Private ruling: Division 7A - deceased estate and debt forgiveness
Date of advice: 29 July 2015
Published: July 2015
Ruling period: 1 July 2015 to 30 June 2016

Ruling: Questions and answers | 1. If the Trust forgives the loan advanced by it to the deceased during the deceased's lifetime, would the forgiveness result in an unfranked deemed dividend being taken to have been paid under section 109F of the Income Tax Assessment Act 1936 to the executor of the deceased's estate? | No. | 2. If the Trust forgives the loan advanced by it to the deceased during the deceased's lifetime, would the forgiveness result in an unfranked deemed dividend being taken to have been paid under section 109XB of the Income Tax Assessment Act 1936 to the executor of the deceased's estate? | No.

Relevant facts and circumstances: The deceased passed away. One of the deceased's children is the executor and trustee of the deceased's estate (the taxpayer). Probate was granted. As at the deceased death, the deceased's liabilities included a loan (the loan) to a trust (the trust). Estate planning Some years prior to the deceased's passing the deceased started thinking about separating the property trusts into separate groups so that each of the deceased's children would take over a trust with a property portfolio. Distributions started to be made to the trust. The trust made distributions to trust 2, which held the majority of the shares in the company. The purpose of trust 2 was to hold the shares in the company, which would increase in value over time as distributions were made to the company. To clean up the legacy of the past, certain legacy unpaid entitlements need to be addressed. A previous ruling sought by related entities was favourable in allowing financial separation between the property trust that had unpaid entitlements between them, so that the unpaid entitlements could be restructured without any of the children being required to pay another child's trust. Financials Financials for the trust show it largely maintained unpaid distributions for related entity trusts for many years. So that the property trusts would stop distributing between each other, some unpaid entitlements were converted into loans and lent for income producing purposes to the property trusts that needed the funds, and some funds were paid down to the company. Family Breakdown The deceased separated from the spouse. The separation led to a family breakdown within the family. In particular, some of the children became estranged from the spouse. The other children became the spouse's favourite. Family Court consent orders (the orders) were sought and made. The deceased, the spouse and the children were party to the orders. Pursuant to the orders; 1. The spouse would transfer their interests in various properties and entities to the deceased, 2. The deceased would transfer their interests in various properties and entities to the spouse, and 3. The deceased would pay (or cause to be paid) a Settlement Sum. The deceased was passionately of the view that all the children should each receive a roughly equal share of the assets that they and the spouse accumulated during their marriage personally and in the trusts they controlled. Following the separation the deceased became concerned that the spouse would leave all of the assets the spouse had acquired, via the matrimonial split, to a favoured child in the spouse's Will, and leave nil or a nominal amount to the other children. The deceased wrote to the spouse shortly after the matrimonial division asking the spouse if they would treat the children equally under their Will. The spouse refused to answer. For this reason, the deceased planned to leave most of their personal estate to the benefit of the estranged children (and their respective families) and exclude a child. This was so that as much as possible, each of the children would receive a roughly equal share of the assets accumulated by the deceased and the spouse. However, this carried the risk that a child would make a claim against the deceased's estate. Funding the Settlement Sum The deceased did not have sufficient available cash or liquid assets to fund the Settlement Sum. The deceased also wanted to avoid selling or mortgaging the liquid assets (i.e. real property) to a bank to fund the Settlement Sum. Instead, the deceased wished to fund the Settlement Sum from related trusts which they controlled. Due to the difficult family situation the deceased was concerned that: • The spouse could make a claim against the deceased's estate despite final family law orders, given the deceased relatively short life expectancy post settlement; • The child could make a claim against the deceased's estate. The deceased considered the following ways of funding the settlement; • Capital distributions from a related trust to the deceased • Capital distributions from a related trust directly to the spouse • Loan from a related trust to the deceased. The capital distributions approaches were rejected by the deceased. Neither of these approaches addressed the deceased's concern about potential claims against the estate. In particular, neither of these approaches could be used to secure the valuable assets which the deceased held in their name, against testator family maintenance claims. The deceased decided to pay the Settlement Sum by borrowing a roughly equivalent sum from the trust. Loan A loan was made to the deceased by the trust pursuant to a loan agreement. The loan agreement governed both the advance to the deceased's spouse, as per the Family Court consent orders, and the balance being funds loaned to the deceased to satisfy old personal loans in which pre-date the family court orders. Pursuant to the terms of the loan agreement, the loan was secured by a mortgage over assets held in the deceased's name to protect the estate against challenges. No further advances were made by the trust to the deceased under the loan agreement since then. The trust raised the funds by calling up existing unpaid trust distributions owed to it from other trusts in the group. Those unpaid trust distributions arose in years prior to the marriage breakdown. If no testator family maintenance claims have been made against the taxpayer by the time the ordinary statutory period for making such claims has ended, the trust proposes to forgive the loan. This is expected to occur in a number of months after the granting of Probate. Unpaid present entitlements The trust received distributions of income from other trust in the group, in particular in respect to income derived from passive property investments of those trusts. It was customary for the trust to distribute that income to trust 2 without any regard for how trust 2 would in turn distribute its income. At the time of the loan the trust had unpaid trust distributions owing to another trust with the group. Namely trust 2. The trust did not have any unpaid trust distributions to a private company at the time of the loan, and does not currently have any unpaid trust distributions owing to a private company. Trust 2 had unpaid trust distributions owing to a company within the group, namely the company. Both trust 2 and the company's unpaid present entitlements (UPE) arose prior to the marriage breakdown and remain largely unpaid. The loan was made prior to the operation of subdivision EB of the Division 7A of the Income Tax Assessment Act 1936 . Accordingly, the loan agreement was not required to be a Division 7A complying loan agreement. The proposed forgiveness of the loan by the trust is occurring some years after the relevant present entitlements were conferred on the company. At the time the company was made entitled to the income from trust 2, or trust 2 made entitled to any income of the trust, there was no consideration of the loan being forgiven. Shareholders of the company There are ordinary shares on issue in the company. Company 2 owns ordinary shares (in a trustee capacity) in the company. Prior to passing the deceased owned ordinary shares in the company. The shares owned by the deceased will be transferred by the taxpayer to an estranged child in accordance with the terms of the deceased's Will.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 109F(1) | Income Tax Assessment Act 1936 subsection 109XA(3) | Income Tax Assessment Act 1936 subsection 109XB(1) | Income Tax Assessment Act 1936 subsection 109XI(1)

Reasons for decision: Summary: Subsection 109F(1) of the Income Tax Assessment Act 1936 (ITAA 1936) states that: A private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either: a) the amount is forgiven when the entity is a shareholder in the private company, or an associate of such a shareholder; or b) a reasonable person would conclude (having regard to all the circumstances) that the amount is forgiven because the entity has been such a shareholder or associate at some time. | Detailed Reasoning - Application to your circumstances: The trust made the loan to the deceased; accordingly as the loan is not made by a company any debt forgiveness of the loan by the trust will not result in an unfranked deemed dividend being taken to have been paid under section 109F of the ITAA 1936. | Detailed Reasoning - Question 2: Subdivision EA of Division 7A of the ITAA 1936 applies to certain trustee payments, loans and debt forgiveness made in favour of a shareholder (or their associate) of a private company with unpaid present entitlement from the trust. The subdivision may result in an amount being included in the assessable income of the shareholder (or their associate) as if it were a dividend. Subsection 109XB(1) of the ITAA 1936 provides that: An amount is included, as if it were a dividend paid by the company at the end of the year of income of the company in which the actual transaction took place, in the assessable income of the shareholder or associate referred to in subsection 109XA(1), (2) or (3) if: (a) had the actual transaction been done by a private company (the notional company ); and (b) had the shareholder or associate been a shareholder of the notional company at the time the actual transaction took place; an amount ( the Division 7A amount ) would have been included in the shareholder's or associate's assessable income because of a provision of this Division outside this Subdivision. Subsection 109XA(3) of the ITAA 1936 states: Section 109XB applies if: (a) all or part of a debt owed to a trustee by a shareholder or an associate of a shareholder of a private company is forgiven (except where the shareholder or associate is a company) (the actual transaction ); and (b) either: (i) the company is presently entitled to an amount from the net income of the trust estate at the time the actual transaction takes place, and the whole of that amount has not been paid to the company before the earlier of the due date for lodgment and the date of lodgment of the trustee's return of income for the trust for the year of income of the trust in which the actual transaction takes place; or (ii) the company becomes presently entitled to an amount from the net income of the trust estate after the actual transaction takes place, but before the earlier of the due date for lodgment and the date of lodgment of the trustee's return of income for the trust for the year of income of the trust in which the actual transaction takes place, and the whole of the amount has not been paid to the company before the earlier of those dates. Subdivision EB of Division 7A of the ITAA 1936 applies to payments and loans made, and debts forgiven, on and after 1 July 2009. It is an integrity measure that enhances the effectiveness of Subdivision EA by preventing the circumventing of Subdivision EA, for instance, by interposing an entity between a trustee and the shareholder or an associate of the shareholder. With regard to entitlements through interposed trust; under subsection 109XI(1) of the ITAA 1936 it provides; For the purposes of paragraphs 109XA(1)((c), (2)(b) and (3)(b), a private company is taken to be or to become entitled to an amount from the net income of a trust estate ( the target trust ) if: (a) the company is or becomes presently entitled to an amount from the net income of another trust estate ( the first interposed trust) that is interposed between the target trust and the company; and (b) a reasonable person would conclude (having regard to all the circumstances) that the company is or becomes so entitled solely or mainly as part of an arrangement involving an entitlement to an amount from the target trust; and (c) either (i) the first interposed trust is or becomes presently entitled to an amount from the net income of the target trust; or (ii) another trust interposed between the target trust and the company is or becomes presently entitled to an amount from the net income of the target trust. | Detailed Reasoning - Application to your circumstances: The taxpayer owes a debt to the trust. The shares in the company are held by company 2. In respect to the shares held by the deceased, prior to passing, are beneficially owned by one of the deceased's children, as per the deceased's Will. At the time of the debt forgiveness the company is not presently entitled to an amount from the trust. The company is presently entitled to an amount from trust 2 and trust 2 is entitled to an amount from the net income of the trust. At the time of the entitlements were conferred there was no consideration of the loan being forgiven. The proximity of timing of the making of the present entitlements, some years ago, and the proposed debt forgiveness is remote. This is supported by the financials which show that the trust maintained unpaid distributions from other trusts in the group for many years. The loan predominately arose so that the deceased could fund the settlement sum to the spouse, as per the court order. Even though part of the loan was used to settle old loans, made to the deceased; the deceased intended for these loans to be extinguished as part of the estate planning. Based on the facts provided the company is not presently entitled to an amount form the trust and it is not considered that the company became presently entitled to an amount from trust 2 solely or mainly as part of an arrangement involving an entitlement to an amount from the trust, where it was envisaged that trust 2 would then forgive the ensuing loan. Consequently, section 109XI of the ITAA 1936 does not apply and any debt forgiveness by the trust, of the loan, would not cause a deemed dividend to be paid under section 109XB of the ITAA 1936.

Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement you asked us to rule on.