Private ruling: Security for a loan by a company to an associate
Published: January 2014

Ruling: Question and answer | Can the security required by subparagraph 109N(3)(a)(i) of the Income Tax Assessment Act 1936 (ITAA 1936) take the form of a call option to acquire real property instead of a registered mortgage over real property? | No. | Year ending 30 June 2014 | 1 July 2013

Relevant facts and circumstances: You have entered into a contract to purchase a property from an unrelated third party on an arm's length basis. In order to purchase the property you have entered into a Loan Agreement with a company in which you are a director and shareholder. You have simultaneously entered into an Option Agreement with the company, whereby you have granted an option to the company, to acquire the property in the event that you default on the Loan Agreement. The call option is protected by a caveat on the title to the property. You have provided comprehensive submissions as to why a call option could be used instead of a registered mortgage, on the basis of the level of security that is provided.

Relevant legislative provisions: Income Tax Assessment Act 1936 - Subdivision D of Division 7A of Part III | Income Tax Assessment Act 1936 - subsection 109D(1) | Income Tax Assessment Act 1936 - subsection 109N(1) | Income Tax Assessment Act 1936 - subsection 109N(3)

Reasons for decision: Summary: A private company is taken to pay a dividend to a shareholder under subsection 109D(1) of the ITAA 1936, if the private company makes a loan to a shareholder during the income year, the loan is not fully repaid by the private company's lodgment day for that income year, and Subdivision D of Division 7A of Part III of the ITAA 1936 does not prevent the private company from being taken to pay a dividend. Subsection 109N(1) of the ITAA 1936 prevents a private company from being taken to pay a dividend under section 109D of the ITAA 1936 if the loan is put under a written agreement before the private company's lodgment day for the income year in which the loan is made, the rate of interest payable on the loan equals or exceeds the benchmark interest rate, and the term of the loan does not exceed the 'maximum term' for that kind of loan. Subsection 109N(3) of the ITAA 1936 defines the 'maximum term' as: (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 a State or Territory; and (ii) when the loan is first made, the market value of the 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. Subparagraph 109N(3)(a)(i) requires that the loan is secured by a registered mortgage over real property. ATO ID 2007/215 Division 7A: mortgage over a Crown lease and no registration in accordance with State law provides clarification as to the meaning of the words 'registered' and 'accordance' in subparagraph 109N(3)(a)(i) of the ITAA 1936. The reasons for decision in ATO ID 2007/215 note that Division 7A of the ITAA 1936 was inserted by Taxation Laws Amendment Act (No. 3) 1998 . The Explanatory Memorandum to Taxation Laws Amendment Bill (No. 3) 1998 does not indicate subparagraph 109N(3)(a)(i) of the ITAA 1936 should be read narrowly to restrict qualifying registration to cases under a deeds registration statute or Torrens statute of a State or Territory. Hence, if registration is required under another statute then that registration may satisfy the requirements of subparagraph 109N(3)(a)(i) of the ITAA 1936. In the case considered by ATO ID 2007/215, no registration was required under any statute and consequently the requirements of the provision could not be satisfied. Pursuant to section 6(1) of the ITAA 1936, mortgage includes any charge, lien or encumbrance to secure the repayment of money; therefore the term can be interpreted broadly. In the current case however, the call option which may or may not be regarded as an equitable mortgage, is only protected by a caveat on the title to the property. No registration of the call option is necessary in accordance with a law of a State or Territory as required by subparagraph 109N(3)(a)(i) of the ITAA 1936. Therefore, the use of the Option Agreement does not satisfy the provision.