Private ruling: Income Tax - Dividend - Family Court order payment from private company
Published: March 2013
Ruling period: The year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Will section 109J of the Income Tax Assessment Act 1936 (ITAA 1936) apply to a Family Court order or consent order made under the Family Law Act 1975 (FLA 1975) that explicitly directs a private company to pay cash to an associate or former associate of a shareholder? | A1: Yes. | Q2: Will the payment of cash to the associate or former associate of a shareholder pursuant to a Family Court order be a dividend pursuant to section 6 of the ITAA 1936? | A2: No.

Relevant facts and circumstances: The taxpayer and the estranged spouse are currently negotiating a matrimonial settlement. The spouse wholly owns a private company. The private company will be made a party to the family law proceedings. The Family Court order will obligate the private company to make a cash payment to the taxpayer.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1) | Income Tax Assessment Act 1936 Part III Division 7A. | Income Tax Assessment Act 1936 subsection 109C(1) | Income Tax Assessment Act 1936 subsection 109C(2). | Income Tax Assessment Act 1936 section 109J. | Income Tax Assessment Act 1936 section 109Y | Income Tax Assessment Act 1936 section 318. | Income Tax Assessment Act 1997 subsection 960-100(1) | Income Tax Assessment Act 1997 subsection 995-1(1).

Reasons for decision: Summary: By virtue of section 109J of the ITAA 1936, the Family Court order binding the private company, as a party to the proceedings, is an explicit order binding the private company to specifically pay cash to the taxpayer, and not some other alternative obligation, the payment would not be considered a dividend. | Detailed Reasoning - Detailed reasoning: Subdivision B of Part III of Division 7A of the ITAA 1936 deals with the circumstances under which certain private company payments will be treated as dividends. A Family Court order directing a private company to pay cash to the taxpayer is a payment for the purposes of section 109C of the ITAA 1936 and would meet the requirements to be treated as a dividend. Subsection 109C(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity, if the private company pays an amount during the income year, to an entity who is or was an associate of a shareholder. A payment to a former associate will be considered a dividend where a reasonable person would conclude that the payment is due to this previous association with the shareholder. Entity is defined in the Income Tax Assessment Act 1997 (ITAA 1997) and includes an individual. Associate is defined by subsection 318(1) of the ITAA 1936, and includes the taxpayer as spouse of the shareholder. As the payment is due to divorce proceedings, there would be sufficient nexus for a reasonable person to conclude the proposed payment is as a direct result of the taxpayer's marriage and consequently the taxpayer's association with the shareholder. Therefore, subsection 109C(1) of the ITAA 1936 would deem the payment a dividend. Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is the amount paid, subject to the private company's distributable surplus calculated under section 109Y of the ITAA 1936. The private company would be deemed under subsection 109C(1) of the ITAA 1936 to have paid a dividend to the taxpayer equal to the arm's length value, subject to the distributable surplus in the income year. However, Subdivision D of Division 7A of Part III of the ITAA 1936 sets out rules about some payments which are not treated as dividends under subsection 109C(1) of the ITAA 1936. Section 109J in Subdivision D of the ITAA 1936 is specifically relevant to the circumstances here. Section 109J of the ITAA 1936 provides that: A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment: (a) discharges an obligation of the private company to pay money to the entity; and (b) is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length. Effectively, section 109J of the ITAA 1936 provides that such a payment is not taken to be the payment of a dividend for the purposes of section 109C of the ITAA 1936 to the extent that it discharges an obligation of the private company to pay money to a shareholder or an associate of the shareholder, and does not exceed the arm's length amount required to discharge that obligation. Consequently, provided that the Family Court order binding the company, as a party to the proceedings, is an explicit order binding the company to specifically pay cash to the taxpayer, and not some other alternative obligation, the payment would not be considered a dividend by virtue of section 109J of the ITAA 1936. | Summary: A payment made by a company to an associate or former associate of a shareholder is not considered a dividend under subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Section 995-1 of the ITAA 1997 provides that dividend has the meaning given by subsection 6(1) of the ITAA 1936. Dividends are defined in subsection 6(1) of the ITAA 1936 as including: (a) any distribution made by a company to any of its shareholders, whether in money or other property; and (b) any amount credited by a company to any of its shareholders as shareholders; (c) (Repealed by No 63 of 1998) but does not include (d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation or a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company; or (e) moneys paid or credited, or properly distributed by a company for the redemption or cancellation of a redeemable preference share if: i. the company gives the holder of the share a notice when it redeems or cancels the share; and ii. the notice specifies the amount paid-up on the share immediately before the cancellation or redemption; and iii. the amount is debited to the company's share account; except to the extent that the amount of those moneys or the value of that property, as the case may be, is greater than the amount specified in the notice as the amount paid-up on the share; or (f) a reversionary bonus on a life assurance policy. In this case the payment to the taxpayer will be made pursuant to court proceedings, and is not in the nature of a distribution to a shareholder in their capacity as a shareholder. The payment is not a distribution by the private company in the sense of distributing a profit to its members; rather it is made in satisfaction of an obligation of the private company under the court order. For a payment to be considered a dividend, the payment must be made by the private company to a shareholder. The definition does not include associates or former associates of a shareholder. Therefore, the payment made by the private company to the shareholder's spouse, an associate or former associate of a shareholder, would not be considered a dividend under subsection 6(1) of the ITAA 1936.