Private ruling: Restructure of security arrangements for some Division 7A 25 year loans
Date of advice: 14 April 2016
Published: June 2016
Ruling period: Income years ended 30 June 2011 to 2017 inclusive
Date scheme commenced: 1 July 2010

Ruling: Q1: If the existing mortgages are replaced with mortgages over the Replacement Properties, on or prior to the date of release of the existing mortgages, will the loan from the Lender continue to be a loan meeting the criteria for minimum interest rate and maximum term as required by section 109N? | A1: Yes | Q2: If the existing mortgages are replaced with mortgages over the Replacement Properties, on or prior to the date of release of the existing mortgages, will the Lender not be taken to pay (or have paid) a dividend to Borrower under Division 7A in any of the 2011 to 2017 income years? | A2: Yes

Relevant facts and circumstances: The Borrower borrowed funds from the Lender (a related entity) in a prior income year. The terms of the loan were originally governed by a written loan agreement that complied with section 109N of Division 7A of the ITAA 1936 on the basis that the loan was repayable on a principle and interest basis over a 7 year term. The loan was refinanced in a later year and converted to one with a maximum term of 25 years (reduced by the expired term of the original 7 year loan) in accordance with section 109N and section 109E of Division 7A of the ITAA 1936. The terms of the refinanced loan were set out in a new 25 year facility agreement. To comply with the requirements for refinancing to a 25 year term, the loan was secured by mortgages over a number of properties which are owned by related parties who guaranteed the repayment of the loan. The properties are also subject to mortgages securing payment of loans owing by other related parties. At the time the loan was refinanced, the equity in the mortgaged properties that secured the loan (after taking into account the other liabilities secured over the properties) exceeded 110% of the amount of the loan. The owner of one of the secured properties is currently negotiating its sale with a prospective purchaser and it is anticipated that the completion of the sale will occur before 30 June 2016. If that sale proceeds it will be necessary for the mortgage granted to the Lender over that property to be released before the date of settlement. The Borrower considers that, if the property is removed the from properties securing the loan, the equity in the remaining properties (after taking into account the other liabilities secured over the properties) will be less than 110% of the amount of the balance of the loan owed by the Borrower. It is proposed that the balance of the loan owed to the Lender at the date of release of the mortgage over the property will be secured by the new mortgages over replacement secured properties (Replacement Properties) owned by related parties.

Relevant legislative provisions: Section 109N of Division 7A ITAA 1936 | Section 109D of Division 7A ITAA 1936

Reasons for decision: Summary: Section 109N of Division 7A of the ITAA 1936 establishes how loans that meet the criteria for minimum interest rate and maximum term are not treated as dividends: 109N(1) Criteria. A private company that makes a loan to an entity in one of the private company's years of income is not taken under section 109D to pay a dividend at the end of the year of income because of the loan if, before the lodgement day for the year of income: a) the agreement that the loan was made under is in writing; and b) the rate of interest payable on the loan for years of income after the year in which the loan is made equals or exceeds the benchmark interest rate for the year; and c) the term of the loan does not exceed the term (the maximum term) for that kind of loan worked out under subsection (3) 109N(2) Benchmark interest rate. The benchmark interest rate for the year of income is the Indicator Lending Rates - Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income. However, the benchmark interest rate is the rate worked out under the regulations, if they provide for working it out. 109N(3) Maximum term. The maximum term is: a) 25 years for a loan if: i. 100% of the value of the loan is secured by a mortgage over real property that has been registered in accordance with a law of the State or Territory; and ii. when the loan is first made, the market value of that real property (less the amounts of any other liabilities secured over that property in priority to the loan) is at least 110% of the amount of the loan; and b) 7 years for any other loan. In your circumstances, the loan in question satisfied the criteria of section 109N when it was originally taken out. The original loan was for a period of 7 years. The loan was then refinanced and that refinanced loan was converted to a 25 year term secured by a mortgage over real property. This loan also satisfied the criteria under section 109N. The proposal is to sell a property which is one of the properties that were mortgaged as security for the loan. The Borrower has confirmed that after the release of the property the value of the remaining properties that are subject to the mortgage (less amounts of other liabilities secured over those properties in priority to the loan) will be less than 110% of the amount of the loan (as at the date of the 25 year refinancing and as at the date when the mortgage is released). However, it is proposed that the balance of the loan owed to the Lender at the date of release of the mortgage over the property for sale will be secured by the new mortgages over replacement secured properties (Replacement Properties) owned by related parties. The Lender has further confirmed that at the date the mortgages are granted over the Replacement Properties, the market value of those Replacement Properties (less the amount of liabilities secured in priority to the loan) will exceed 110% of the balance of the loan at the date the new mortgages are granted and also at the date the loan was refinanced. The Commissioner therefore confirms that the loan will continue to be a 25 year complying loan pursuant to section 109N of Division 7A of the ITAA 1936. As the loan has at all times been a complying loan pursuant to section 109N of Division 7A of the ITAA 1936, the Lender is not taken under section 109D to pay a dividend to the Borrower at the end of the year of income.