Private ruling: Business - Division 7A and allowable deductions
Published: May 2013
Ruling period: 1 July 2011 to 30 June 2014

Ruling: Question and answer | 1. Is the use of the demonstrator vessels by the Associates of the Shareholder a deemed dividend for the purpose of Division 7A of the Income Tax Assessment Act 1936 ? | Yes. | 2. Is the value of the deemed dividend calculated under subsection 109CA(10) of the Income Tax Assessment Act 1936 ? | Yes. | 3. Are the costs incurred in acquiring and maintaining the demonstrator vessels deductible to the company? | Yes.

Relevant facts and circumstances: The Company is a privately held company. The Company is engaged in the business of purchasing luxury vessels for the purpose of resale. The Company at present holds a number of luxury vessels for the purpose of resale and on show to potential clients at different locations around Australia. Some vessels which are held for resale are used as 'Demonstrator' models. At all times, the demonstrator vessels are held for the purpose of resale, with the view to realising a profit. The demonstrator vessels are not used in the charter operations of the Company. Currently, the demonstrator vessels are moored at a yacht club. There is a cumulative monthly cost to moor the vessels at the yacht club. The demonstrator vessels have been moored at the yacht club, in the front most berths of the mariner in order to maximise exposure and viewing by the members and visitors of the yacht club. The Company considers the member base of the yacht club and their guests are representative of the vessel's target clientele. The demonstrator vessels are registered with the Maritime in the name of individual 1 or individual 2. The demonstrator vessels are only registered in the individual names of the associates in order to comply with the yacht clubs regulations in order to moor the vessels as the marina. The demonstrator vessels are listed as trading stock under the insurance policy. The keys to the demonstrator vessels are always kept in a safe by the Office Manager of the Company at the Company's office. A spare set of keys to each of the demonstrator vessels is held by the yacht club, in order to comply with the regulations of the marina. The Office Manager also keeps a detailed register of the usage of all trading stock, including the demonstrator vessels, held by the Company, as well as their availability and current locations. The demonstrator vessels are predominantly utilised by the Company for the following purposes; - Test voyages by clients of the Company who have expressed a serious interest in purchasing either the demonstrator vessels or another similar vessel held by the Company. - As display models at numerous boat shows each year. Individual 1 and individual 2 are able to request access to the demonstrator vessels for occasional recreational use. The use of the demonstrator vessels for recreational use is strictly limited to times when the Company does not require the vessels. On limited occasions when either individual 1 or individual 2 request access to the demonstrator vessels, the following process must be undertaken; - Individual 1 or individual 2 place a call with the Company's office to request to use the demonstrator vessel for recreational purposes. - Subject to the demonstrator vessel's availability, the keys are then collected from the Company's office, which are kept in a safe by the Office Manager. - Upon completion of the recreational use, the keys are returned to the Company's office. Neither individual 1 nor individual 2 personally hold keys, or have access to the keys without the Company's knowledge and authorisation, to the demonstrator vessels. No substantial personal items or effects of individual 1 or individual 2 are stored on board the demonstrator vessels. Any personal items kept on the vessels would assist the Company in creating an ambience for potential customers; for example ipods, CDs, Food and beverages. Whilst individual 1 and individual 2 would be considered employees for Fringe Benefits purposes the occasional access to use the demonstrator vessels for recreational purposes is provided to individual 1 and individual 2 in their capacity as associates of the shareholder of the Company. It does not occur in respect of any employment relationship between individual 1 and individual 2 and the Company. No other employees are allowed to use the demonstrator vessels for their recreational use. The Company charges individual 1 and individual 2 for the use of the demonstrator vessels. The rates are based on what the Company would charge an entity dealing at arms length. Surcharges apply to the base rates for special events as well as the provision of any food or beverages. After approximately one year of being used as a demonstrator vessel, the Company will cease using these vessels as demonstrators whilst continuing to hold them for the purpose of sale. It is the policy of the Company to constantly refresh it demonstrator vessels to ensure customers can view and test the most recent models. The Company has a distributable surplus in excess of any potential deemed dividend arising under Division 7A of the Income Tax Assessment Act 1936 .

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109C | Income Tax Assessment Act 1936 subsection 109C(1) | Income Tax Assessment Act 1936 subsection 109C(2) | Income Tax Assessment Act 1936 subsection 109C(3) | Income Tax Assessment Act 1936 subsection 109CA(1) | Income Tax Assessment Act 1936 subsection 109CA(2) | Income Tax Assessment Act 1936 subsection 109CA(10) | Income Tax Assessment Act 1936 Section 109Y | Income Tax Assessment Act 1936 subsection 109Y(1) | Income Tax Assessment Act 1997 subsection 8-1(1) | Income Tax Assessment Act 1997 subsection 8-1(2) | Income Tax Assessment Act 1997 subsection 26-47(2) | Income Tax Assessment Act 1997 subsection 26-47(3) | Income Tax Assessment Act 1997 subsection 70-10(1) | Income Tax Assessment Act 1997 subsection 960-100(1)

Reasons for decision: Summary: Question 1 Subdivision B of Part III of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) deals with circumstances under which certain private company payments will be treated as dividends. Subsection 109C(1) of the ITAA 1936 in Subdivision B states that a private company is taken to pay a dividend to an entity if the private company makes a payment to the entity during the year and either; (a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or (b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time. 'Entity' is defined in subsection 960-100(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and includes an individual. 'Payment' is defined in subsection 109C(3) of the ITAA 1936 and includes a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity. The concept of a payment to an entity for the purposes of Division 7A of the ITAA 1936 was extended with effect from 1 July 2009 to include the provision of an asset for use by the entity (eg a licence to use a boat, car or holiday home) under subsection 109CA(1) of the ITAA 1936. Under 109CA(1) of the ITAA 1936 a payment to an entity includes the provision of an asset for use by the entity. | Detailed Reasoning - For example:: Yacht builder Mainbrace Enterprises Pty Ltd owns a yacht for the purpose of sales demonstrations. With the private company's permission, one of its shareholders uses the yacht on weekends. The company has made a payment to the shareholder, unless one of the exceptions to subsection (1) applies. | Detailed Reasoning - Application to your circumstances: Individual 1 and individual 2, associates of the Company, are able to request permission from the Company to use the demonstrator vessels for private recreational purposes. Therefore, under section 109C of the ITAA 1936 the use of the demonstrator vessels by individual 1 and individual 2 for recreational purposes is a payment and will result in a dividend. Question 2 Under subsection 109Y(1) of the ITAA 1936, reduction of amounts of dividends; If, apart from this section, the sum of all the dividends a private company is taken under this Division to pay at the end of the year of income would be more than the company's distributable surplus for that year, the amount of each of those dividends is the amount worked out under subsection (3). Under subsection 109C(2) of the ITAA 1936 the dividend is taken to equal the amount paid, subject to section 109Y of the ITAA 1936. Under section 109CA(10) of the ITAA 1936 the amount of the payment is; (a) the amount that would have been paid for the provision of the asset by the parties dealing at arm's length; less (b) any consideration given for the provision of the asset by the entity. Under subsection 109CA(2) of the ITAA 1936 the time the payment is made is the time the entity first: (a) uses the asset with the permission of the provider of the asset; or (b) has a right to use the asset (whether alone or together with other entities), at a time when the provider of the asset does not have a right: (i) to use the asset; or (ii) to provide the asset for use by another entity. | Detailed Reasoning - For example:: Paragraph (a) could apply if a shareholder were driving a company car with the company's permission. Paragraph (b) could apply if the shareholder had the car parked at his or her house or at another place of his or her choosing. The Explanatory Memorandum for Tax Laws Amendment (2010 Measures No.2) Bill 2010 (EM) provides an explanation of the new laws in relation to a payment that arises from the provision of an asset for use (other than a transfer of property). These amendments extend the meaning of 'payment' to include the provision of an asset; at paragraph 1.20 it states; A payment may also occur when the asset is available for use to the exclusion of the company. As such, it does not matter when the right to use the asset is granted. In the example provided by the EM the shareholder of the private company uses the company's luxury yacht, stores personal items on the yacht and keeps the keys at his home; it is considered the asset (the yacht) is available to the shareholder for use to the exclusion to the company. The EM provides an alternative view at paragraph 1.22; If there is merely a general entitlement to use the company's assets, an asset is not available for a shareholder's use to the exclusion of the company. In this instance the shareholder had use of company cars however the assets were not available to the shareholder for use to the exclusion to the company. | Detailed Reasoning - Application to your circumstances: On limited occasions when either individual 1 or individual 2 request access to the demonstrator vessels, the following process must be undertaken; - Individual 1 or individual 2 place a call with the Company's office to request to use the demonstrator vessel for recreational purposes. - Subject to the demonstrator vessel's availability, the keys are then collected from the Company's office, which are kept in a safe by the Office Manager. - Upon completion of the recreational use, the keys are returned to the Company's office. The Company charges individual 1 and individual 2 for the use of the demonstrator vessels. The rates are based on what the Company would charge an entity dealing at arms length. Accordingly; the value of the deemed dividend is calculated under subsection 109CA(10) of the ITAA 1936. Question 3 Subsection 8-1(1) of the ITAA 1997 allows a deduction from assessable income any loss or outgoing to the extent that it is incurred in gaining or producing assessable income, or it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Subsection 8-1(2) of the ITAA 1997 provides that you cannot deduct a loss or outgoing to the extent that the expenditure is private, domestic or capital in nature. Under subsection 26-47(2) of the ITAA 1997 it states; This Act applies to you as if so much of the amounts relating to using or holding boats that you could otherwise deduct for an income year as exceeds your assessable income from using or holding boats for that year: (a) were not deductible for that income year; and (b) were an amount (a quarantined amount ) relating to using or holding boats that you can deduct for the next income year. However under subsection 26-47(3) exclusions apply, stating; The rule in subsection (2) does not apply to amounts that are attributable to one or more of the following: (a) holding a boat as your trading stock; Income Tax Ruling IT 2648, although it applies to motor vehicles, its intention can also be relevant to vessels. At paragraph 3 of the ruling it states; A demonstration model (also known in the industry as a "demonstrator") is a vehicle purchased for the purpose of sale but set aside for the purpose of providing prospective customers an opportunity to test drive a particular model of the vehicle. At paragraph 5 of the ruling it states; Demonstrators are part of the trading stock of a dealer because they are "acquired or purchased for purposes of... sale or exchange". A vehicle does not ordinarily cease to be trading stock when it is set aside for use as a demonstrator because it is intended that it will be resold and that resale will occur in the not distant future. Under subsection 70-10(1) of the ITAA trading stock includes: ( a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.. | Detailed Reasoning - Application to your circumstances: The Company is engaged in the business of purchasing luxury vessels for the purpose of resale. The vessels held for resale used as 'Demonstrator' models. At all times, the demonstrator vessels are held for the purpose of resale, with the view to realising a profit. The demonstrator vessels are listed as trading stock under the insurance policy. The demonstrator vessels are moored at a yacht club. The Company considers the member base of the yacht club and their guests are representative of the vessels' target clientele. After a period of time the Company will cease using these vessels as demonstrators and continue to hold them for the purpose of sale. Consequently, the costs incurred in acquiring and maintaining the demonstrator vessels are deductible to the company under section 8-1 of the ITAA 1997.

Does Part IVA apply to this ruling?: 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 you asked us to rule on.