ATO Interpretative Decision

ATO ID 2011/104

Income Tax

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Issue

Can section 109T of the Income Tax Assessment Act 1936 (ITAA 1936) operate to treat a private company as having made a payment or loan to a shareholder or an associate of a shareholder (the target entity) in circumstances where the interposed entity is also a shareholder of the private company and the payment made to the interposed entity is the payment of an actual dividend?

Decision

Yes. Section 109T of the ITAA 1936 operate to treat a private company as having made a payment or loan to a shareholder or an associate of a shareholder (the target entity) in circumstances where the interposed entity is also a shareholder of the private company and the payment made to the interposed entity is the payment of an actual dividend provided the conditions in subsection 109T(1) of the ITAA 1936 are satisfied.

Facts

Jack Jones is a shareholder of Private Company A, holding 100 A class shares.

Jack Jones needs $100,000 to enable him to purchase a new residence.

Private Company A has significant cash reserves and a distributable surplus.

Private Company B is also a shareholder of Private Company A, holding 100 B class shares.

Private Company A paid a fully franked dividend of $100,000 to Private Company B and on the same day Private Company B made an interest free loan of $100,000 to Jack Jones.

No repayments of the loan were made by Jack Jones before the private company's lodgment day for the relevant year of income.

Private Company B has no distributable surplus.

Reasons for Decision

Subdivision E of Division 7A of the ITAA 1936 allows a private company to be taken under Subdivision B of the ITAA 1936 to pay a dividend to a shareholder or an associate of a shareholder (the target entity) if an entity interposed between the private company and the target entity makes a payment or loan to the target entity under an arrangement involving the private company.

The Explanatory Memorandum to Taxation Laws Amendment Bill (No.3) 1998 explains the operation of Subdivision E as follows:

9.63 New Subdivision E applies to back-to-back arrangements under which a private company pays or loans an amount to an interposed entity on the understanding that the interposed entity or another interposed entity will pay or loan an amount to a shareholder of the private company or an associate of the shareholder. In such cases, the private company will be treated as having directly paid or loaned an amount to the shareholder or associate. The amount of the payment or loan will be determined by the Commissioner having regard to certain specified conditions.

Therefore, Subdivision E prevents Division 7A of the ITAA 1936 being circumvented by causing an entity interposed between the private company and the target entity to itself make the payment to the target entity.

If the conditions in subsection 109T(1) of the ITAA 1936 are satisfied then, subject to subsection 109T(3) of the ITAA 1936, Division 7A of the ITAA 1936 operates as if the private company made the payment or loan direct to the target entity. Section 109T of the ITAA 1936 relevantly provides:

109T(1) This Division operates as if a private company makes a payment or loan to an entity (the target entity ) as described in section 109V or 109W if:

(a)

the private company makes a payment or loan to another entity (the first interposed entity ) that is interposed between the private company and the target entity; and

(b)

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

(c)

either:

(i)

the first interposed entity makes a payment or loan to the target entity; or

(ii)

another entity interposed between the private company and the target entity makes a payment or loan to the target entity.

109T(2) ...................................

109T(3) This Division does not operate as described in subsection (1) (and sections 109V and 109W) if the private company is taken under Subdivision B (as it applies apart from this Subdivision) to pay a dividend as a result of the payment or loan to the first interposed entity.

Subsection 109X(1) of the ITAA 1936 is also relevant. The section provides:

109X(1) Despite sections 109K and 109L, a private company may be taken under section 109C or 109D to pay a dividend as a result of this Subdivision treating the private company as making a payment or loan to an entity (the target entity ), even if:

(a)

the private company is treated that way because it makes a payment or loan to an entity that is a company interposed between the private company and the target entity; or

(b)

some or all of the amount paid or lent by a private company to an entity interposed between the private company and the target entity is included in the interposed entity's assessable income for a year of income.

Paragraph 109X(1)(b) of the ITAA 1936 makes it clear that section 109T (and sections 109V and 109W of the ITAA 1936) can apply in circumstances where the amount paid by the private company is included in the interposed entity's assessable income.

On the present facts, the operation of Division 7A of the ITAA 1936 will need to be considered in respect of:

1.

the payment made by Private Company A to Private Company B

2.

the loan made by Private Company B to Jack Jones; and

3.

any notional loan taken to be made by Private Company A to Jack Jones

The payment made by Private Company A to Private Company B

Because of the operation of subsection 109L(1) of the ITAA 1936 there is no prospect for the fully franked dividend paid to private company B to also be taken to be a dividend under section 109C of the ITAA 1936. This is because the dividend is already included in the assessable income of Private Company B under section 44 of the ITAA 1936.

The loan made by Private Company B to Jack Jones

Private Company B is taken to have paid a dividend to Jack Jones under section 109D of the ITAA 1936 but the amount of the dividend is capped at the company's distributable surplus.

As the amount of distributable surplus is $nil the amount of the dividend that Private Company B is taken to have paid to Jack Jones is $nil.

The notional loan made by Private Company A to Jack Jones

On the present facts, the subsection 109T(1) of the ITAA 1936 conditions are satisfied. There is a back to back arrangement in which Private Company A has made a payment to Private Company B as part of an arrangement involving a loan to Jack Jones.

As subsection 109T(3) of the ITAA 1936 has no application, Division 7A of the ITAA 1936 can operate as if Private Company A made a loan to Jack Jones as described in section 109W of the ITAA 1936.

Under section 109W of the ITAA 1936, the amount of the notional loan is the amount (if any) determined by the Commissioner. Given the facts and circumstances relating to the loan made to Jack Jones, the Commissioner would determine that the amount of the notional loan was $100,000. There has been an informal or disguised distribution of Private Company A profits to Jack Jones.

Year of income:  Year ending 30 June 2006 Year ending 30 June 2007 Year ending 30 June 2008 Year ending 30 June 2009

Legislative References:
Income Tax Assessment Act 1936
   section 44
   Division 7A
   Subdivision B
   Subdivision E
   section 109C
   section 109D
   subsection 109L(1)
   section 109T
   subsection 109T(1)
   subsection 109T(3)
   section 109V
   section 109W
   subsection 109X(1)
   paragraph 109X(1)(b)

Other References:
Explanatory Memorandum to the Taxation Laws Amendment Bill (No.3) 1998

Keywords
Anti avoidance measures
Deemed dividends
Dividend income
Income
Private company distributions
Shareholder payments
Shareholder loans

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  23 December 2011

ISSN: 1445-2782