Private ruling: Loans to Associated Entities
Published: October 2014
Ruling period: 1 July 2011 - 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Would the loan from Company X to Company A be a 'dividend' within the meaning of subsection 6(1) of the Income Tax Assessment Act 1936 that is included in Company A's assessable income pursuant to section 44 of that Act? | A1: No | Q2: Would, as a result of the loan from Company X to Company A there be an amount taken to be a dividend to Company A pursuant to Division 7A of the Income Tax Assessment Act 1936 and included in its assessable income pursuant to section 44 of that Act? | A2: No | Q3: Would, as a result of the Application of the Funds by Company A, there be an amount taken to be a dividend from Company A pursuant to Division 7A of the Income Tax Assessment Act 1936 and, as a consequence, a debit to that entity's franking credit account pursuant to section 205-30 of Income Tax Assessment Act 1997 ? | A3: No | Q4: Does section 230-15 of the Income Tax Assessment Act 1997 operate such that an amount will be deductible by Company A for any interest that may be payable by it under the loan from Company X to Company A? | A4: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. Background Company X was one of several entities involved in a business founded by Entity 1 and Entity 2. The directors of X are Entity 1 and Entity 3. Entity X has issued capital of a number of shares, some of which are held by Entity 1 and the remainder by Entity 2. Entity 1 and Entity 2 are associated with Entity 3, Entity 4 and Entity 5. Entity 1 and Entity 2 intend that the relevant Entities will ultimately benefit from their wealth. Entity 1 and Entity 2 have decided to provide a share of capital to three companies, each of which is controlled by one of the entities. The Company Company A is incorporated. That entity has issued capital of ordinary shares: a. a number of which is held by Entity 4; and, b. with the remaining held by Trust 4. The sole director of Company A is Entity 4. The Loan to Company A $ was advanced from Company X to Company A. The Loan Agreement states that the parties agree the Loan Principal is not repayable until called upon by Company X. The Loan Principal is $ and no further amounts are intended to be advanced although there are provisions to do so in certain circumstances. Under the Loan Agreement, Money Owing includes the Loan Principal and other amounts, including interest. The Loan Principal was advanced interest free, except in certain circumstances unless a Default Event occurs, even then it may be discretionary. Company X can issue an Interest Notice seeking interest or it can see repayment of the Loan Principal and all other Money Owing. Interest can be payable from the Advance Date, which means the date upon which any part of the Loan Principal was first advanced to Company A. The Interest Period is from the Advance Date until Default Date determined by the Lender where appropriate. The Application of the Funds Company A Company A applied the funds advanced to it to savings accounts and term deposits. This is referred to in this ruling as the "Application of the Funds by Company A". Relevant Legislation Income Tax Assessment Act 1936 Division 7A Income Tax Assessment Act 1936 Section 44 Income Tax Assessment Act 1936 Section 109B Income Tax Assessment Act 1936 Section 109C Income Tax Assessment Act 1936 Section 109CA Income Tax Assessment Act 1936 Section 109K Income Tax Assessment Act 1936 Section 109N Income Tax Assessment Act 1936 Section 109T Income Tax Assessment Act 1936 Section 109Y Income Tax Assessment Act 1936 Section 109Z Income Tax Assessment Act 1936 Section 159GQ Income Tax Assessment Act 1936 Section 159GP Income Tax Assessment Act 1936 Subsection 6(1) Income Tax Assessment Act 1936 Subsection 109D Income Tax Assessment Act 1997 Division 230 Income Tax Assessment Act 1997 Subsection 230-15(1) Income Tax Assessment Act 1997 Subsection 205-30(1) Income Tax Assessment Act 1997 Subsection 960-120(1) Income Tax Assessment Act 1997 Subsection 995-1(1)


Reasons for decision: Summary: Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) relevantly provides that: (1) In this Act, unless the contrary intention appears: dividend includes: (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; 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 of 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 property 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 capital 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. Note: Subsection (4) sets out when paragraph (d) of this definition does not apply. The definition of 'dividend' requires there to be a distribution or an amount credited by a company to its shareholders. Company A is not a shareholder of Company X. Accordingly, the loan does not meet either paragraph (a) or paragraph (b) of the definition of 'dividend', as it is not from Company X "to any of its shareholders". Paragraph 44(1)(a) of the ITAA 1936 relevantly provides that: (1) The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes: (a) if the shareholder is a resident: (i) dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and (ii) all non-share dividends paid to the shareholder by the company; … As above, Company A is not a shareholder of Company X. The dividends or non-share dividends referred to in paragraph (a) are dividends "paid to the shareholder by the company". Both Company X and Company A are each a "company" within the meaning provided by subsection 6(1) of the ITAA 1936 and subsection 995-1(1) of Income Tax Assessment Act 1997 (ITAA 1997). Further, relevantly, Company X is a "private company" within the meaning of section 103A(1) of the ITAA 1936.. The application of Division 7A Section 109B explains that Division 7A of the ITAA 1936 "treats 3 kinds of amounts as dividends paid by a private company: …" including, relevantly, "amounts lent by the company to a shareholder or shareholder's associate". That section also explains that "[t]his treatment makes the amounts assessable income of the shareholder or associate". Certain exceptions also exist. In this instance, the proposed loan is a loan within the meaning of section 109D(3). At a minimum, it is both "an advance of money" and "a payment of an amount for … an entity," with "an express or implied obligation to repay the amount", within paragraphs (a) and (c) of that subsection. Section 109D(1) of Division 7A relevantly provides that: | Detailed Reasoning - 109D Loans treated as dividends: Loans treated as dividends in year of making (1) A private company is taken to pay 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 before the lodgment day for the current year; and (c) Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and (d) either: (i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or … Some aspects of section 109D(1) of the ITAA 1936 are clearly satisfied. For instance, Company X, a private company, is to make a loan to Company A. However, it is not necessary to consider the requirements of section 109D in detail, as paragraph 109D(1)(c) of ITAA 1936 cannot be satisfied. The result of one of the requirements of section 109D(1) not being satisfied is that Company X is not taken to pay a dividend under that section. Paragraph 109D(1)(c) recognises that Subdivision D may "prevent the private company from being taken to pay a dividend because of the loan". Subdivision D, entitled 'Payments and loans that are not treated as dividends', includes section 109K, which provides: | Detailed Reasoning - 109K Inter-company payments and loans not treated as dividends: A private company is not taken under section 109C or 109D to pay a dividend because of a payment or loan the private company makes to another company. Note: This does not apply to a payment or loan to a company in its capacity as trustee. (See section 109ZE.) The loan is a loan that a private company, Company X, makes to another company, Company A. Section 109K of the ITAA 1936 will be satisfied unless an exclusion applies. There is an exclusion to the exception provided by section 109K that needs to be considered. Subdivision E, which is entitled 'Payments and loans through interposed entities', contains section 109X. That provision relevantly provides that: Despite sections 109K and 109L, a private company may be taken under section 109C or 109D to pay a dividend as a result of this Subdivision … That provision, amongst other things, acknowledges that Subdivision E of the ITAA 1936 excludes the operation of section 109K. However, the exclusions do not apply in this instance. | Detailed Reasoning - Question 3: Subsection 205-30(1) of the ITAA 1997 provides that "The following table sets out when a debit arises in the franking account of an entity and the amount of the debit. The debit is called a franking debit." The table sets out several items, none of which are applicable. If one of those items was to be relevant, it would likely be Item 1. That item provides that if "the entity franks a distribution" there is a debit to the company's franking account. Subsection 995-1(1) of the ITAA 1996 provides that "In this Act, except so far as the contrary intention appears: … distribution, by a corporate tax entity, has the meaning given by subsection 960-120." Subsection 960-120(1) provides that "what constitutes a distribution" by a company is "a dividend, or something that is taken to be a dividend, under this Act": Item 1. Section 109K of the ITAA 1936 disregards the loan from Company X to Company A as a deemed dividend. Accordingly, there is no distribution for the purpose of a franking debit. | Detailed Reasoning - Question 4: Division 230 of the ITAA 1997 provides for the taxation of financial arrangements. Subsection 230-15(2) provides that 'You can deduct a loss you make from a *financial arrangement, but only to the extent that' you make it in gaining or producing assessable income or you necessarily make it in carrying on a business for the purpose of gaining or producing your assessable income. Subsection 230-15(3) also provides for deductions. However, even if one of those subsections of the Division would otherwise apply to any losses relating to the loan from Company X, they do not apply to losses that are subject to exceptions under Subdivision 230-H. This includes where subsection 230-455(1) is satisfied. That subsection is satisfied here. Company A is an entity of the kind identified in sub-paragraph 230-455(1)(a)(iv), so is required to satisfy the requirements in subsection (4): paragraph 230-455(1)(d). Subsection 230-455(4) sets certain requirements for aggregated turnover, the value of financial assets, and the value of assets, which are met in this case. Accordingly, section 230-15 will not provide a deduction for Company A.