Private ruling: Restructure of security arrangements for some 25 year Division 7A loans
Date of advice: 14 April 2016
Published: June 2016
Ruling period: Years ended 30 June 2011 to 2017 inclusive
Date scheme commenced: 1 July 2010

Ruling: Q1: If the existing mortgage over one of a number of secured properties is released, will the loan from the Lender continue to be a loan meeting the criteria for minimum interest rate and maximum term, as required by section 109N of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936), where security exists over the remaining properties? | A1: Yes | Q2: If the answer to Question 1 is Yes, will the Lender not be taken to pay (or have paid) a dividend to the Borrower under Division 7A in any of the 2011 to 2017 income year? | A2: Yes

Relevant facts and circumstances: The Borrower borrowed funds from the Lender (a related entity) in a prior income year. The terms of the loan were originally governed by a written loan agreement that complied with section 109N of Division 7A of the ITAA 1936 on the basis that the loan was repayable on a principle and interest basis over a 7 year term. The loan was refinanced in a later year and converted to one with a maximum term of 25 years (reduced by the expired term of the original 7 year loan) in accordance with section 109N and section 109E of Division 7A of the ITAA 1936. The terms of the refinanced loan were set out in a new 25 year facility agreement dated dd/mm/yyyy. To comply with the requirements for refinancing to a 25 year term, the loan was secured by mortgages over a number of properties some of which are owned by the Borrower and some of which are owned by related parties who guaranteed the repayment of the loan. The properties are also subject to mortgages securing payment of loans owing by other related parties. At the time the loan was refinanced, the equity in the mortgaged properties that secured the loan (after taking into account the other liabilities secured over the properties) exceeded 110% of the amount of the loan. The Borrower is currently negotiating with a prospective purchaser of one of the secured properties and it is anticipated that the completion of the sale will occur before 30 June 2016. If that sale proceeds it will be necessary for the mortgage granted to the Lender over that property to be released before the date of settlement. It is proposed that the balance of the loan owed to the Lender at the date of release will continue to be secured by the existing mortgages over the remaining secured properties.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109N and | Income Tax Assessment Act 1936 Section 109D.

Reasons for decision: Summary: Section 109N of Division 7A of the ITAA 1936 establishes how loans that meet the criteria for minimum interest rate and maximum term are not treated as dividends: 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 lodgement 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) 109N(2) Benchmark interest rate. The benchmark interest rate for the year of income is the Indicator Lending Rates - Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income. However, the benchmark interest rate is the rate worked out under the regulations, if they provide for working it out. 109N(3) Maximum term. The maximum term is: a) 25 years for a loan if: i. 100% of the value of the loan is secured by a mortgage over real property that has been registered in accordance with a law of the State or Territory; and ii. when the loan is first made, the market value of that real property (less the amounts of any other liabilities secured over that property in priority to the loan) is at least 110% of the amount of the loan; and b) 7 years for any other loan. In your circumstances, the loan in question satisfied the criteria of section 109N when it was originally taken out. The original loan was for a period of 7 years. The loan was then refinanced and that refinanced loan was converted to a 25 year term secured by a mortgage over real property. This loan also satisfied the criteria under section 109N. The proposal is to sell a property which is one of the properties that were mortgaged as security for the loan. However, the remaining properties will still be subject to mortgages as security for the loan. The Borrower has confirmed that after the release of the mortgage over the property the value of the remaining properties that are subject to the mortgage (less amounts of other liabilities secured over those properties in priority to the loan) are at least 110% of the amount of the loan (as at the date of the 25 year refinancing and as at the date when the mortgage is released). The Commissioner therefore confirms that the loan will continue to be a 25 year complying loan pursuant to section 109N of Division 7A of the ITAA 1936. As the loan has at all times been a complying loan pursuant to section 109N of Division 7A of the ITAA 1936, the Lender is not taken under section 109D to pay a dividend to the Borrower at the end of the year of income.