Private ruling: Marriage breakdown - Division 7A
Published: November 2012
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Questions and Answers: | Does section 109J of the Income Tax Assessment Act 1936 (ITAA 1936) apply to a payment that Company A pays to the Trust in order to discharge an obligation of Company A pursuant to a Family Court order? | Yes | Does section 109J of the ITAA 1936 apply to a payment that Company B pays to the Trust in order to discharge an obligation of Company B pursuant to a Family Court order? | Yes | Is the payment from either company to the Trust a deemed dividend to the Trust under section 109C of the ITAA1936? | No

Relevant facts and circumstances: Person X and Person Y were married and have separated. Person X has instigated proceedings against Person Y in the Family Court. The following entities are associates of person X and person Y for the purposes of section 318 of the ITAA 1936: · Company A (a private company) · Company B (a private company) · A family trust (the Trust) Person X and Person Y are the only two directors of Company A. They each own 50% of the shares. Person X and Person Y are the only two directors of Company Y. Person Y owns a percentage of the shares with the balance held by another entity. The Trust is a discretionary trust of which Person X and Person Y are both beneficiaries. Both Company A and Company B will become parties to the Family Court proceeding. Family Court orders will obligate Company A and Company B to each make a cash payment to the Trust. Company A and Company B will make the cash payments to the Trust to discharge their obligations imposed upon them by the Family Court order. The amount of both the payments will be at arm's length. Both Company A and Company B have a 'distributable surplus' for the purposes of section 109Y of the ITAA 1936.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109C | Income Tax Assessment Act 1936 Section 109J | Income Tax Assessment Act 1997 Subsection 960-100(1)

Reasons for decision: Detailed Reasoning - Payments treated as dividends: Section 109C of the Income Tax Assessment Act 1936 (ITAA 1936) treats certain payments, loans and debt forgiveness made by a private company to shareholders, or associates of shareholders as dividends. Subsection 109C(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity if the private company pays an amount to the entity during the income year and either: a) the entity is a shareholder or associate of a shareholder in the company at the time of the payment; or b) a reasonable person would conclude that the payment was made because the entity has been a shareholder or associate at some time. Payment by virtue of subsection 109C(3) of the ITAA 1936 includes a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity. Entity is defined in subsection 960-100(1) of the ITAA 1997 and includes a trust. The payment from Company A to the Trust satisfies section 109C of the ITAA 1936 as: · Company A is a private company that will pay an amount of cash to the Trust. · The trust is an associate of Person X and Person Y, the shareholders of Company A. Pursuant to paragraph 318(1)(d) of the ITAA 1936, an associate of a natural person includes the trustee of a trust of which the person is a beneficiary. · As Company A has a distributable surplus pursuant to section 109Y of the ITAA 1936, the dividend is prima facie taken to equal the amount paid. Similarly, the payment from Company B to the Trust satisfies section 109C of the ITAA 1936 as: · Company B is a private company that will pay an amount of cash to the Trust. · The trust is an associate of Person Y, one of the shareholders of Company B. Pursuant to paragraph 318(1)(d) of the ITAA 1936, an associate of a natural person includes the trustee of a trust of which the person is a beneficiary. · As Company B has a distributable surplus pursuant to section 109Y of the ITAA 1936, the dividend is prima facie taken to equal the amount paid. | Detailed Reasoning - Exception under section 109J of the ITAA 1936: A payment under section 109C of the ITAA 1936 does not give rise to a deemed dividend if an exclusion in Subdivision D of Division 7A of the ITAA 1936 applies. One of the exclusions is section 109J of the ITAA 1936 which provides: A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment: a) discharges an obligation of the private company to pay money to the entity; and b) is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length. The term 'obligation' is not expressly defined for the purposes of section 109J of the ITAA 1936 and therefore adopts its ordinary meaning. The Macquarie Dictionary defines 'obligation' as: 'a binding requirement as to action; the binding power or force of a promise, law, duty, agreement, etc. ; a binding promise or the like'. Hence, an obligation can only arise from a court order made under the Family Law Act where the entity is a party to the proceedings. | Detailed Reasoning - Application of sections 109C and 109J: Section 109J of the ITAA 1936 is satisfied in relation to the proposed payments from both Company A and Company B to the Trust as: · The cash payments will be made as a result of an order by the Family Court. · Company A and Company B will both be parties to the Family Court proceedings and will therefore be parties to the Court Order. This will create an obligation on the part of both Company A and Company B which will be discharged upon payment. · Company A and Company B will each make a cash payment to the Trust to discharge its obligation under the Family Court Order. · The amount of both the payments will be at arm's length. As section 109J of the ITAA 1936 is satisfied, the payments to be made by Company A and Company B to the Trust will not constitute a deemed dividend to the Trust for the purposes of section 109C of the ITAA 1936.