Private ruling: Deemed dividends and commercial debt forgiveness
Date of advice: 22 June 2015
Published: June 2015
Ruling period: 1 July 20xx to 30 June 20yy
Date scheme commenced: 1 July 20xx

Ruling: Q1: Will Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the proposed execution by Red Pty Ltd of two deeds of release to waive its rights in relation to unpaid present entitlements to income of the Blue Trust and the Green Trust for years 1 to 3? | A1: No | Q2: Will Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the proposed execution by Red Pty Ltd of two deeds of release to waive its rights in relation to the unpaid entitlements to income of the Blue and the Green Trust for years 1 to 3? | A2: No

Relevant facts and circumstances: Background 1. The Blue Trust is a discretionary trust in the Blue group of entities. 2. The Green Trust is a discretionary trust in the Green group of entities. Trust Distributions and Application of section 100A of the ITAA 1936 3. Red Pty Ltd was made presently entitled to income of the Blue and the Green Trusts in years 1 to 3 which resulted in amounts being included in its assessable income under section 97 of the ITAA 1936. The income entitlements were recorded in accounts of Red Pty Ltd as an asset labelled "trust income entitlement" and remain unpaid. 4. The Commissioner undertook an audit the taxpayers' affairs. As a result of the audit, the Commissioner concluded that the appointments of income from the Blue and the Green Trusts in years 1 to 3 were made in favour of Red Pty Ltd pursuant to a reimbursement agreement to which section 100A of the ITAA 1936 applied. Consequently, amended assessments were issued to Red Pty Ltd, the Blue Trust and the Green Trust to treat the following amounts of tax net income as assessable to the Trustees of the Blue and the Green Trust under section 99A of the ITAA 1936: Year Blue Trust ($) Green Trust ($) 1 1,000 1,000 2 2,000 2,000 3 3,000 3,000 Proposed deeds for release 5. Red Pty Ltd proposes to execute deeds of release to waive its rights to the unpaid present entitlements to income from the Blue and the Green Trusts for years 1 to 3.

Relevant legislative provisions: Section 99A of the Income Tax Assessment Act 1936 | Section 100A of the Income Tax Assessment Act 1936 | Division 7A of Part III of the Income Tax Assessment Act 1936 | Division 245 of the Income Tax Assessment Act 1997

Reasons for decision: Summary: Will Division 7A of Part III of the ITAA 1936 apply to the proposed execution by Red Pty Ltd of two deeds of release to waive its rights in relation to the unpaid present entitlements to income of the Blue Trust and the Green Trust for year 1 to year 3? | Detailed Reasoning - Distributions to entities connected with a private company: 6. For year 1 to year 3, Red Pty Ltd was presently entitled to distributions of income of the Blue and the Green Trust. The entitlements remain recorded in the accounts of the parties as unpaid entitlements and remain unpaid. 7. Red Pty Ltd now proposes to execute deeds of release in respect of these unpaid entitlements. These releases will result in a transfer of value between the entities and a question arises as to whether this will cause an amount to be included in the assessable income of the trusts pursuant to Division 7A of the ITAA 1936. Relevant to this issue is the fact that those entitlements arose in connection with a reimbursement agreement attracting the application of section 100A. | Detailed Reasoning - Present entitlement arising from reimbursement agreement: 8. Generally, a beneficiary of a trust who is presently entitled to a share of the income of a trust estate, and is an Australian resident not under a legal disability, is required to include that proportionate share of the trust's tax net income in their assessable income pursuant to section 97 of the ITAA 1936. 9. Subsection 100A(1) of the ITAA 1936 provides an exception to the general operation of the trust taxation rules. That subsection provides as follows: Where: (a) apart from this section, a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate; and (b) the present entitlement of the beneficiary to that share or to a part of the that share of the income of the trust estate (which share or part, as the case may be, is in this subsection referred to as the relevant trust income ) arose out of a reimbursement agreement or arose by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a reimbursement agreement; the beneficiary shall, for the purposes of this Act, be deemed not to be, and never to have been, presently entitled to the relevant trust income. 10. The effect of subsection 100A(1) of the ITAA 1936 is that, for all income tax purposes ('for the purposes of this Act'), beneficiaries are treated as not being presently entitled to income to which the section applies. | Detailed Reasoning - Application to the taxpayer's circumstances: 11. Section 100A of the ITAA 1936 applied to the income entitlements conferred on Red Pty Ltd by the Trustees of the Blue Trust and the Green Trust in year 1 to year 3. The result is those entitlements ceased to be recognised for income tax purposes. Consequently, the Trustees of the Blue and the Green Trusts were assessed to tax on the relevant proportionate shares of the net income of the respective trusts under section 99A for these years. 12. Consistent with this treatment, as Red Pty Ltd's rights to income of the Blue and the Green Trusts are not recognised for the purposes of the Act due to the operation of section 100A of the ITAA 1936, the waiver of these entitlements does not have any tax consequences. As such, Division 7A will not apply to the deeds of release to be executed by Red Pty Ltd in relation to these income entitlements. | Detailed Reasoning - Question 2: Will Division 245 of the ITAA 1997 apply to the proposed execution by Red Pty Ltd of two deeds of release to waive its rights in relation to the unpaid present entitlements to income from the Blue and the Green Trusts for year 1 to year 3? | Detailed Reasoning - Forgiveness of Commercial Debts: 13. Broadly, Division 245 of the ITAA 1997 offsets forgiven commercial debts against amounts that could otherwise reduce a taxpayer's taxable income in the same or later year. A debt is a commercial debt if part or all of the interest payable on the debt is, or would be, an allowable deduction. 14. According to section 245-35 of the ITAA 1997, a debt will be forgiven if: a. the debtor's obligation to pay the debt is released, waived or otherwise extinguished by means other than by repayment of the debt in full, or b. the period in which the creditor is able to sue for recovery of the debt ends without the repayment of the debt. | Detailed Reasoning - Application to the taxpayer's circumstances: 15. For Division 245 of the ITAA 1997 to apply as a result of the execution of the proposed deeds of release, it is necessary for a commercial debt to exist and then be forgiven. However, as discussed above, the application of section 100A of the ITAA 1936 to Red Pty Ltd's entitlements to income of the Blue and the Green Trusts with respect to years 1 to 3 results in Red Pty Ltd being deemed to never have been presently entitled the relevant income for tax purposes. Again, as Red Pty Ltd's income entitlements are not recognised for the purposes of the Act, neither can the waiver of these entitlements be recognised for the purposes of the Act. As such, Division 245 will not apply to the deeds of release executed by Red Pty Ltd in relation to these income entitlements.