Private ruling: The Commissioner of Taxation’s discretion in section 109RB of the Income Tax Assessment Act 1936
Date of advice: 28 January 2019
Published: May 2019
Ruling period: Income year ending 30 June 2018
Date scheme commenced: Income year ending 30 June 2008

Ruling: Q1: Will the Commissioner exercise the discretion under section 109RB of the Income Tax Assessment Act 1936 to disregard a dividend deemed to have been paid by a company to a trust? | A1: Yes.

Relevant facts and circumstances: A trust borrowed money from a company under a written loan agreement in the income year ending 30 June 2008. The loan agreement is compliant with the requirements in section 109N of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936). The trust is the sole shareholder in the company. The loan agreement provided that the company will provide a loan to the trust from time to time on terms that comply with the tax law. Under this loan agreement, the company advanced a number of amounts to the trust each year and the trust: ● paid the minimum yearly repayments required under section 109E ● incurred and paid the interest rate equal to the benchmark interest rate ● was required to repay the loan at the end of the loan term, which was seven years in accordance with Division 7A. The loan agreement required that the trust was to make a minimum repayment by 30 June 2018. Meanwhile, the trust entered into an agreement (the new loan) with the company to transfer a sum of money to the company by 30 June 2018 to: ● clear the Division 7A loan from the company to the trust ● provide the balance as a loan from the trust to the company. The trust’s lawyers prepared loan documentation regarding the new loan and provided this in draft form to the trustee shortly before 30 June 2018. The new loan agreement was executed in July 2018. The trust transferred the amount under the new loan to the company on that day. The balance of the existing loan from the company to the trust was immediately set off. The agents for the trust and company provided Division 7A advice regarding the loans, which was complied with up until the time in question. The agents generally prepared the annual accounts from records maintained by a bookkeeper. Prior to the end of the relevant year, it was the agents’ understanding that a franked dividend was not required to be paid as the entire loan, including interest, would be repaid by the end of the relevant year with the setting off and execution of the new loan. This was represented in a year-end review and action letter to the trustee from the agent, provided with the ruling request. It was the agents’ understanding that this had occurred, until preparation of the annual accounts and returns, when the agents discovered that the repayment did not in fact occur until later. On querying this with the client, it was discovered that the trustee of the trust mistakenly believed that the terms of the new loan needed to be resolved prior to transferring the funds, particularly due to the value of the money being transferred. The trustee did not appreciate that the actual transfer was required to be made before the end of the relevant year so that the Division 7A loan could be set off before that date. Upon discovering this breach, the trustee requested that the agents disclose this to the Commissioner. Division 7A has not operated previously in relation to the trust or the company.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 109E | Income Tax Assessment Act 1936 section 109N | Income Tax Assessment Act 1936 section 109RB

Reasons for decision: Summary: All references in this ruling are to the Income Tax Assessment Act 1936 unless otherwise specified. Section 109RB provides the Commissioner with the discretionary power to either disregard the operation of Division 7A or allow a deemed dividend to be franked. This can be exercised only when the deemed dividend arose because of an honest mistake or inadvertent omission by any of the following: ● the recipient ● the private company ● any other entity whose conduct contributed to that result. Practice Statement Law Administration PS LA 2011/29 Exercising the discretion under section 109RB of Division 7A (PS LA 2011/29) provides guidance when exercising the Commissioner’s discretion. PS LA 2011/29 details a two-step procedure: (1) Identify the honest mistake or inadvertent omission giving rise to a Division 7A deemed dividend (2) Apply the factors in subsection 109RB(3) to determine whether the discretion should be exercised. Step One: Did the Division 7A deemed dividend arise due to an honest mistake or inadvertent omission? As the terms ‘honest mistake’ and ‘inadvertent omission’ are not defined in the ITAA 1936, they take their ordinary meaning. In determining whether an honest mistake or inadvertent omission has occurred, Taxation Ruling TR 2010/8 Income tax: application of subsection 109RB(1) of the Income Tax Assessment Act 1936 (TR 2010/8) provides guidance on the meaning of ‘honest mistake’ and ‘inadvertent omission’ in paragraph 109RB(1)(b). Paragraph 11 of TR 2010/8 provides that a mistake in the context of 109RB(1) is an incorrect view or opinion or misunderstanding about: ● how Division 7A operates ● facts that are relevant to its operation ● other matters that affect its operation. Such a mistake must be honestly made. Paragraph 12 of TR 2010/8 provides that an omission in the context of subsection 109RB(1) is a failure to take action that is relevant to, or affects, the operation of Division 7A. Such an omission must be inadvertent. In deciding whether to exercise the discretion in section 109RB, we have reviewed the guidance in PS LA 2011/29 and TR 2010/8 and consider the following factors relevant to your case: ● The voluntary nature of your disclosure to us of the Division 7A breach. ● The trust and the company had sought professional advice regarding ongoing compliance with Division 7A, and legal advice in drafting a compliant loan agreement. ● The agents provided advice and notice to remain Division 7A compliant and were under the impression it had been complied with. ● The trust and the company were compliant with Division 7A throughout the term of the loan and endeavoured to maintain continued compliance with the new loan. ● Corrective action has already been taken and within a short period of time after the breach. Based on the above, it is determined that the deemed dividend under Division 7A occurred because of an honest mistake by the trustee of the trust. Step Two: Apply the factors in subsection 109RB(3) to determine whether the discretion should be exercised On the basis that a deemed dividend arose under Division 7A due to an honest mistake, it is necessary to now consider whether the Commissioner’s discretion should be exercised. The contributing factors in subsection 109RB(3) will now be considered in turn. The circumstances that led to the mistake The trustee would usually have made the minimum repayments in accordance with the requirements of Division 7A and the loan agreement. The trustee’s understanding of the minimum repayments was only mistaken in the relevant year due to the intention to offset the payment with the amount being transferred under the new loan from the trust to the company, which happened only days after the income year ended. The agent informed the trustee as soon as the Division 7A breach became apparent and this was also promptly reported to us once discovered. The available funds to make the minimum repayment were readily available to the trust and no benefit accrued to the trust or the company from the very slight delay in the repayment. The extent to which the trust has taken action to try to correct the mistake and how quickly that action was taken The mistake was fully rectified within days of the mistake occurring and reported to us when the yearly accounts were prepared. Whether Division 7A has operated previously in relation to any of the entities involved The entities have a good Division 7A compliance record and have provided a full history of the loan account, demonstrating proper payments of minimum interest amounts, minimum repayments and maximum loan lengths. Conclusion Based on the above, the discretion in section 109RB to disregard the operation of Division 7A is exercised for the following loans: As corrective action has already been taken, this discretion is not subject to any conditions under subsection 109RB(4).