Private ruling: Taxable income
Date of advice: 29 January 2019
Published: May 2019
Ruling period: Income year ending 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will a payment by the Company to A in accordance with the Family Court order be a deemed dividend under Division 7A of the Income Tax Assessment Act 1936 ? | A1: Yes | Q2: Will a payment by B to A in accordance with the Family Court order be taxable income of A? | A2: No

Relevant facts and circumstances: 1. The Family Court made an order pursuant to section 79 of the Family Law Act 1975 that B pay to the solicitor of A or alternatively B cause the Company to pay to the Solicitor of A an amount 2. The parties to the Family Court proceeding were A (the wife) and B (the husband). 3. B, or an entity controlled by B, is the sole shareholder of the Company. 4. The Company has sufficient retained earnings to make the payment to A. 5. The payment by the Company to A will not be converted to a loan. 6. A payment by B to A will be a one off lump sum payment.

Relevant legislative provisions: Section 44 of the Income Tax Assessment Act 1936 | Section 109C of the Income Tax Assessment Act 1936 | Section 109J of the Income Tax Assessment Act 1936 | Section 109ZD of the Income Tax Assessment Act 1936 | Section 318 of the Income Tax Assessment Act 1936 | Section 4-15 of the Income Tax Assessment Act 1997 | Section 6-5 of the Income Tax Assessment Act 1997 | Section 6-10 of the Income Tax Assessment Act 1997

Reasons for decision: Summary: Detailed reasoning Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) operates to treat payments, loans, and forgiven debts of a company to a shareholder or an associate of a shareholder as a dividend, and assessable income, under section 44 of the ITAA 1936 (subject to exclusions in Division 7A). Relevantly, section 109C of the ITAA 1936 provides: A private company is taken to pay a dividend to an entity at the end of the private company’s year of income if the private company pays an amount to the entity during the year and either: (a) the payment is made 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 payment is made because the entity has been such a shareholder or associate at some time. Section 109ZD of the ITAA 1936 provides that ‘associate’ has the meaning provided in section 318 of the ITAA 1936. Paragraph 318(a) provides that a relative of a natural person is an associate of that person. A relative of a natural person includes a spouse. A is not a shareholder of the Company, and is a former spouse (wife) of B (a shareholder of the Company). As A is not a shareholder or a current spouse of a shareholder (a former spouse is not an associate for the purposes of section 318 of the ITAA 1936), section 109C of the ITAA 1936 will only apply if paragraph 109C(b) is satisfied. Taxation ruling TR 2014/5 Income Tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate) provides the Commissioners view on the tax treatment of payments made in accordance with a family court order made under section 79 of the Family Law Act 1975 , and states the following on requirements of paragraph 109C(b): 78. … The paragraph operates where a reasonable person would conclude that the payment or transfer of property was made 'because' the recipient entity is a former shareholder or former associate of a shareholder. The Commissioner's view on the meaning of 'because' in context is contained in Taxation Determination TD 2008/14. Paragraph 1 of TD 2008/14 relevantly states: 1. In this context 'because' means by reason that. The reason must be a real and substantial reason for the payment, loan or debt forgiveness concerned, even if it is not the only reason or not the main reason for the transaction. 79. In the family law context, where the matrimonial parties are already divorced or separated, the very reason why the section 79 order is available to the Court is that a right to bring Family Court proceedings is available by virtue of the recipient's status as a former spouse. Therefore, the 'real and substantial' reason for the payment or transfer of property (as contemplated in TD 2008/14) is the recipient's status as a former associate of a shareholder. The temporal question of whether at the time a payment or transfer of property is made, the recipient is still an associate of the shareholder does not, therefore, affect the operation of Division 7A. As the payment arises from a section 79 order of the Family Court, it is reasonable to conclude that the payment will be made ‘because the entity has been such a shareholder or associate at some time’; the real and substantial reason for the payment is that A and B were spouses (associates). Paragraph 109C(1)(b) of the ITAA 1936 will operate to treat the payment as a dividend (deemed dividend) unless the payment is excluded from being treated as a dividend under Division 7A of the ITAA 1936. One of the exclusions is contained in section 109J of the ITAA 1936, which provides that payments discharging certain obligations do not give rise to a deemed dividend under section 109C of the ITAA 1936: A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment: (a) discharges an obligation of the private company to pay money to the entity; and (b) is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length. TR 2014/5 states the following about the requirements of section 109J of the ITAA 1936: 86. In order for section 109J of the ITAA 1936 to be satisfied, there needs to be an obligation of the private company to pay money to an entity. Where an order is made under section 79 of the FLA 1975 against a matrimonial party to cause a private company to pay money or transfer property to an associate of a shareholder, no binding requirement in law is imposed upon the private company to make a payment of money or transfer of property. 87. The binding requirement in law is imposed against the matrimonial party against whom the order is made. 88. Therefore, the requirement in paragraph 109J(a) of the ITAA 1936 that the payment 'discharges an obligation of the private company to pay money', cannot be satisfied. 89. Section 109J of the ITAA 1936 therefore cannot operate to prevent a deemed dividend from arising under section 109C of the ITAA 1936 in respect of the transfer of property or payment of money, where the transfer or payment has arisen as a result of an order against a matrimonial party to cause the company to make the payment or transfer the property to an associate of a shareholder. The Family Court order requires B to either cause the Company to make the payment to A or make the payment himself (the Company was not a party to the proceedings). The obligation to make payment is on B and not the Company. As such, the requirement in paragraph 109J(a) of the ITAA 1936 is not satisfied, and section 109J will not operate to prevent the payment from being treated as a dividend. Conclusion Section 109C of the ITAA 1936 will operate to treat the Court ordered amount paid by the Company to A (if so paid) as a dividend (deemed dividend), and will be assessable income of A. Section 109RC of the ITAA 1936 enables deemed dividends to be franked in accordance with Part 3-6 of the Income Tax Assessment Act 1997 (ITAA 1997): (1) [Application] This section applies if a dividend is taken to be paid under this Division because of a family law obligation. (2) [Dividend not made unfrankable] Subparagraph 202-45(g)(i) of the Income Tax Assessment Act 1997 does not make the amount of the dividend unfrankable. (3) [Conditions for franking] The dividend can be franked in accordance with Part 3-6 of the Income Tax Assessment Act 1997 only if: (a) the dividend is franked at the private company's benchmark franking percentage for the franking period in which the dividend is taken to be paid; or (b) if the private company does not have a benchmark franking percentage for the period - the dividend is franked at a franking percentage of 100%. (4) [Recipient] For the purposes of subsection (3), if the recipient of the dividend is not a member of the private company for the purposes of Part 3-6 of the Income Tax Assessment Act 1997, treat that recipient as such a member. Provided the requirements of section 109RC are satisfied, a payment by the Company to A in accordance with the Court order is eligible to be franked in accordance with Part 3-6 of the ITAA 1997. Detailed reasoning Section 4-15 of the ITAA 1997 provides that your taxable income is your assessable income less deductions. Section 6-1 of the ITAA 1997 states that ‘assessable income consists or ordinary income and statutory income’. Section 6-5 of the ITAA 1997 provides that an amount is assessable income if it is income according to ordinary concepts (ordinary income). The Commissioners view on determining whether an amount is ordinary income is expressed in Taxation Ruling TR 1999/17 Income Tax: sportspeople receipts and other benefits obtained from involvement in sport , which states: 16. In determining whether an amount is ordinary income, the courts have established the following principles: ● what receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as a statute dictates otherwise; ● whether the payment received is income depends upon a close examination of all relevant circumstances; and ● it is an objective test. 17. Relevant factors in determining whether an amount is ordinary income include: ● whether the payment is the product of any employment, services rendered, or any business; ● the quality or character of the payment in the hands of the recipient; ● the form of the receipt, that is, whether it is received as a lump sum or periodically; and ● the motive of the person making the payment. Motive, however, is rarely decisive as in many cases a mixture of motives may exist. Ordinary income has generally been held to include three categories: ● income from rendering personal services ● income from property, and ● income from carrying on a business. The characteristics of income that have evolved from case law include receipts that: ● are earned ● are expected ● are relied upon, and ● have an element of periodicity, recurrence or regularity. The amount to be paid by B arises from a Family Court order made pursuant to section 79 of the Family Law Act 1975 ; the amount is in respect of the interests each spouse had in the matrimonial property. The payment does not have the characteristics of income; the amount is not derived from rendering personal services, from property, or from carrying on a business. The amount is not earned, and has no element or periodicity, recurrence or regularity. Such a payment is not ordinary income. Section 6-10 of the ITAA 1997 provides that assessable income includes amounts that are not ordinary income but are included in assessable income by provisions about assessable income (statutory income). Section 10-5 of the ITAA 1997 lists these provisions. The payment will not be statutory income. Therefore, the payment by B to A (if so paid) will not be assessable income of A for the purposes of section 6-5 of the ITAA 1997, and would not be included in the taxable income of A.