997.