Private ruling: Income tax and the treatment of an unconditional in-specie distribution by a private company of its interest in listed securities for no consideration to a special disability trust associated with a shareholder in the private company
Date of advice: 22 October 2018
Published: January 2019
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Can the private company disregard any capital gain or capital loss it makes under section 118-85 of the Income Tax Assessment Act 1997 (ITAA 1997) when it makes an unconditional in-specie distribution of its interest in listed securities for no consideration to a special disability trust? | A1: Yes Issue 2 | Q2: Is the private company considered to be making a payment that is treated as a dividend under section 109C of the Income Tax Assessment Act 1936 (ITAA 1936) when it makes an in-specie distribution of listed securities for no consideration to a special disability trust associated with one of its shareholders? | A2: Yes | Q3: Is the private company considered to have forgiven a debt that would be treated as a dividend under section 109F of the ITAA 1936 when it makes an in-specie distribution of listed securities for no consideration to the special disability trust? | A3: No | Q4: Is the private company able to enter into an arrangement with its shareholder to convert any payment considered to be made to the special disability trust to a loan before the company’s lodgement day under subsection 109D(4A) of the ITAA 1936, such that it is not treated as a dividend under section 109N of the ITAA 1936? | A4: No

Relevant facts and circumstances: A parent has a disabled child. The parent would like to provide for the child’s ongoing accommodation and care needs for the remainder of the child’s life. The parent intends to establish a Special Disability Trust, as provided for in the Social Security Act 1991 , for this purpose. The parent intends to act as one of the trustees for the trust. The Department of Social Services (Centrelink) have confirmed that the child meets the definition of having a severe disability under section 1209M of the Social Security Act 1991 to qualify as a beneficiary under a special disability trust. A private company intends to make an in-specie distribution of listed securities it holds and owns as part of its investment portfolio to the special disability trust for no consideration. The transaction is a gift / donation and the company will not receive any material advantage or benefit. The parent is a minority shareholder in the private company. The majority shareholder is a family trust that the parent controls. In accordance with section 1209P of the Social Security Act 1991 the Secretary may, by legislative instrument, determine one or more of the following: ● the form of the trust deed required for a special disability trust ● provisions which must be included in the trust deed ● the form of those provisions, or ● provisions which cannot be included in the trust deed. In respect of that provision the Model Trust Deed for Special Disability Trusts published by Centrelink provides: ● at clause 3.2 - that the trustee cannot accept any conditional contributions by any donor to the trust ● at clause 3.4 – that the trustee cannot borrow money from a related or non-related party ● at clause 3.5 - that the trustee cannot intentionally acquire, except by way of contribution, property other than listed security acquired at market value from a related party, ● at clause 4 – that upon the winding up of the trust entities that have contributed assets may receive back their contributions on a proportional basis or someone else may be nominated to whom the assets should be transferred (e.g. other children or grandchildren). The parent intends to adopt their legal advisor’s trust deed which is based on the Model Trust Deed. The parent intends that on the winding up of the special disability trust that the balance of the trust (i.e. the Donor’s Contribution Balance), if any, would be transferred to: ● the private company if the parent or the company survives the child, or ● the parents other children by nomination request if the child survives the company or the parent.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 7A | section 109C | subsection 109C(1) | subsection 109C(2) | subsection 109C(3) | paragraph 109C(3)(c) | subsection 109C(4) | subsection 109D(1) | subsection 109D(3) | subsection 109D(4A) | section 109F | subsection 109F(3) | section 109J | section 109K | section 109L | section 109N | section 109Y | section 109ZD | section 318 | paragraph 318(1)(a) | paragraph 318(1)(d) | Income Tax Assessment Act 1997 section 108-5 | section 118-85 | section 245-35 | section 245-37 | Social Security Act 1991 section 1209M | section 1209P

Reasons for decision: Detailed Reasoning - Question: Can the private company disregard any capital gain or capital loss it makes under section 118-85 of the ITAA 1997 when it makes an unconditional in-specie distribution of its interest in listed securities for no consideration to a special disability trust? | Summary: The private company can disregard any capital gain or capital loss it makes under section 118-85 of the ITAA 1997 when it makes an unconditional in-specie distribution of its interest in listed securities for no consideration to a special disability trust. | Detailed Reasoning - Detailed reasoning: In general, a capital gain or loss made from a capital gains tax (CGT) event is included in an entity’s tax return for the income year in which the event happens. However, in some cases an exemption may apply that allows a taxpayer to reduce, or disregard (and therefore not include in their tax return), any gain or loss made as a result of the CGT event. Where applicable, such exemptions are provided for by the tax law. Section 118-85 of the ITAA 1997 provides that an entity may disregard a capital gain or loss it makes from the transfer of CGT asset to a special disability trust for no consideration. According to the definition of a ‘special disability trust’ in section 995-1 of the ITAA 1997, for the exemption provided by section 118-85 of the ITAA 1997 to apply to the transfer of a CGT asset, the transfer must be to a ‘special disability trust’ within the meaning of the Social Security Act 1991 or a trust that becomes a special disability trust as soon as practicable after the transfer. A trust will satisfy this requirement if it applies to become a special disability trust within a reasonable time and the application is later approved. In this circumstance, the private company intends to directly transfer listed securities it holds and owns to a trust that meets the necessary requirements for a special disability trust as outlined in the Social Security Act 1991 for no consideration. A share in a company is an example of an asset that falls within the meaning of CGT asset in section 108-5 of the ITAA 1997. The CGT exemption in section 118-85 of the ITAA 1997 would therefore apply. Any gain or loss made on the transfer of the listed securities by private company to the ‘special disability trust’ will be disregarded. | Detailed Reasoning - Question 1: Is the private company considered to be making a payment that is treated as a dividend under section 109C of the ITAA 1936 when it makes an in-specie distribution of listed securities for no consideration to a special disability trust associated with one of its shareholders? | Summary: The private company does make a payment that may be treated as a dividend under section 109C of the ITAA 1936 when it makes an in-specie distribution of listed securities to the special disability trust (an associate of one of its shareholders). | Detailed Reasoning - Detailed reasoning: A payment or other benefit provided by a private company to a shareholder or their associate can be treated as a dividend for income tax purposes under Division 7A of the ITAA 1936. In particular, subsection 109C(1) of the ITAA 1936 provides that a private company is taken to pay a dividend at the end of the year of income if: ● the payment was made when the entity was a shareholder or an associate of a shareholder, or ● a reasonable person would conclude that the payment is made because the recipient has been a shareholder or associate at some time. In this case it needs to be determined if the transfer of the listed securities by the private company to the special disability trust is a ‘payment’. By virtue of paragraph 109C(3)(c) of the ITAA 1936 the definition of 'payment' in subsection 109C(3) of the ITAA 1936 includes a transfer of property. Property includes land, buildings, vehicles, tools, equipment and shares. The transfer of the listed securities owned by the private company would be considered to be a transfer of the property of the company. The transaction would therefore fall within the meaning of ‘payment’ for the purposes of Division 7A of the ITAA 1936. As a payment would be made by the private company it needs to be determined if the payment would be made to a shareholder or an associate of a shareholder at the time of the transfer. In this circumstance the payment would be made to a special disability trust. It needs to be determined if the trust is an associate of one of the shareholders of the private company. By virtue of section 109ZD of the ITAA 1936 the term ‘associate’ for the purposes of Division 7A of the ITAA 1936 has its meaning given by section 318 of the ITAA 1936. Under paragraph 318(1)(d) of the ITAA 1936 an ’associate’ of an individual includes a trustee of a trust where the individual, or another entity that is an associate of the individual under another paragraph of subsection 318(1) of the ITAA 1936, benefits under the trust. In this case, the parent of the beneficiary is one of the shareholders of the private company, and would be one of the trustees of the special disability trust. The trust would be established for the benefit of one of the parent’s children – an associate of the parent under paragraph 318(1)(a) of the ITAA 1936 (i.e. a relative). It follows that the payment would be to an associate of a shareholder at the time the listed securities are transferred. Subsection 109C(1) of ITAA 1936 would therefore apply to the payment to be made by the private company to the special disability trust. It is noted that Subdivision D of Division 7A of the ITAA 1936 sets out certain types of payments that are not treated as dividends for the purposes of section 109C of ITAA 1936. This Subdivision provides that a payment is not treated as a dividend: ● if it discharges a private company's obligation to pay money to the shareholder or their associate and the payment does not exceed the amount required to discharge the obligation if the shareholder or their associate and the company were dealing at arm's-length - section 109J of the ITAA 1936 ● if it is made to another company (and they are not acting in the capacity of trustee) – section 109K of the ITAA 1936 ● if the payment would be included in the shareholder's or their associate's assessable income under a provision of the tax law – section 109L of the ITAA 1936 ● if the payment would be excluded from the shareholder's or their associate's income under a provision of the tax law – section 109L of the ITAA 1936, and ● if it is made to the shareholder or their associate in their capacity as an employee or an associate of an employee. The Commissioner does not consider any of the exclusions outlined above to apply to the transfer of the listed securities because it: ● does not discharge an obligation of the private company to pay money to the special disability trust ● is not made to another company that is not acting in the capacity of trustee ● has not been included in, nor excluded from, the shareholder’s or associate’s income under a provision of the tax law, and ● has not been made to the special disability trust, an associate of one of the shareholders, in their capacity as an employee of the private company. As the payment will be by transfer of property, subsection 109C(4) of the ITAA 1936 provides that the amount of the payment would be the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the special disability trust. Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend will be the amount paid, subject to the private company’s distributable surplus calculated under section 109Y of the ITAA 1936. | Detailed Reasoning - Question 2: Is the private company considered to have forgiven a debt that would be treated as a dividend under section 109F of the ITAA 1936 when the company makes an in-specie distribution of listed securities for no consideration to the special disability trust? | Summary: The private company has not forgiven a debt that would be treated as a dividend under section 109F of the ITAA 1936 because a debt would not come into existence as a result of the transfer of the listed securities. There is no express or implied obligation on the special disability trust to pay an amount for the transfer of the listed securities. | Detailed Reasoning - Detailed reasoning: Where a private company forgives, wholly or partly, a debt owed to it by a shareholder or their associate, the amount forgiven may be treated as a dividend at the end of the company’s income year under section 109F of the ITAA 1936. In the first instance it needs to be determined if the transfer of the listed securities by the private company to the special disability trust brings a debt into existence. The word ‘debt’ is not defined in the ITAA 1936 or the ITAA 1997. It therefore takes its ordinary meaning, being a legal obligation to pay a sum of money to another. In the circumstances of this case, the private company will make an unconditional transfer of listed securities it owns to the special disability trust. This transaction will be for no consideration and without any express or implied obligation on the special disability trust to pay an amount for the transfer of the listed securities. The conditions of this transfer align with the provisions made by Department of Social Services in the model trust deed for special disability trusts to the extent the trust cannot accept any conditional contributions or borrow money from a related or non-related party. The Commissioner therefore considers that the transfer of the listed securities does not bring a debt into existence. Further, the transaction does not fall within the meaning of a loan for the purposes of subsection 109D(3) of the ITAA 1936. The private company therefore does not forgive a debt to the special disability trust as a result of transferring its listed securities for the purposes of section 109F of the ITAA 1936. | Detailed Reasoning - Question 3: Is the private company able to enter into an arrangement with its shareholder, the parent of the beneficiary of the trust, to convert any payment considered to be made to the special disability trust to a loan before the company’s lodgement day under subsection 109D(4A) of the ITAA 1936, such that it is not treated as a dividend under section 109N of the ITAA 1936? | Summary: The private company cannot enter into an arrangement with its shareholder, in his own capacity, to convert the payment to the special disability trust to a loan under subsection 109D(4A). The arrangement would need to be between the private company and the special disability trust. | Detailed Reasoning - Detailed reasoning: A payment or other benefit that may be treated as a dividend under Division 7A of the ITAA 1936 may be converted to a loan under paragraph 109D(4A) of the ITAA 1936. The shareholder or their associate will have until the earlier of the due date for lodgment or the date of lodgment of the company's tax return for the income year in which the payment is made to repay the loan in full or enter into a complying loan with the company meeting the terms of section 109N of the ITAA 1936 to prevent the company being taken to pay a dividend under subsection 109D(1) of the ITAA 1936. Subsection 109D(4A) of the ITAA 1936 states in relation to the conversion of a payment to a loan that: If: (a) a private company makes a payment to an entity at a time in a year of income; and (b) the payment is converted to a loan before the end of the private company' s lodgment day for the year of income; for the purposes of this Division, treat the events mentioned in paragraphs (a) and (b) as the private company making a loan to the entity at the time mentioned in paragraph (a). The effect of this provision is that the private company would be treated as making a loan to the entity that it made the payment to at the time that the payment is made. In the circumstances of this case, if the payment were converted to a loan, the private company would be considered to be making the loan to the special disability trust at the time of making the transfer of the listed securities. The conditions under section 109N of the ITAA 1936 for the loan not to be taken to be the payment of a dividend under section 109D of the ITAA 1936 therefore would need to be met between the private company and the special disability trust. The conditions cannot be met between the private company and one of its shareholder (acting in their own capacity and not as trustee of the trust) because the payment and subsequent loan would be made to the special disability trust. The Commissioner is empathetic to the circumstances of the taxpayers and appreciates the compassionate reasons under which the transaction is contemplated. The Commissioner also understands the conflict between the conditions under which a special disability trust receives such a status and the application of Division 7A of the ITAA 1936 that would result in the trustee of the special disability trust being in receipt of a dividend. Unfortunately, there are no express modifications to the provisions of Division 7A of the ITAA 1936 for special disability trusts, such as those modifications provided for under the capital gains tax and trust income provisions, that allows the Commissioner to apply the Division 7A provisions in an alternate manner.