Private ruling: Liquidations-Division 7A- Trusts
Published: April 2015

Ruling: This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information. | Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. In 2011, Company A sold its major asset. It is proposed to liquidate Company A in the year ended 2015. Company A was incorporated several decades ago. All of the shareholders acquired their shares in Company A before the CGT Regime was introduced in 20 September 1985. The vast majority of the shares are held by a trust. Company A's franking account as at 30 June 2014 was estimated to be $17 million. These franking credits attach to the dividend of $48 million approximately, which will be derived under section 47 of the ITAA 1936. It is proposed that Company A be placed into liquidation under a member's voluntary liquidation. The duration of this liquidation may be over a number of years, and may involve several distributions by the liquidator. The liquidator would be required to anticipate liabilities and set aside an amount for those which would be paid out via interim distributions, prior to any final distribution. Consistent with previous years, it is expected that the Shareholder Trust would pay the income distributions to Company B after year end. Division 7A Implications Of the total loan receivables that Company A held as at 30 June 2014, Division 7A loans currently amount to $32 million and $57 million receivables held are not subject to Division 7A. This is for the reasons that: • They are current year loans that will be subsequently placed on Division 7A terms; • They are not loans to shareholders, or associates that are subject to Division 7A; and/ or • One loan preceded the introduction of Division 7A. The transfer of the $32 million of loans currently subject to Division 7A, and the potential Division 7A implications is a critical taxation aspect of the proposed liquidation. It is proposed that the following steps would occur upon the liquidation of Company A in relation to these receivables: Step 1: Company A will declare a liquidator's distribution to the Shareholder Trust. Step 2: To satisfy the distribution, Company A will transfer its balance sheet assets (which are primarily cash of almost $1.5 million and an assignment of its receivables to the Shareholder Trust. Step 3: In effect, all related party borrowers that previously had loans owing to Company A would instead now owe the Shareholder Trust. Assumptions Please note that as the taxpayers have not requested that the Commissioner consider the taxation impact of distributions of Corpus from the Shareholder Trust, this ruling provides no indication of the same.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1936 section 109C | Income Tax Assessment Act 1936 section 109NA | Income Tax Assessment Act 1936 section 109T | Income Tax Assessment Act 1936 section109F | Income Tax Assessment Act 1936 section109Y | Income Tax Assessment Act 1997 Division 230 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1936 Division 6 | Income Tax Assessment Act 1936 section 97 | Income Tax Assessment Act 1936 Division 6E | Income Tax Assessment Act 1997 Division 207 | Income Tax Assessment Act 1936 section 100A | Income Tax Assessment Act 1936 Part IVA


Issue 1 Question 1: Will the liquidator's distribution satisfied primarily by an assignment of Company A receivables, (being loans owed to Company A, subject to Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) satisfy the relevant borrower's Division 7A loan repayment obligations to Company A in full? | Summary: Yes, provided that the value of the property assigned by the liquidation equals or exceeds the face value of loans owed to Company A, and provided the requirements of section 109F and section 109N are strictly adhered to. | Detailed reasoning: One of the requirements of Division 7A requires that where a loan is advanced to an entity which is either a shareholder of the Company A, or is an associate of that shareholder, the loan is either repaid before the lodgement day of the current year or, alternatively, the loan is subject to the requirements of section 109N, including interest at benchmark rates and a fixed term. Should this not be adhered to, a dividend is deemed to the extent of the loan, subject to the distributable surplus of the company as defined by section 109Y. | In this instance, the Commissioner has been informed that the loans in question are between Company A, as lender, and associates of the shareholders, as borrowers, rather than the shareholders themselves. Ordinarily a loan obligation for proper service of the loan, including repayment, remains the obligation of each borrower, and not an associate of the lender. | The Commissioner has been informed that the intention of the trustee of the shareholder discretionary trust is to resolve to distribute the income of the trust estate to an eligible corporation as a trust beneficiary, identified as Company B. | The Commissioner also notes that for a Division 7A dividend not to result under section109D there needs to be a full repayment of any Division 7A loan before the lodgement day of the company tax return for the current year. As the existing loans subjected to section 109D and section 109N are between Company A and associates of the shareholders, and not the shareholders themselves, it is the associates themselves that have the obligation to repay those respective loans, irrespective of liquidator distributions. | According to the information provided to the Commissioner, an assignment of the loans by Company A is to be made to the Shareholder Trust. The Commissioner notes that such an assignment satisfies the definition of a forgiven debt that will be subject, prima facie, to section 109F. | Notwithstanding the application of section 109F, the Commissioner also notes the intended application of subsection 109F(4). | The basis of application of section 109F will then turn on what the assignees being the Shareholder Trust seeks to recover by way of repayment of the assigned loans including the assigned rights. To assure that Division 7A is not transgressed, and to satisfy the reasonable person tests, loans that are subject to Division 7A that are assigned should be on identical terms with the Division 7A exposures of Company A and should be fully repaid (by cash or property) within their standard loan terms. | Issue 2 Question 1: Will the liquidator's distribution of Company A's cash and assets constitute a 'payment' pursuant to section 109C? | Subsection 109C(3) of the ITAA 1936 defines a 'payment' to mean: (a) a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and | (b) a credit of an amount to the extent that it is: | ii. on behalf of the entity; or | iii. for the benefit of the entity and | (c) a transfer of property to the entity. | The Commissioner notes that the declaration of the liquidator's dividend satisfied by the transfer of company property involves a 'crediting' of an amount for the benefit of the Shareholder Trust and a transfer of property to it. As such and without more, this satisfies the criteria of payment and as such, there is a 'payment' for the purposes of section 109C. | However, the Commissioner also notes that in a simple case where a liquidation occurs within 12 months that due to the operation of subsection 109C (4), the value of the 'payment' in a completed liquidation is likely to be nil, as the amount of the payment is normally equal to the value of shares that are being disposed of via the liquidation process | Of note however to both simple and complex liquidations that span multiple years, is the operation of section 109NA. Section 109NA provides that there is no application of section 109C in circumstances where distributions of property are made in the course of winding up the company. However, and importantly should loan obligations be outstanding at the end of the following year, as the liquidation may not be final, subsection 109D(1A) may still apply. | The Commissioner will not apply section 109C in cases involving liquidator's distributions, due to the mechanical operation of section 109NA in conjunction with subsection 109D (1A) but will instead apply subsection 109D(1A) in cases where a loan as defined under subsection 109D(3) has been provided to the Shareholder Trust or its associates. | The liquidator's distributions, satisfied by way of the assignment of Receivables to related parties will not attract the application of section 109T | Detailed reasoning: Section 109T of the ITAA 1936 applies if: | • a private company makes a payment or loan to an entity that is interposed between the private company and the target entity; | • a reasonable person would conclude (having regard to all the circumstances) that the payment or loan was solely or mainly made as part of an arrangement involving a payment or loan to the target entity; and | • the interposed entity makes a payment or loan to the target entity. | Based on the information provided, section 109T does not apply in these circumstances for the following reasons: | • Notwithstanding a payment may be made by Company A to its shareholders, relevantly, the payment is a liquidators distribution to which section 109C does not apply due to the operation of section 109NA; and | • There is no interposition of an entity in this instance between the private company and the target entity. Instead the intent of the company is to distribute its property on liquidation to the Shareholder Trust, who will in turn manage distributions received on liquidation in accordance with its trust resolutions. | In order for there to be an arrangement to which section 109T may apply, Company A must enter into an arrangement to provide a payment or loan to a target entity It is clear that a liquidators distribution in winding up an entity, where such a distribution is on consistent terms with the arm's length value of existing related party loans, is not part of an arrangement to which section 109T was designed to deal with. | Technically, any debt that is assigned that meets the conditions of section 245-36 and is in the Commissioner's view, a debt forgiveness, to which the provisions contained in section 109F can ordinarily apply. | As previously discussed however, the Commissioner considers that a deemed dividend will only ensue in cases only where the rights and obligations required by section 109N when Company A entered into such arrangements, are assigned on terms that are not exercised consistently, having regard to the circumstances, with the original obligations (and that would offend the conclusion that a reasonable person would make under paragraph 109F(5)(b)). | Subsection 109F(5) states: Debt Forgiveness by debt parking | An amount of debt an entity (the debtor) owes a private company is also forgiven for the purposes of this Division if: | (a) The private company assigns the right to receive payment of the amount to another entity (the new creditor) who is either: | i. An associate of the debtor; or | ii. A party to an arrangement with the debtor about the assignment; and | (b) A reasonable person would concludes (having regard to all circumstances) that the new creditor will not exercise the assigned right | It is noted that in the current situation: | • The related party borrowers in relation to the receivables assigned have a clear history of repayment. It is noted that it is the intention of the associates of Company A that the assignment to them should not disturb this; and | • It is the understood intention of the parties, as provided, that going forward distributions will be made by the Shareholder Trust in a consistent fashion to past years, being distributions to Company B and that in turn, to satisfy the present entitlement owing to those companies, the Shareholder Trust will be required to call on the assigned rights and call on the loans provided to associates. As such, and on the basis that the assigned right is on consistent terms with the loans between Company A as lender and the respective associated borrowers, a reasonable person would conclude that the new creditors, being the Shareholder Trust has fully exercised assigned rights. | It is accepted that for the purposes of Division 230, the Shareholder Trust will be taken to have provided financial benefits in respect of acquiring these rights equal to the arm's length value of assigned receivables It is also accepted that the Shareholder Trust will be taken to have provided consideration equal to the shares in Company A provided in return for acquiring these receivables.: Subsection 230-510(2) and (3) also apply to the current arrangement. These subsections provide the following: | 230-510(2): Subsection (3) applies if the parties to the dealing that resulted in you starting to have the arrangement were not dealing at arm's length in relation to the dealing. | 230-510(3): For the purposes of this Division: | (a) Disregard the amount of the financial benefit (if any) that you provided or received in relation to you starting to have the arrangement; | (b) Instead, treat yourself as having provided or receive a financial benefit in relation to you starting to have the arrangement that is equal to the amount of the financial benefit that you would have provided or received if the parties to the dealing mentioned in subsection (2) were dealing at arm's length in relation to the dealing. | Accordingly, the operation of Division 230 will deem the Shareholder Trust to have provided financial benefits equal to the arm's length dealing amount. | The ultimate collection of the receivables by the Shareholder Trust provided the assignment for their face value, is equal to the arm's length value of the debts assigned does not give rise to either a gain or loss. | Summary: Yes, the Commissioner can confirm for the purposes of Part 3-1 of the ITAA 1997, that the Shareholder Trust will not derive a capital gain if the Company A assigned receivables are repaid to the Shareholder Trust at the face value in a future period, where the market value of property provided to acquire the assigned debts, is equal to that face value. | Detailed reasoning: The Company A receivables are CGT Assets within the meaning of that term in section 108-5 of the Income Tax Assessment Act 1997. The Shareholder Trust would receive a combined cost base for the purposes of Part 3-1 equal to the market value of the property each trustee is required to provide for the acquisition of the assigned debts, under paragraph 110-25(2)(b) - in this case the market value of the shares in Company A. | Accordingly the repayment of the receivables at face value, where face value equals market value, will not give rise to a capital gain to the Shareholder Trust, as the capital proceeds that it will receive on debt repayment by the lender, will be equal to the cost base of the relevant asset from their perspective. | In addition, any application of Part 3-1 is subject to section 118-20 in that should other parts of the ITAA apply, Part 3-1 will not apply to the transactions. | Summary: Yes, the Commissioner confirms that liquidator distributions distributed from Company A to the Shareholder Trust is capital or corpus from the perspective of the shareholder trust estate. | Detailed reasoning: It is a well settled principle of law that a liquidator's distribution upon winding up is capital and not income from the perspective of the trust shareholders under general law concepts, including general trust law concepts. As such, a distribution in liquidation will be capital or corpus of the shareholder trust (Refer Hill v. Perpetual Trustees [1930] AC 720 where the principle is expressly recognised). | Whilst the characterisation of liquidation distributions at general law is settled, regard where trusts are concerned should also be given to the relevant terms of the specific Trust Deed. In the case of the specific trust deed, being the Trust Deed of the Shareholder Trust, there is no express intention to classify a capital receipt as income. For completeness however, it should be noted that the Trust Deed for the Shareholder Trust empowers the trustee to determine whether assets or receipts of the trust funds are 'income' or 'capital' of the trust. As such a power vests with the trustee and it is that trustee who will determine same for trust law purposes. In so far as application of Division 6 of the ITAA (1936) has application to the trust estate, the section 97 definition of 'income of the trust estate' refers to what is the income of the trust estate under general law concepts having regard to the specific trust instrument (refer FCT v. Bamford [2010] 240 CLR 481). Accordingly, Division 6 cannot in itself re-characterise amounts to be income. Instead it is the relevant trust instrument that determines same. | The Commissioner can confirm that the beneficiary of the Shareholder Trust will be assessed on its proportionate share of the assessable income of that trust estate, subject to the express requirement of a valid trust resolution being passed by the trustee prior to or on the last day of the financial year. On the basis that it is Company B that is the only beneficiary made presently entitled to the income of the trust estate, it will be that company that will be assessed on its proportionate share of amounts being the assessable income of the trust, in accordance with section 97 of the ITAA (1936). | Detailed Reasoning: The Commissioner understands that it is planned that prior to the end of the accounting period, being the end of the 2015 financial year, the trustee of the Shareholder Trust will make resolution in accordance with the trust instrument to make distribution of the whole of the income of the trust to Company B. | The Commissioner further understands that Company B is a general beneficiary of the trust estate as it is an eligible corporation as defined by the Deed of Settlement. | On making a valid resolution for the distribution of income of the trust estate in favour exclusively to Company B, Company B will become presently entitled to the income of the trust estate. | Company B will be required to include in its respective assessable income calculations for income tax purposes an amount equal to the section 97 proportional share of the net income of the trust estate, as defined in section 95 and in accordance with the principles enunciated in Zeta Force Pty Ltd v. FCT 84 FCR 80 and FC of T v Bamford (2010) 240 CLR 481. | Issue 10 Question 1: The Commissioner is requested to confirm that Division 6E operates in this case to prevent an amount being included in assessable income twice by reducing Company B's present entitlement to income of the shareholders trust, to the extent that the franked dividend (already included in assessable income of Company B) is to be disregarded | Summary: Yes, subject to the specific requirement that a frankable distribution is made by the Shareholder Trust to the beneficiary of the trust estate. | The Commissioner confirms that the intention of Division 6E is to prevent an amount being included in assessable income twice, by reducing a presently entitled beneficiary's income by the amount of a franked dividend that is specifically included in the beneficiary's net income due to the operation of Division 207 of the ITAA (1997). | On the basis of Company B being presently entitled to a frankable distribution from the Shareholder Trust, Subdivision 207-B will operate to include the frankable distribution and the relevant franking credit into the assessable income of the trust beneficiary. | Detailed Reasoning: Section 102UW of the ITAA 1936 states that Division 6E applies if (relevantly): | (a) The net income of a trust estate exceeds nil; and | (b) Any of the following things are taken into account in working out the net income of the trust estate: | (ii) a franked distribution (to the extent that an amount of the franked distribution remained after reducing it by deductions that were directly relevant to it); | (iii) a franking credit. [emphasis added] | Specifically, subsection 102UY(4) provides that a beneficiary of the trust estate has an amount of a Division 6E present entitlement to the income of the trust estate that is equal to the amount of the beneficiary's present entitlement to the income of the trust estate, decreased by: | (c) for each franked distribution taken into account as mentioned in paragraph 102UW(b) - so much of the beneficiary's share of the franked distribution as was included in the income of the trust estate; | In this particular instance, due to the operation of section 47 to the liquidator's distributions, distributions by the liquidator of Company A will be deemed to be dividends paid to the Shareholder Trust, by the company out of profits derived by it. | Such dividends are frankable distributions to the extent that they meet the criteria contained in section 202-40 and 202-45 of the ITAA (1997) | Division 202 of the ITAA 1997 enables Company A to frank a deemed dividend to the extent of its available franking credits. On the basis that the conditions of Subdivision 207-F are satisfied by the trustee of the Shareholder Trust, then Company B will be entitled to apply the franking credits.: Accordingly, Company B, being beneficiary of the Shareholder Trust will include its share of both the liquidation distribution taken to be a dividend under section 47 (which flows from the trust distributions made by the Shareholder Trust) and the franking credits relating to that distribution. | Summary: Yes The Commissioner confirms that section 100A does not apply to trust distributions made by the Shareholder Trust in the circumstances outlined, provided that the Shareholder Trust makes payment to Company B equal to the full entitlement in full to Company B. | Detailed reasoning: Section 100A of the ITAA 1936 provides that where a beneficiary of a trust estate who is not under a legal disability, is presently entitled to trust income, and that present entitlement is linked either directly or indirectly to a reimbursement agreement, the beneficiary is deemed not to be presently entitled to the income. Trust distributions which fall within section 100A of the ITAA 1936 are assessed to the trustee under section 99A of the ITAA 1936. | Subsection 100A(7) of the ITAA 1936 defines a reimbursement agreement to include: | ...the payment of money or the transfer of property to, or the provision of services or other benefits for, a person or persons other than the beneficiary or the beneficiary and another person or persons. | Further, the term 'agreement' is defined in subsection 100A(13) of the ITAA 1936 to include any agreement, arrangement or understanding, whether formal or informal, express or implied, and either enforceable or unenforceable. However, the term does not include any agreement entered into in the course of ordinary family or commercial dealings. | The Commissioner considers that Company B' present entitlements does not arise out of a 'reimbursement agreement,' due to the intention of the trustee to make full payment to Company B to the extent of its unpaid present entitlement. | Issue 13 Question 1: Can the Commissioner confirm that Part IVA does not apply to the transactions described herein? | Summary: Yes, the Commissioner can confirm that Part IVA does not have application to the broad arrangement of liquidation of Company A and distribution of the proceeds of liquidation in the manner as described. | In a strict sense Part IVA could have some residual application only, should the operation of the specific integrity mechanisms contained in Division 7A fail to achieve their intended application as a matter of policy. | The essential elements of Part IVA are: a) There must be a scheme; | b) a taxpayer must obtain a tax benefit in connection with the scheme; and | c) a taxpayer to the scheme must have the dominant purpose of enabling the taxpayer to obtain a tax benefit | Each will be analysed briefly | 1. Scheme: There is one possible scheme within the transactions described: | a. The assignment of Company A receivables, as a liquidation step, to the shareholder of Company A on terms that result in a reduced assessable income from the receivables to that expected had the scheme not been entered into ('the scheme'). | 2. Tax Benefit: Having identified the scheme, it must next be determined whether, in accordance with section 177C of the ITAA 1936, the taxpayer obtains a tax benefit in connection with a scheme if an amount is not included in the assessable income of the taxpayer in the year of income and: | (i) That amount would have been included; or | (ii) Might reasonably be expected to be included, | in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out. | Insofar as the scheme identified, a 'tax benefit' in respect of the identified scheme can only result where an assignment is performed by the related parties on more favourable terms to the borrower then would be the case, should the assignment not have been entered into. | As to the nature of any tax benefit, this will largely turn on the existing section 109N arrangements and the tax included in assessable income, but for the purported assignment being entered into, so long as the assignment is performed having regard to interest rates under section 109N for loans assigned, there is no apparent tax benefit. | 3. Dominant Purpose: The identified scheme can only be described as having a dominant purpose as to tax benefit if the overarching reason for the identified scheme was for same. This will be the case for example, where the parties subject to the assignment have performed steps of the liquidation in a manner that makes limited if any sense, commercially, other than for the purposes of the resultant tax benefit. | a) It is noted however that the liquidation process in itself is a liquidation of a redundant company, and hence the liquidation, at a headline level is commercially driven. | b) Further, the payment of taxable dividends by Company A and distribution of taxable income of the shareholder trust is consistent with 20 years of distribution patterns (in accordance with proper and due performance of trustee duties and obligations pursuant to the trust deed). This would occur regardless of assignment of the debts or a liquidation process for that matter. | The Commissioner can confirm that a taxable capital gain will not arise on the ultimate cancellation of Company A's shares, following all liquidation distributions being made, and the deregistration process is adhered to. | Detailed reasoning: If a company is wound up voluntarily, it is deregistered three months after the liquidator lodges a return of the holding of the final meeting of members or of members and creditors (subsection 509(5) of the Corporations Act 2001 ). Taxation Determination TD 2000/7 (TD 2000/7) provides that in such a case, CGT event C2 happens to the members' shares for the purposes of Part 3-1 and Part 3-3. | The Commissioner's view in Taxation Determination TD 2001/27 is that, for the purposes of CGT event C2, 'the full amount' of a liquidator's final distribution on the winding-up of a company is capital proceeds from the ending of the shareholders' shares in the company. | 104-25 Cancellation, surrender and similar endings: CGT event C2 | (1) CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: | (a) being redeemed or cancelled; or | (b) being released, discharged or satisfied; or | (d) being abandoned, surrendered or forfeited; or | (e) if the asset is an option - being exercised; or | (f) if the asset is a convertible interest - being converted. | Deregistration is the specific occurrence which triggers CGT event C2. 'Shares' in a company are an 'intangible CGT asset' which 'ends', when the intangible chose is 'released, discharged or satisfied' by the shareholder and is 'cancelled' by operation of law. | Paragraph104-25(5)(a) provides that a capital gain or capital loss you make from CGT event C2 is disregarded if you acquired the asset before 20 September 1985 ('Pre CGT Assets'). As indicated, Company A was incorporated prior to 20 September 1985. Accordingly the shares, which are the CGT Asset in this instance, are Pre CGT Asset. Therefore, any capital gain or capital loss would be ordinarily disregarded. | It should be noted, however, that where companies which are incorporated prior to the introduction of a Capital Gains Tax regime, a taxable event being CGT event K6 can still occur where Pre CGT shares are disposed of. Such is the case where the Post CGT property within the company is greater than 75% of the property of the Pre CGT incorporated company. | It has been explained to the Commissioner that liquidators distributions are to be finalised over a number of years and at the end of all distributions, including in specie property distribution, the liquidator will then finalise the deregistration process. | Although CGT event K6 is theoretically capable of happening in this case as the majority of the property of Company A is Post CGT property (being loans receivable), it is most unlikely that the company would have any property of the kind referred to in in the relevant section, being subsection 104-230(2) just before the deregistration process, and CGT event C2 happens. | That is, Company A is highly likely to be a 'shell' at that stage. This is the position established by Taxation Ruling TR 2004/18 (paragraphs 48 and 49). | In the unlikely event that CGT event K6 is attracted, section 118-20 of the ITAA 1997 reduces any capital gain under subsection 104-230(6), in any event by the amount (if any) of the liquidator's distribution that is assessed as a dividend. | Finally, for the purposes of completeness, CGT event G3, which provides that you can crystallise a capital loss if the liquidator declares the shares in Company A worthless, will not apply and is not relevant to the above transactions. Relevantly, subsection 104-145(6) provides that you cannot choose to make a capital loss if you acquired the shares before 20 September 1985.