Private ruling: Are 109N loans distributions under section 47?
Published: December 2013
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Were the transfer of funds that occurred during the years ended 30 June 20xx to 20xx, in the making of your section 109N compliant loans to your shareholders, distributions within the meaning of subsection 47(2A) and paragraph 47(2B)(b) of the Income Tax Assessment Act 1936 (ITAA 1936), if the company is liquidated 3 years after the respective loans were made? | A1: No

Relevant facts and circumstances: You are a private company, incorporated prior to 20 September 1985, having only your two original shareholders. You were used predominately as an investment vehicle for the shareholders to invest in commercial properties, which were leased to unrelated parties at commercial rates. You purchased and leased both pre-CGT and post-CGT property, which were later sold. From the sale proceeds, during the years ended 30 June 20xx to 20xx, inclusive, you made a number of section 109N loans to your shareholders, which they used for private purposes (rather than borrowing funds from financial institutions). Your directors are now considering winding up the company by appointing a liquidator. At this time a liquidator has not been appointed.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 47

Reasons for decision: Summary: Section 47 of the Income Tax Assessment Act 1936 (ITAA 1936) is about distributions by a liquidator. Subsection 47(2A) of the ITAA 1936 was specifically introduced with the object of ensuring that distributions in the course of an informal winding of a company are treated for income tax purposes in the same way as distributions by a liquidator in a formal liquidation. The subsection states where: (a) the business of a company has been, or is in the course of being, discontinued otherwise than in the course of a winding up of the company under any law relating to companies; (b) in connexion with the discontinuance, any moneys of the company have been or other property of the company has been, on or after 19 October 1967, distributed, otherwise than by the company, to shareholders of the company; and (c) the moneys or other property so distributed are not, for the purposes of this Act, dividends; the distribution shall, subject to subsection (2B), be deemed to be, for the purposes of this section, a distribution to the shareholders by a liquidator in the course of winding up the company. [Emphasis added] Clause 10 in the Explanatory Memorandum to the Income Tax Assessment Bill (No. 4) 1967 , which introduced subsection 47(2A) into the legislation, explained an informal winding up as follows: Where shareholders in a company do not put the company into formal liquidation but merely take possession of the company's tangible assets , collect and retain debts due to it, discharge debts due by it and then treat the company as wound up… Sub-section (2A.) will apply where the business of a company is wound up otherwise than in the course of a formal liquidation under company law and, in connection with the winding up of the business, assets of the company are , after the date of introduction of the Bill into Parliament, distributed to shareholders otherwise than by the company. If the assets so distributed are not treated as dividends by other provisions of the income tax law, the sub-section provides that the distribution is to be treated , for the purposes of section 47, as if it had been made by a liquidator in the course of winding up the company. Sub-section (1.) of section 47 will then operate to treat the distribution as a dividend paid out of profits to the extent that it represents income derived by the company…[Emphasis added] Subsection 47(2B) of the ITAA 1936 provides where: (a) subsection (2A) would, but for this subsection, apply in relation to any moneys or other property of a company distributed to shareholders of the company; and (b) the company does not cease to exist within a period of 3 years after the distribution, or within such further period as the Commissioner allows; subsection (2A) shall not apply, and shall be deemed never to have applied, in relation to those moneys or that other property, and those moneys or that other property so distributed shall, for the purposes of this Act, be deemed to be dividends paid by the company to the shareholders out of profits derived by it. About subsection 47(2B) of the ITAA 1997, the Explanatory Memorandum states: It accordingly provides that, where sub-section (2A.) would otherwise apply in relation to distributions made in the course of an informal winding-up, but the company is not dissolved within three years (or such further time as the Commissioner of Taxation allows) after the date of the distribution, sub-section (2A.) is not to apply to the distribution. In these circumstances the distribution is to be treated as a dividend paid by the company to the shareholders out of profits derived by it and is to be taxable on that basis. In conclusion, as explained in the Explanatory Memorandum, the "distribution" referred to in subsection 47(2A) of the ITAA 1936 is one where "shareholders…take possession of the company's tangible assets…and then treat the company as being wound up". It follows subsection 47(2B) of the ITAA 1936 applies to the aforementioned distribution of a company's tangible assets and, for subsection 47(2A) to apply (so distributions to the shareholders represents company income rather than company profits), subsection 47(2B) requires the company to cease within a period of 3 years after the aforementioned distribution of the company's tangible assets is made. Therefore, in your case, your loaning of funds (using section 109N compliant loans) during the years ended 30 June 20xx to 20xx, inclusive, to your shareholders, are not distributions within the meaning of subsections 47(2A) and 47(2B)(b) of the ITAA 1936 because section 47 is exclusively concerned with when shareholders take possession of the company's tangible assets and then treat the company as being wound up.