Private ruling: Division 7A
Date of advice: 12 February 2016
Published: April 2016
Ruling period: Year ended 30 June 2015 | Year ending 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Question and answer | Would a reasonable person conclude that the loan was made to the individual by the Company because the individual was previously an associate of a shareholder in the Company in terms of paragraph 109D(1)(d)(iii) of the Income Tax Assessment Act 1936 ? | No.

Relevant facts and circumstances: The individual is an employee of the Company. The individual has a remuneration package with the Company commensurate with that of an employee with similar skills and experience. The individual has never been a director or company secretary of the Company. The Trust acquired X ordinary shares in the Company which represented a small minority shareholding in the Company. The individual and spouse as trustees for the Superannuation Fund (the Fund) acquired Y ordinary shares in the Company which represented a small minority shareholding in the Company. The individual and spouse are each members of the Fund and are potential beneficiaries of the Trust. The Company subsequently released an offer to subscribe for new shares to certain employees, including the individual. The Company offered the employees a loan at a concessional interest rate to enable them to take up the share subscription offer. The amount advanced was up to X% of the purchase price. The offer was not made to all the Company's employees. It was made to X employees in total. Not all elected to take up the loan and share offer. The offer to acquire subscription shares was made on the same terms and price to each participating employee, most of whom had not been a shareholder or associate of a shareholder in the Company before accepting the offer. The shares in the Company were also allowed to be bought by a related entity. Each new share was offered at the market value at the time. The Fund and the Trust sold their ordinary shares in the Company and made capital gains on the disposal. Following the sales, the individual and spouse were neither shareholders, nor associates of a shareholder, in the Company. The Fund applied the share sale proceeds to provide for the Y% upfront payment on the new shares and also to provide for the resulting CGT liability. The Trust distributed the capital gain to the individual and spouse. The capital proceeds were used to provide for the Y% upfront purchase price, to enable the beneficiaries to provide for CGT and other purposes. The individual accepted the loan offer from the Company and on-lent the funds to the Fund and the Trust to assist the entities in acquiring the new shares in the Company. The loan from the Company to the individual preceded the new Fund and Trust shareholdings as it funded the purchase of the shares. After the Fund and the Trust purchased the new shares in the company, they held in total a small minority shareholding in the Company.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 109D(1) | Income Tax Assessment Act 1936 paragraph 109D(1)(d)(i) | Income Tax Assessment Act 1936 paragraph 109D(1)(d)(ii)

Reasons for decision: Summary: Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates). Subsection 109D(1) of the ITAA 1936 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 if: a) the private company makes a loan to the entity during the year; and b) the loan is not fully repaid before the lodgment day for the year; and c) Subdivision D does not apply to prevent the company from being taken to pay a dividend because of the loan at the end of the 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. In this case, a private company made a loan to the individual, the loan has not been fully repaid and Subdivision D does not apply. Further, as the two entities the individual is associated with sold their entire shareholdings in the Company prior to the provision of the loan to the individual paragraph 109D(1)(d)(i) does not apply as the individual was not a shareholder in the Company, or an associate of such a shareholder, at the time the loan was made. Therefore, paragraph 109D(1)(d)(ii) must be considered to see whether the Company is taken to pay a dividend to the individual in relation to the loan. TR 2008/14 explains that paragraph 109D(1)(d)(i) applies if a taxpayer is a shareholder, or an associate of a shareholder, when a payment is made. No causal relationship between the payment and the entity's status as a shareholder or associate is required. However, paragraph 109D(1)(d)(ii) does require a causal relationship. In regard to wording of paragraph 109D(1)(d)(ii), TR 2008/14 explains that the word 'because' means by reason that. The reason must be a real and substantial reason for the payment, loan or debt forgiveness concerned, even if it is not the only reason or not the main reason for the transaction. The test for determining whether the transaction falls within the relevant provisions of Division 7A is a reasonable person's conclusion which is an objective test requiring a weighing up of all the circumstances to determine whether the reason is real and substantial. In this case, • the individual is an employee of the Company but has never been a director or company secretary of the Company; • the Company released an offer to subscribe for new shares to certain employees, including the individual; • the share offer was made on the same terms and price to each participating employee, most of whom had not been a shareholder or associate of a shareholder in the Company before accepting the offer; • participants were offered a loan to assist them take up the share offer; • not all the employees elected to take up the loan and share offer; • the individual's associated entities originally held together a small minority shareholding in the Company; and • the individual's associated entities still held a small minority shareholding in the Company after taking up the new share subscription. From the information provided, there is nothing to suggest that the past shareholdings of the individual's associated entities were a real or substantial reason for the loan being made to the individual. Instead, it is considered that the loan was made to the individual because of his employment status and that the purpose of the loan was to enable the individual to acquire shares in the Company. Consequently, it is considered that a reasonable person would not conclude that the loan was made because the individual was previously an associate of a shareholder in the Company.