Private ruling: Division 7A - whether a loan will be treated as a dividend
Published: November 2011
Ruling period: Year ending 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Will the funds lent to an associate of a shareholder be treated as a dividend in the year the loan is made pursuant to section 109D of the Division 7A provision in the Income Tax Assessment Act 1936 (ITAA 1936) where the loan meets the criteria in section 109N of the ITAA 1936? | A1: No.

Relevant facts and circumstances: Company A is a trading company. The shareholder of Company A is Person A. Company A is proposing to lend an amount to Trust A. The trust is a discretionary trust. The trustee of the trust is Company B. Person A is named as a beneficiary of Trust A. Other beneficiaries include Person A's spouse, Person A and/or his spouse's siblings, Person A and/or his spouse's children, remoter family, eligible corporations and eligible trusts. Trust A built a warehouse. The property was purchased and the warehouse constructed for a total of $XXX. Trust A financed the property purchase and warehouse construction by way of loan finance from Company A. The loan finance was $XXX and is interest bearing. The loan finance was a complying Division 7A unsecured loan. Since building the warehouse, Trust A has leased the warehouse to Company A on an arm's length basis. Trust A has made annual loan repayments to Company A (comprising both principal and interest). In most years, the annual loan repayments have been partially funded by Trust A borrowing funds from Person A. Trust A proposes to repay the amount currently owing to Person A. To repay the amount currently owing to Person A, Trust A proposes to borrow from Company A in order to repay the amount owing. The amount to be borrowed by Trust A from Company A will be documented in a section 109N complying written loan agreement. The term of the loan will be XX years. The term of the loan has been determined by reducing the maximum term of the loan (ie 25 years) by the number of years which have passed since Trust A first borrowed the funds from Company A in relation to the construction of the property. The loan will be interest bearing with interest being charged at the benchmark interest rate set by the Australian Taxation Office for Division 7A purposes. In addition, the loan will be secured over the property, and the unencumbered property value will exceed 110% of the value of the loan. Trust A will repay the amount owing to Company A in accordance with the Division 7A provisions of the ITAA 1936 by making yearly minimum loan repayments comprising both principal and interest. Trust A is not a shareholder of Company A, but qualifies as an associate of Person A (ie the shareholder of Company A) within the meaning of section 318 of the ITAA 1936.

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

Reasons for decision: Summary: Section 109D of Division 7A of the ITAA 1936 treats a private company as having paid a dividend to an entity at the end of one of the private company's years of income (the current year) if: (a) The private company makes a loan to the entity during the current year; and (b) The loan is not fully repaid by the end of the current year; and (c) Subdivision D of Division 7A does not 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 was 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, Company A, a private company, intends to make a loan to Trust A, an associate of a shareholder of the company. The loan will not be repaid by the end of the year. Therefore this loan will be caught under the provisions of section 109D of the ITAA 1936 unless a provision prevents the company from being taken to pay a dividend because of the loan. Subdivision D of Division 7A of the ITAA 1936 sets out what sorts of loans are not treated as dividends. Section 109N of the ITAA 1936 provides that a loan made by a private company in one of its income years to an entity is not taken to be a dividend at the end of the year of income for the purposes of section 109D of the ITAA 1936 if the loans comply with certain interest rate and maximum term requirements. Subsection 109N(1) of the ITAA 1936 prevents a loan from being treated as a dividend under section 109D of the ITAA 1936 if all of the following three conditions are satisfied: (a) The loan was made under a written agreement. This implies that the written agreement must be in place before the loan transaction. (b) The interest rate on the loan for years of income after the year in which the loan is made is equals to or exceeds the "benchmark interest rate" for the year, that is, the Indicator Lending Rates Bank Variable housing loan interest rate last published by the Reserve Bank of Australia before the start of the income year. The benchmark interest rate for the year is intended to refer to the benchmark interest rate for each of the years of income in which the loan subsists. (c) The term of the loan does not exceed the 'maximum term' for the loan The maximum tern of a loan is specified in section 109N(3) of the ITAA 1936 as either: (a) 25 years if the loan is secured by a registered mortgage over real property as to 100% of its value and the market value of the property at the time of the loan is made (less any other loans secured over that property in priority to that loan) is at least 110% of the amount of the loan; or (b) Seven years for other loans (eg unsecured loans or loans over other types of property or loans not complying with the 110% valuation requirements). A loan that satisfies the requirements of section 109N of the ITAA 1936and is not fully repaid by the end of the year in which the loan was made is taken to be an amalgamated loan under subsection 109E(3) of the ITAA 1936. Such an amalgamated loan is not treated as a dividend in the year in which the loan is made however minimum repayments must be made in each of the years in which the loan subsists, following the year in which the loan is made. If the minimum repayments are not made, the whole outstanding loan is treated as a dividend in the first year that the minimum repayment is not made. In this situation, the loan will be in writing as evidenced by the draft loan agreement provided. The loan will be secured by real property and the term of the loan is less than the maximum 25 years as required under section 109N of the ITAA 1936. The interest rate will be determined each year by reference to the Benchmark Interest Rate, and minimum repayments will be required each year as per the loan agreement. Therefore, as the loan meets the criteria contained in section 109N of the ITAA 1936, the loan will not be deemed a dividend for the purposes of Division 7A of the ITAA 1936.

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