Private ruling: Commissioner's Discretion to disregard Division 7A
Date of advice: 6 November 2017
Published: March 2018
Ruling period: Income year ending 30 June 2015 | Income year ending 30 June 2016 | Income year ending 30 June 2017 | Income year ending 30 June 2018 | Income year ending 30 June 2019
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the Commissioner exercise his discretion under section 109RB of the Income Tax Assessment Act 1936 (ITAA 1936) to disregard a dividend deemed to have been paid by Company A to Shareholder A? | A1: Yes

Relevant facts and circumstances: ● All further legislative references are to the ITAA 1936, unless otherwise stated. Shareholder A is one of two shareholders of Company A. The other shareholder is Shareholder A’s spouse. Until the year ended 30 June 2015, Company A carried on the Business. In the year ended 30 June 2015 Company A sold the Business. During the year ended 30 June 2015 a loan was made by Company A to Shareholder A. The loan was not repaid nor put on commercial terms complying with section 109N, by Company A’s lodgement date for the year. Rather, minimum yearly repayments have been less than what was required. The loan has always been disclosed in Company A’s books of account. At all relevant times throughout the relevant period, a registered tax agent was engaged as the Advisor (The first Advisor). The first Advisor indicated that Company A could lend the money to Shareholder A without consequence. The first Advisor failed to mention that deemed dividends would arise unless: ● a written loan agreement compliant with section 109N was in place by the Company A’s lodgement date for the year in which the loan was made; and ● the loan made by Company A to Shareholder A was fully repaid by the due date for the lodgement of Company A’s return for that year, or alternatively that minimum yearly repayments calculated in accordance with section 109E of the ITAA 1936 were made. Shareholder A relied on this professional advice. Subsequently, on seeking the services of another Advisor (the second Advisor) for an unrelated issue, the second Advisor discovered that the loan between Company A and Shareholder A would attract the operation of Division 7A. Shareholder A has since engaged the services of the second Advisor. The second Advisor has put in place a Loan Agreement, which complies with section 109N. The Loan Agreement has an effective date of 30 June 2015. A copy of the Loan Agreement was provided. Shareholder A has not made “catch-up payments” in the amount of the minimum yearly repayments under section 109E. Shareholder A has committed to doing this, for example, in circumstances where the exercise of the Commissioner’s discretion is made, and such discretion is subject to “catch-up payments” being made. There is a reasonable prospect that Shareholder A will be able to repay the loan. A schedule setting out estimations of the catch-up payments required, the interest and capital components, and the tax payable by Company A (with Shortfall interest Charge) was also provided. Shareholder A has made a voluntary disclosure within a relatively short period of time between the identification of the mistake or omission and the Commissioner being notified.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109E | Income Tax Assessment Act 1936 Section 109N | Income Tax Assessment Act 1936 Section 109RB | Income Tax Assessment Act 1936 Subsection 109RB(1) | Income Tax Assessment Act 1936 Paragraph 109RB(1)(b) | Income Tax Assessment Act 1936 Subsection 109RB(2) | Income Tax Assessment Act 1936 Subsection 109RB(3) | Income Tax Assessment Act 1936 Paragraph 109RB(3)(a) | Income Tax Assessment Act 1936 Paragraph 109RB(3)(b) | Income Tax Assessment Act 1936 Paragraph 109RB(3)(c) | Income Tax Assessment Act 1936 Paragraph 109RB(3)(d) | Income Tax Assessment Act 1936 Subsection 109RB(4) | Income Tax Assessment Act 1936 Paragraph 109RB(4)(a) | Income Tax Assessment Act 1936 Subsection 109RB(5)

Reasons for decision: Detailed Reasoning - Section 109RB Discretion: Section 109RB provides the Commissioner 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 recipient; ● the private company; ● any other entity whose conduct contributed to that result (paragraph 109RB(1)(b)). Practice Statement Law Administration PS LA 2011/29 provides guidance for Tax Office staff exercising the discretion. The Practice Statement describes a two-step procedure; the first step being the identification of an honest mistake or inadvertent omission giving rise to a Division 7A deemed dividend, and the second step being the application of factors in subsection 109RB(3) to determine whether the discretion should be exercised. | Detailed Reasoning - Did the Division 7A deemed dividend arise due to an honest mistake or inadvertent omission?: Taxation Ruling TR 2010/8 Income tax: Application of subsection 109RB(1) of the ITAA 1936 (TR 2010/8), provides guidance in terms of the requirements in subsection 109RB(1), including the meaning of ‘honest mistake’ and ‘inadvertent omission’ in paragraph 109RB(1)(b). Paragraph 11 provides that a mistake in the context of subsection 109RB(1) is an incorrect view or opinion or misunderstanding about how Division 7A operates; about facts that are relevant to its operation; or about other matters that affect its operation. Such a mistake must be honestly made. Paragraph 12 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 order to determine whether the operation of Division 7A arose because of an honest mistake or inadvertent omission, the following factors are relevant: ● The actions of the first Advisor were not intended to deceive, rather they were inattentive. They resulted from an incorrect view or misunderstanding of what the law is specific to Division 7A. ● Loan repayments made were less than the minimum yearly repayments required, and the loan was not documented nor put on commercial terms complying with section 109N. ● Shareholder A reasonably relied on the advice of the first Advisor, and so any mistake or omission resulting from that reliance is likely to be honest or inadvertent. ● The loan has always been disclosed in the Company A’s books of account. ● Shareholder A did not intend to deceive. ● Shareholder A made a voluntary disclosure to the Australian Taxation Office (ATO) in 2017, before being made aware by the Commissioner of any examination of Shareholder A’s affairs for the relevant period. ● Shareholder A has engaged the services of the second Advisor who identified the breach, and put in place a Loan Agreement compliant with section 109N. Not before this time did Shareholder A have the knowledge or experience to address matters in respect of Division 7A. ● Corrective action is being proposed which includes catch-up payments being made as soon as practicable, and the ultimate repayment of the loan. All of these factors support the view that the Division 7A deemed dividend arose due to an honest mistake or inadvertent omission. | Detailed Reasoning - Applying the factors in subsection 109RB (3) to determine whether the discretion should be exercised: On the basis that a breach of Division 7A has occurred due to an honest mistake or inadvertent omission, it is necessary to consider whether the Commissioner's discretion should be exercised. | Detailed Reasoning - Paragraph 109RB(3)(a): Circumstances leading to mistake or omission: Shareholder A acted in accordance with professional advice of the first Advisor. The loan was disclosed in the Company A’s books of account by the first Advisor. The first Advisor overlooked the effect of the loan, and was in fact ignorant of the application of Division 7A to the loan made by Company A to Shareholder A. In doing so, a mistake or omission resulted which led to the honest mistake or inadvertent omission relevant to subsection 109RB(1), and that the result of the operation of Division 7A arose because of it (as per paragraph 13 TR 2010/8). Paragraph 109RB(3)(b): Further corrective action The second Advisor has put in place a Loan Agreement which complies with section 109N. The interest charged on the loan each year is equal to the benchmark rate for Division 7A. The loan will be repaid via a schedule of catch-up payments, as part of the corrective action proposal. Paragraph 109RB(3)(c): Previous application of Division 7A There is no evidence of any prior breaches of Division 7A. | Detailed Reasoning - Paragraph 109RB(3)(d): Other matters: A voluntary disclosure was made to the ATO following the loan made by Company A to Shareholder A in respect of the income year ended 2015. The first Advisor is no longer engaged. Rather, the second Advisor that is knowledgeable in the operation of Division 7A has been engaged. The loan has always been disclosed in Company A’s books of account. | Detailed Reasoning - Subsection 109RB(4): Paragraph 15 of PSLA 2011/29 provides guidance specific to subsection 109RB(4). Briefly subsection 109RB(4) authorises the Commissioner to exercise his discretion subject to the following kinds of conditions: ● a condition that the recipient or other entity must make specified payments to the private company or another entity within a specified time; or ● a condition that a specified requirement in Division 7A must be met within a specified time. If the Commissioner exercises his discretion subject to a condition, the relevant deemed dividend is not disregarded until such time as any conditions imposed by the Commissioner are satisfied. Therefore, any amount assessable as a result of Division 7A remains assessable if the condition is never satisfied. | Detailed Reasoning - Decision: The Commissioner is of the view that the application of Division 7A arose because of an honest mistake or inadvertent omission. The proposed corrective action is considered acceptable to the Commissioner . The Commissioner has decided to exercise his discretion in accordance with paragraph 109RB(2)(a) to disregard the deemed dividend, on the condition that the corrective action proposal is fully implemented (paragraph 109RB(4)(a)).