Private ruling: Income tax: Division 7A implications of proposed contribution of capital
Date of advice: 3 July 2018
Published: September 2018
Ruling period: Year ending 30 June 2019
Date scheme commenced: The date on which the proposed capital is contributed by Partner 1 to the Partnership

Ruling: Q1: Would the further contribution of capital to the Partnership by Partner 1 be taken to be a dividend paid by Partner 1 to the Partnership for the purposes of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No

Relevant facts and circumstances: Partner 1 and Partner 2 entered into a Partnership. Partner 2 owns land acquired post 20 September 1985. Under the terms of the Partnership Agreement, the corporate trustee of a trust makes the land and buildings available to the Partnership for the purposes of the business and the company makes a capital contribution. The business carried on by the partners in partnership is redevelopment of the land and buildings for commercial purposes. The Partnership Agreement was varied twice with the company making additional capital contributions with a corresponding increase in its share of the net profits and losses made by the partnership on each occasion. Partner 1 proposes to make additional capital contributions to fund significant alterations to the land and buildings for commercial purposes. Partner 1 will contribute the proposed capital, but its share of the net profits and losses made by the partnership will remain unchanged. The funds will be retained in the Partnership and used for the purposes of its business.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 109C | Income Tax Assessment Act 1936 section 109D | Income Tax Assessment Act 1936 section 109J Further issues for you to consider | This private ruling only applies to the proposed capital contribution made for the purpose stated in the facts of this private ruling. | If additional capital contributions are made for purposes other than the purpose stated in this private ruling during the period covered by this private ruling, the taxpayer should seek a separate private ruling on the tax implications of those additional capital contributions. | Summary | The proposed capital contribution to be made by Partner 1 to the Partnership is not a loan by virtue of the ordinary meaning of the term or by virtue of the extended definition for the purposes of section 109D of the ITAA 1936. | The proposed capital contribution will be a payment for Division 7A purposes; however, Partner 1 will not be taken to pay a dividend by virtue of section 109J of the ITAA 1936. | There are therefore no Division 7A consequences stemming from the proposed capital contribution. | Detailed reasoning | Division 7A is an anti-avoidance measure designed to prevent private companies from making tax-free distributions of profits to shareholders or their associates in the form of, relevantly, loans or payments. Amounts loaned or paid by a private company to shareholders or their associates are treated as dividends (unless specific exclusions apply). | Loan - section 109D of the ITAA 1936 | Pursuant to subsection 109D(1) of the ITAA 1936, if a private company makes a loan to a shareholder or an associate of a shareholder; or a reasonable person would conclude that the loan is made because the recipient has been a shareholder or associate at some time, the loan will be taken to be a dividend if it is not repaid by the earlier of the due date for lodgement and the actual date of lodgement of the company’s income tax return for the year of income in which the loan is made (unless an exclusion applies). | Taxation Determination TD 2008/14 Income tax: Division 7A of Part III of the Income Tax Assessment Act 1936 – what is the meaning of ‘because’ in the context of the expression ‘because the entity has been such a shareholder or associate at some time’ in relation to payment, loans and debt forgiveness made by a private company to the entity? (TD 2008/14) states in determining whether a reasonable person would conclude that the loan is made because the recipient has been a shareholder or associate at some time, what is important is whether the real and significant reason for the transaction is the fact the entity has been a shareholder or associate at some time. Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements (TR 2010/3) provides guidance on the ordinary meaning of the term ‘loan’ and the extended meaning of the term for the purposes of Division 7A. | The essential element of an ordinary loan is the obligation to repay a borrowed amount. For the purposes of Division 7A, what constitutes a loan is listed at subsection 109D(3) of the ITAA 1936 and extends beyond the ordinary meaning of the term to include: | ● an advance of money | ● a provision of credit or any other form of financial accommodation | ● a payment with the express or implied obligation to repay the amount; and | ● a transaction which in substance effects a loan of money. | The Commissioner’s view at paragraph 85 of TR 2010/3 is that the phrase ‘advance of money’ suggests a payment of moneys ahead of a due date, or a payment in expectation of repayment or reimbursement. | The phrase ‘provision of credit’ involves allowing time to pay any debt, not just that arising under a loan agreement and could, depending on the circumstances, extend to allowing time to pay as stipulated at paragraph 87 of TR 2010/3. | The phrase ‘financial accommodation’ can be read both narrowly and widely. The Commissioner’s view at paragraphs 92 and 96 of TR 2010/3 is that ‘financial accommodation’ is limited to: | ● the supply or grant of some form of pecuniary aid or favour | ● under a consensual arrangement; and | ● where a pecuniary sum or equivalent is ultimately payable. | A transaction which in substance effects a loan of money will consist of a payment requiring repayment as stated at paragraph 116 of TR 2010/3. | The proposed capital contribution is made in accordance with the Partnership Agreement and for purposes which are consistent with purpose of the Partnership. | The proposed capital contribution is not an ordinary loan or a loan by virtue of the extended definition of the term for the purposes of Division 7A, but rather a bona fide capital contribution. As such, it follows that there will be no deemed dividend arising under section 109D of the ITAA 1936. | Payment – section 109C of the ITAA 1936 | Pursuant to subsection 109C(1) of the ITAA 1936, if a private company pays an amount during a year to an entity, the private company will be taken to pay a dividend at the end of the year of income if either 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 (unless an exclusion applies). | Paragraphs 22 through 24 of TD 2008/14 state in determining whether a reasonable person would conclude that the loan is made because the recipient has been a shareholder or associate of such a shareholder at some time, what is important is whether the real and significant reason for the transaction is the fact the entity has been a shareholder or associate at some time. | For the purposes of Division 7A, a payment is defined at subsection 109C(3) of the ITAA 1936 to include: | ● a payment to, on behalf of or for the benefit of a shareholder or associate | ● a credit to, on behalf of or for the benefit of a shareholder or associate; and | ● a transfer of property to a shareholder or associate. | However, under subsection 109C(3A) of the ITAA 1936, a loan to a shareholder or associate of such a shareholder is not a payment to the shareholder or associate. | The proposed capital contribution is not a loan according to its ordinary meaning or by the extended definition for the purposes of Division 7A. | The proposed capital contribution does, however, constitute a payment for the purposes of Division 7A and is to be made to an associate of a shareholder of the corporate partner. In the event the proposed capital contribution is made as a lump sum, there will be one payment. If the proposed capital contribution is made in instalments, each instalment will constitute a payment for Division 7A purposes. | As the exemption in section 109J of the ITAA 1936 applies, no deemed dividend will arise from the proposed capital contribution under section 109C of the ITAA 1936. | ATO view documents | Taxation Ruling TR 2010/3 Income tax: Division 7A loans: trust entitlements .