Private ruling: Commissioner's discretion - Division 7A subsection 109G(4)
Published: January 2013
Ruling period: 1July 2010 to 30 June 2011

Ruling: Question and Answer | Will the Commissioner exercise his discretion under section 109G(4) of the Income Tax Assessment Act 1936 and not treat the forgiven debt as a deemed dividend? | No. | Did you make a "loan" under subsection 109T(1) in Division 7A of the Income Tax assessment Act 1936 when you loaned money to the shareholder who inturn loaned the money to associates? | Yes

Relevant facts and circumstances: In your letter you have stated the facts as follows: The company currently has a sole director and shareholder. The company was incorporated by the shareholder's spouse, in order to conduct a mechanics business. At the time, the shareholder's spouse a number of ordinary shares and the shareholder held 1 ordinary share. Prior to 20 September 1985 the company acquired land from which the mechanics business was conducted. The company conducted a mechanics business for many years. This was the main source of income for the family. The shareholder's spouse died, and the mechanics business ceased trading. All the shares were then transferred to the shareholder. The company sold its land to a third party. The profits from the sale of the land were included in the retained profits. The cash held by the company was then lent to the shareholder over a number of years and in accordance with Section 109N loan agreements. Loan 1, the term of the loan is 7 years, with an option to extend the term of the loan up to a 25 year term. At that time the shareholder transferred the loan monies to a personal superannuation account and paid several outstanding accounts. The shareholder had the ability to repay the debt at the time it was incurred. Loan 2, the term of the loan is 7 years, with an option to extend the terms of the loan up to a 25 year loan. At that time the shareholder lent the money to 3 relatives. The shareholder had the ability to repay the debt at the time it was incurred. Loan 3, the term of the loan is 7 years, with an option to extend the terms of the loan. At that time the shareholder lent the money to 3 relatives The shareholder had the ability to repay the debt at the time it was incurred. The minimum required loan repayments have been made each year in accordance with the agreements. The company has incurred and paid tax liability on the interest income received from these loans each year as required. The shareholder loans to the company are still outstanding. Assets of the company consist of cash and loans to the sole shareholder. The company and shareholder have no current income tax liabilities outstanding. Due to the inability of the company or the shareholder to satisfy ongoing future potential tax liabilities and fund loan repayments the shareholder has resolved to liquidate the company under a corporate Members Voluntary Liquidation ("MVL"). The company acknowledges that the loans remain outstanding and were written off in accordance with a Member's Special Resolution. This results in a debt forgiveness under Section 109F and the amount forgiven may be treated as a deemed dividend to the shareholder. The debt owed by the shareholder to the company was forgiven because the payment of the debt would cause the shareholder undue hardship. The shareholder lost the ability to pay the debt in the foreseeable future as a result of circumstances beyond their control. The shareholder is elderly and suffers from serious health issues and is unable to work. Due to the shareholders age their medical expenses have significantly increased, resulting in them undertaking a strict budget to ensure that these costs are paid and also to ensure that they can meet future medical costs, which are likely to be significant. The ongoing repayments and tax liability can not be funded from their existing cash reserves or assets. The shareholder does not and will not have the ability to continue to fund the repayments of the loans and tax liabilities. If the loans were called upon or the tax liabilities continued, the shareholder would need to sell the home and allocate all resources which will deprive them of any means of acquiring necessities such as home, medical supplies, food and clothing. The shareholder has limited funds available after paying essential living costs. Therefore based on the shareholder's position they do not have the capacity to pay the deb. If the shareholder was to satisfy the debt this would cause them undue hardship, and they would not be able to meet the every day living expenses. The shareholder's assets are modest, and consisted of their main residence, cash at bank, motor vehicle and a pension fund. The pension fund is a self funded pension fund which is currently in pension mode. The shareholder is a self-funded retiree and relies on this pension fund to pay for all the necessities for the rest of their life. The shareholder has no means, other than self funded pension funds, from which to source funds to pay for their necessities. The shareholder's main residence continually requires essential repairs which are required to ensure that the main residence remains habitable.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 109F(1) | Income Tax Assessment Act 1936 subsection 109G(4) | Income Tax Assessment Act 1936 subsection 109T(1) | Income Tax Assessment Act 1936 subsection 109T(2) | Income Tax Assessment Act 1936 Section 109V | Income Tax Assessment Act 1936 Section 109W Further issues for you to consider | We have limited our ruling to the questions raised in your application. | Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement to which you asked us to apply the Commissioner's discretion.

Reasons for decision: Summary: Subsection 109F(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that a private company is taken to pay a dividend to an entity at the end of the company's income year if during that year the company forgives all or part of a debt owned by an entity who is a shareholder or an associate of a shareholder. The debt forgiven will still be deemed a dividend if it is forgiven after the entity ceases to be a shareholder or an associate of a shareholder if a reasonable person would conclude that the debt was forgiven because the entity was a shareholder or their associate at some time. Subsection 109G(4) of the Income Tax Assessment Act 1936 Commissioner may treat forgiveness as not giving rise to dividend. A private company is not taken under this Division to pay a dividend because of the forgiveness of a debt owed by an entity if the Commissioner is satisfied that: (a) the debt was forgiven because payment of the debt would have caused the entity undue hardship; and (b) when the entity incurred the debt, the entity had the capacity to pay the debt; and (c) the entity lost the ability to pay the debt in the foreseeable future as a result of circumstances beyond the entity's control. The Commissioner has an overriding discretion to allow a forgiveness of a debt which would otherwise be a deemed dividend under Division 7A, by ignoring the effect of section109F of the ITAA 1936, provided that payment of the debt would cause the entity "undue hardship". It is a condition for the Commissioner's discretion to be exercised that the Commissioner is satisfied that when the debt arose the recipient had the capacity to pay the debt and that the recipient "lost" the ability to pay the debt as a result of circumstances beyond the entity's control. It is unclear what will constitute circumstances beyond the entity's control. However, it may be expected that such circumstances may include loss of market share, loss of competitive advantage, high staff costs and turnover, unfavourable exchange rate variations, unfavourable stock market fluctuations. The Explanatory Memorandum to Act No 47 of 1998 states: In exercising his discretion the Commissioner will take into account the ability of the shareholder or associate to repay the loan at the time it was granted, at the time it was forgiven and at any foreseeable future time. The Commissioner will only exercise his discretion if he is satisfied that the shareholder had the ability to pay at the time of receipt of the loan and lost the ability to pay, permanently, through no fault of his or her own'' | Detailed Reasoning - Interposed Entities: Subsection 109T(1) of the ITAA 1936 states as follows: This Division operates as if a private company makes a payment or loan to an entity (the target entity ) as described in section 109V or 109W if: (a) the private company makes a payment or loan to another entity (the first interposed entity ) that is interposed between the private company and the target entity; and (b) a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment or loan solely or mainly as part of an arrangement involving a payment or loan to the target entity; and (c) either: (i) the first interposed entity makes a payment or loan to the target entity; or (ii) another entity interposed between the private company and the target entity makes a payment or loan to the target entity. Subsection 109T(2) of the ITAA 1936 goes on to state that: For the purposes of this section, it does not matter: a) whether the interposed entity made the payment or loan to the target entity before, after or at the same time as the first interposed entity received the payment or loan from the private company; or b) whether or not the interposed entity paid or lent the target entity the same amount as the private company paid or lent the first interposed entity. In order for subsection 109T(1) to apply to the proposed arrangement the interposed entity would need to make a payment or loan to the target entity. | Detailed Reasoning - Application to your circumstances: To be eligible for debt forgiveness you must satisfy all the requirements set out under 109G(4) of the ITAA 1936. You have not satisfied requirement (c) of section 109G(4) of the ITAA 1936. The company has made loans to the shareholder. The shareholder lent the money to three relatives (associates); therefore, the shareholder has not lost the capacity to pay the debt as the relatives will be required to repay the loan/s to the shareholder. Further; because the money loaned by the company to the shareholder (first interposed entity) was lent to associates (target entity) of the shareholder and taking into consideration the information which you have provided we conclude that the loans have been made solely or mainly as part of an arrangement to get the funds into the associate's hands. Please make any necessary amendments to the relevant year/s income tax returns.

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