Private ruling: Loans made by a private company to associated unit trust where no similar loans are made
Date of advice: 3 July 2018
Published: September 2018
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2011

Ruling: Q1: Are the advances made to the rulee that arose from legislation (which is not taxation related), excluded from being treated as a dividend under Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) pursuant to section 109M of the ITAA 1936?

Relevant facts and circumstances: The Unit Trust owns premises. Private Company leases the premises from Unit Trust and pays rent to Unit Trust at market rates. The shareholders of the Private Company are also the unit holders in the Unit Trust, in exactly the same proportions. Private Company and Unit Trust are associated entities for income tax purposes. The Private Company operates a business from the premises owned by Unit Trust. Private Company is an approved provider for its business purposes and is required to act in accordance with rules and regulations of the non-tax related legislation. As a normal part of its business, Private Company receives Lump Sum payments. The permitted use of the Lump Sum payments received by the Private Company is regulated under the non-tax related legislation and Private Company acts in accordance with this. Private Company advanced the Lump Sum payments to Unit Trust which is a permitted use. A written loan agreement is in place in relation to the Lump Sum payments. The loan agreement is not compliant with section 109N of the ITAA 1936. Private Company has made other miscellaneous loans to Unit Trust and borrowed various funds from Unit Trust over the years. No formal documentation or arrangements were in place in relation to these. These loans were at call loans and were not interest bearing. Private Company has not made any similar loans to arm's length parties or entities.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109M

Reasons for decision: Summary: Section 109M of the ITAA 1936 does not apply to the loans advanced to Unit Trust as it does not meet the requirements of paragraph 109M(b). | Detailed Reasoning - Detailed reasoning: The making of a loan by a private company to a shareholder or an associate of the shareholder is treated as the payment of a dividend in the circumstances outlined in section 109D of the ITAA 1936. However, section 109M provides that such a loan is not taken to be the payment of a dividend for the purposes of section 109D if the loan meets the two requirements set out in section 109M. Both these requirements need to be satisfied for section 109M to have application. Section 109M of the ITAA 1936 states: A private company is not taken under section 109D to pay a dividend because of a loan made: (a) in the ordinary course of the private company's business; and (b) on the usual terms on which the private company makes similar loans to parties at arm's length. | Detailed Reasoning - (a) Ordinary course of the private company's business: Paragraph 109M(a) of the ITAA 1936 requires a loan to have been made in the ordinary course of the private company's business and not in the ordinary course of business in general. | Detailed Reasoning - (b) Usual terms on which the private company makes similar loans to parties at arm's length: Paragraph 109M(b) of the ITAA 1936 requires consideration of whether there are, or have been, similar loans made to parties at arm's length. If so, a comparison of the loan terms made to parties at arm's length is required to determine if the loans are similar. This means that in circumstances where there are loans made by a private company to an associated entity, there must be a contemporaneous loan made to an arm's length party, which can be used for comparison purposes. Where a loan is made to a party which is not at arm's length (even though such loans may be made on arm's length terms), paragraph 109M(b) is not satisfied. In Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 75 ALR 287 it was held that parties will be at arm's length if neither party is able to exercise any control or influence over the other. This will also be relevant for cases where multiple loans by a private company are provided within a group to a number of entities. In these cases paragraph 109M(b) will fail as such loans would not be made at arm's length. | Detailed Reasoning - Application to Unit Trusts’ circumstances: Private Company have provided loans to Unit Trust in accordance paragraph 109D(3) of the ITAA 1936. In this case the loan is the advancement of Lump Sum payments from Private Company to Unit Trust. This has occurred in the course of its ordinary business which meets the requirements of paragraph 109M(a). Paragraph 109M(b) of the ITAA 1936 requires Private Company to have made loans on the usual terms on which similar loans had been made to an arm’s length party. ATO ID 2003/588 explains that where multiple loans by a private company are provided within a group to a number of entities would also fail to satisfy paragraph 109M(b) because they are not made at arm's length. The loan made by Private Company is contended to be in conformity with certain regulations (non-tax related) and this is not disputed, however the usual terms within this context refers to loans made to arm’s length entities regardless of the regulations under which it is operational (if any). Private Company and Unit Trust are associated entities pursuant to section 318 of the ITAA 1936 sharing common shareholders and unit holders in exact proportions. As the private company and the unit trust are associated entities and there are no similar loans made to external parties at arm's length, the requirements of paragraph 109M(b) have not been satisfied. It follows that the loans made by Private Company to Unit Trust do not fulfil the requirements prescribed in section 109M of the ITAA 1936. Consequently, section 109D may operate to treat the loan as a dividend.

ATO view documents: ATO Interpretative Decision ATO ID 2003/588, Income Tax: Division 7A – loan in the ordinary course of business from a private company to an associated partnership treated as dividends.