Edited version of private advice

Authorisation Number: 1051886322540

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Date of advice: 17 August 2021

Ruling

Subject: Debt forgiveness and deceased estate

Question

Will a deemed divided arise under section 109F of the Income Tax Assessment Act 1936 (ITAA 1936) to the Estate of xxxxxxxx, an individual associate or shareholder, if X Private Co Pty Ltd (The Company) forgives the pre-existing Division 7A loan before the Grant of Probate to the Executor for the Estate?

Answer

No

Question 2

Will the commercial debt forgiveness rules in Division 245 of the ITAA 1997 apply to the Estate if The Company forgives the pre-existing Division 7A loans?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

XX/XX/XXXX

Relevant facts and circumstances

1.            The deceased was the sole director and shareholder in The Company until their death.

2.            The company and the deceased had entered into a complying Division 7A loan agreement on 30 June 20XX in relation to funds advanced from the company to the now deceased.

3.            All payments required under the agreement were made up to and including for the year ended 30 June 20XX.

4.            The loans to the deceased were all complying Division 7A loans.

5.            There were no current year loans.

6.            There was a balance on the loan of $X as at 30 June 20XX and no repayments have occurred since then.

7.            The loaned funds were used to fund a share portfolio by the deceased which was sold in the 20XX year.

8.            Loan interest was claimed in the deceased previous tax returns.

9.            The deceased died on XX/XX/20XX.

10.         The new director of The Company is considering forgiving the remaining balance of the Division 7A loan prior to the Grant of Probate.

11.         The shares in The Company will form part of the Estate residue.

12.         All decisions about withdrawal of funds from The Company were made by the deceased during their lifetime.

Status of the estate of deceased

13.         Probate has not yet been granted.

14.         The estate has the funds to repay the loans outstanding to the company.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Subdivision D

Income Tax Assessment Act 1936 section 109D

Income Tax Assessment Act 1936 section 109E

Income Tax Assessment Act 1936 section 109F

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 section 245-10

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 subsection 960-100(1)

Income Tax Assessment Act 1997 subsection 995-1(1)

Taxation Administration Act 1953 Schedule 1 subsection 260-140(2)

Probate and Administration Act 1898 (NSW) section 61

Other references

ATO ID 2012/77

PCG 2018/4

Reasons for decision

Question 1

Will a deemed dividend arise under section 109F of the Income Tax Assessment Act 1936 (ITAA 1936) to the Deceased Estate, an individual associate or shareholder, if The Company forgives the pre-existing Division 7A loan before the grant of Probate to the Executor for the Estate?

Summary

No, a deemed dividend will not arise under section 109F to the Estate of a deceased person if the company will forgive the pre-existing Div7A loans during the period between the time of death and prior to the grant of Probate.

Detailed reasoning

Section 109F - Forgiven debts treated as dividends

Subsection 109F(1) provides 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; or

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

Subsection 109F(2) provides the amount of the dividend is equal to the amount of debt forgiven subject to the private company's distributable surplus as determined under section 109Y.

Subsection 109F(7) provides that where a private company forgives an amount of debt resulting from a constituent loan that is taken into account in working out the amount of an amalgamated loan pursuant to subsection 109E(3), the private company is taken to forgive the same amount of debt resulting from the amalgamated loan.

The death of a shareholder borrower does not, of itself, trigger an automatic forgiveness of a loan.

Subsection 109F(3) provides that an amount of a debt is forgiven for the purposes of Division 7A if and when the amount would be forgiven under the commercial debt forgiveness rules in Division 245 of the ITAA 1997.

Relevantly, section 245-35 of the ITAA 1997 provides a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived or is otherwise extinguished other than by repaying the debt in full.

An issue arises as to whom the potential dividend will arise under section 109F where a loan is made to a shareholder who dies before the loan is repaid.

For a deemed dividend to arise under subsection 109F(1) in respect of a forgiven debt, the entity at the time the debt is forgiven must be:

•                    a shareholder in the private company, and

•                    it owes the debt.

When a person dies, the legal personal representative such as an executor named in the Will of the deceased, 'stands in the shoes of the deceased person' regarding the outstanding tax-related liabilities of the deceased - subsection 260-140(2) of Schedule 1 to the Taxation Administration Act 1953.

Practical compliance guide PCG 2018/4: Income tax - liability of a legal personal representative of a deceased person explains that an executor who has obtained probate of a deceased person's Will is required to provide tax returns and other information that the deceased was required to provide to the ATO. The executor is also liable to pay any outstanding tax-related liabilities of the deceased person up to the value of the deceased's assets that come into the hands of the executor.

Relevantly, subsection 995-1(1) of the ITAA 1997 defines a legal personal representative to mean an executor or administrator of an estate of an individual who has died.

Broadly, Australian property law provides that there cannot be a lapse in the chain of property ownership. When a person dies and prior to the Grant of Probate, the property of the deceased person will immediately vest in either the Public Trustee or in the named Executor depending on the jurisdiction and whether the person dies testate or intestate.

For example, in NSW the property (real and personal) of a deceased person will vest in the Public Trustee - section 61 of the Probate and Administration Act 1898 (NSW) (the Probate Act).

ATO Interpretive Decision ATO ID 2012/77: operation of section 109F of the Income Tax Assessment Act 1936 to forgiveness of amalgamated loan debt by a private company to a shareholders estate while it is in administrationexplains that section 109F applies to deem a private company to have paid a dividend to a deceased's legal personal representative in circumstances where a private company is taken to have made an amalgamated loan to a shareholder who dies before the amalgamated loan is repaid, and the private company forgives that loan while the shareholder's estate is in administration.

Application to your facts and circumstances

Pre-existing Div7A loans

The pre-existing Div7A loans (the Loans) made by the Company to the deceased shareholder met the conditions in subsection 109E(3). As such, the Loans are taken to be amalgamated loans for the purposes of Division 7A.

The Company has sufficient distributable surplus at the time the forgiveness of the pre-existing Div7A loans is proposed to occur for the purposes of subsection 109F(2).

Based on the Probate Act, the shares in the Company which were owned by the Deceased just before death, have vested in the Public Trustee at the time of the Deceased's death and prior to the Grant of Probate.

Accordingly, prior to the Grant of Probate, the Public Trustee would be deemed to be the relevant shareholder of the Company for the purposes of subsection 109F(1).

However, the Public Trustee is not expected to apply for Probate considering the Deceased died testate. In the Will, an Executor of the Estate is named. Hence, it is the Executor who must apply for Probate to prove the Will.

The Grant of Probate by the Court will confirm the Executor's title to the shares giving the Executor recognition of their standing to deal with the shares. The Grant will make the Executor accountable for the administration of the Estate of the Deceased.

Based on PCG 2018/4, the Executor will assume the obligation to repay the debts of the Deceased following the Grant of Probate. This is consistent with the view expressed in ATO ID 2012/77.

Prior to the Grant of Probate nobody assumes the obligation to repay the debts of the Deceased. Both the Public Trustee and the Executor will not be taken to owe the debts (the Loans) being forgiven prior to the Grant of Probate. As such one of the conditions in subsection 109F(1) will not be satisfied because no entity is taken to owe the Loans being forgiven.

Therefore, a deemed dividend will not arise under section 109F to the Estate of a deceased person if the company will forgive the pre-existing Div7A loans during the period between the time of death and prior to the Grant of Probate.

Question 2

Will the commercial debt forgiveness rules in Division 245 of the ITAA 1997 apply to the Estate if The Company forgives the pre-existing Division 7A loans?

Reasons for decision

The commercial debt forgiveness rules in Division 245 of the ITAA 1997 will apply to the forgiveness of a loan if the loan is considered a commercial debt.

Section 245-10 of the ITAA 1997 provides that a debt is a commercial debt if:

(a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

(b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

(c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2) (a), (b) and (c)) that has the effect of preventing a deduction.

Note: Paragraphs 8-1(2) (a), (b) and (c) prevent deductions for capital, private or domestic outgoings and for outgoings relating to exempt income or non-assessable non-exempt income.

Section 245-35 of the ITAA 1997 provides that a debt is forgiven if and when:

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

The effect of the debt forgiveness rules is contained in section 245-1 of the ITAA 1997 where it states:

When a creditor forgives a commercial debt you owe, you make a gain. This is usually not included in your assessable income. Instead, this Division offsets the forgiven amount against amounts that could otherwise reduce your taxable income in the same or a later income year. Those amounts are:

(a) your tax losses and net capital losses; and

(b) capital allowances and some similar deductions; and

(c) the cost bases of your CGT assets.

Section 245-3 of the ITAA 1997 provides how the forgiven debt is treated for tax purposes;

The net forgiven amounts of all your forgiven debts in an income year are added up. This total net forgiven amount is applied to reduce the following amounts (in the following order):

(a) your tax losses from previous income years;

(b) your net capital losses from previous income years;

(c) the deductions you would otherwise get in the income year, or in a later year, because of expenditure from a previous year (e.g. the capital allowance deductions you would get for the cost of a depreciating asset);

(d) the cost bases of your CGT assets.

Section 245-2(4) ITAA 1997

Any unapplied total net forgiven amount is disregarded.

Application to your facts and circumstances

You have stated the loaned money was used by the deceased to purchase a share portfolio and the interest payments were claimed by the deceased in their income tax returns. Consequently, in accordance with the definition of a commercial debt in section 245-10 of the ITAA 1997 the loaned money is considered a commercial debt.

In accordance with section 245-3 of the ITAA 1997 the net forgiven amount will need to be applied to reduce firstly any tax losses of the deceased from previous income years, then against any net capital losses from previous years, then against any income tax deductions of the deceased in the current income year and finally against any cost bases of CGT assets. Any unapplied total net forgiven amount is disregarded.

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