ATO ID 2004/967: Interaction between Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) and Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997)
Date of decision: 15 November 2004
Year of income: Year ended 30 June 2004
Business line: Private Groups and High Wealth Individuals

Issue
Is a loan, that is a deemed dividend under section 109D of the Income Tax Assessment Act 1936 (ITAA 1936), included in the assessable income of the taxpayer under section 44 of the ITAA 1936 where:

Decision
No. Where income is derived by a private company that is personal services income of the taxpayer within the meaning of subsection 84-5(1) of the ITAA 1997 and is included in the taxpayer's assessable income under subsection 86-15(1) of the ITAA 1997, a loan made by the private company to the taxpayer out of profits from that income and treated as a dividend under section 109D of Division 7A of the ITAA 1936, will not be included in the taxpayer's assessable income under section 44 of the ITAA 1936.

Facts
The taxpayer is a shareholder of a private company. The private company is a personal services entity and its ordinary income is the personal services income of the taxpayer. In the income year, the private company derived ordinary income of $125,000 from the personal efforts or skills of the taxpayer and incurred expenses of $25,000. These expenses are allowable deductions and relate to the taxpayer's personal services income. The private company is not conducting a personal services business within the meaning of Division 87 of the ITAA 1997 and an amount of $100,000 was included in the taxpayer's assessable income in that year. In the following income year, the private company made a loan of $100,000 to the taxpayer which represented the personal services income included in the taxpayer's assessable income in the prior year. The loan was not an excluded loan and was not repaid by the end of the income year in which it was made. As at 30 June in the income year the loan was made, the private company had a distributable surplus of $100,000 for the purposes of section 109Y of the ITAA 1936.

Reasons for decision
Summary: As the private company is a personal services entity within the meaning of subsection 86-15(2) of the ITAA 1997, and is not conducting a personal services business within the meaning of Division 87 of the ITAA 1997, $100,000 is included in the assessable income of the taxpayer for the income year under subsection 86-15(1) of the ITAA 1997. Subsection 109D(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to a shareholder or their associate at the end of the private company's year of income if the private company makes a loan to the shareholder or their associate during the year which is not fully repaid before the lodgement day for the current year and Subdivision D of Division 7A of the ITAA 1936 does not apply. The amount of the dividend is the lesser of the amount of the loan that has not been repaid and the private company's distributable surplus (subsection 109D(1AA) and section 109Y of the ITAA 1936). As the loan to the taxpayer is not an excluded loan under Subdivision D of Division 7A of the ITAA 1936, and has not been repaid by the end of the income year in which it was made, the taxpayer is taken to receive a dividend of $100,000 under section 109D of the ITAA 1936 for that income year. Under section 109Z of the ITAA 1936, the dividend is taken to have the necessary characteristics to be included in the assessable income of the taxpayer under section 44 of the ITAA 1936. These characteristics are that the dividend is taken to be paid: However section 86-35 of the ITAA 1997 will apply to exclude the dividend from the assessable income of the taxpayer. Section 86-35 of the ITAA 1997 treats any later payments of personal services income that have been included in the assessable income of the taxpayer under subsection 86-15(1) of the ITAA 1997 as being neither assessable nor exempt income of the taxpayer.

Legislative references: Income Tax Assessment Act 1936 section 44 subsection 44(1) Division 7A subdivision D of Division 7A section 109D subsection 109D(1) subsection 109D(1AA) section 109Y section 109Z
Related public rulings and determinations: Taxation Ruling TR 2003/6
Subject references: Shareholder loans Deemed dividends Private companies Personal Services Income