Private ruling: Section 109RB of the Income Tax Assessment Act 1936
Date of advice: 21 March 2016
Published: May 2016
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the Commissioner exercise the discretion under section 109RB of the Income Tax Assessment Act 1936 (ITAA 1936) to disregard the dividend deemed to have been paid under section 109E of the ITAA 1936 in the relevant income year? | A1: Yes

Relevant facts and circumstances: The Company made a loan to a shareholder. The Company engaged a law firm to draft the loan agreement. The loan satisfies the requirements of Section 109N of the ITAA 1936. The Company and the Borrower were aware that minimum yearly repayments would be required. No loan repayment was made in the relevant income year. The Borrower believed the minimum yearly repayment was required to be made by the date of lodgement of the Company's income tax return, and not 30 June of the relevant income year. Following 30 June of the relevant income year, the Borrower became aware that the minimum repayment was due to be paid by 30 June in the relevant year. The Borrower immediately paid the minimum yearly repayment to the Company. Division 7A of the ITAA 1936 has not previously applied to the Company or the Borrower.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1936 section 109D | Income Tax Assessment Act 1936 section 109E | Income Tax Assessment Act 1936 section 109N | Income Tax Assessment Act 1936 section 109RB.

Reasons for decision: Summary: Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) operates to treat certain loans and other payments made by a private company to a shareholder or their associate as assessable income (unfranked dividends) of the shareholder or associate. Section 109D of the ITAA 1936 provides that where a private company makes a loan to a shareholder or their associate in an income year, and the loan is not fully repaid by the lodgement day of that income year, the loan is taken to be a dividend paid to the shareholder or their associate at the end of that income year, unless the provisions in subdivision D of Division 7A of the ITAA 1936 prevent the loan from being treated as a dividend. Section 109N in subdivision D of Division 7A of the ITAA 1936 states: (1) 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 lodgment 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). Benchmark interest rate (2) 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. Maximum term (3) 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 a 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. … Taxation determination TD 2008/8 Income tax: if a private company makes a loan to a shareholder or their associate in an income year and the loan has not been fully repaid, what elements of the loan agreement need to be in writing for the purposes of paragraph 109N(1)(a) of Division 7A of Part III of the Income Tax Assessment Act 1936? provides that the entire agreement between the parties must be in writing to satisfy the requirement in paragraph 109N(1)(a), including: • the names of the parties; • the loan terms (i.e., the amount of the loan and the date the loan amount is drawn, the requirement to repay the loan amount, the period of the loan and the interest rate payable); • that the parties named have agreed to the terms; and • when the written agreement was signed or executed (at paragraph 1). The loan between the Company and the Borrower satisfies the requirements of section 109N of the ITAA 1936. Section 109D of the ITAA 1936 will not apply to treat the loan as a dividend paid by the Company to the Borrower. Section 109E of the ITAA 1936 states that: (1) A private company is taken to pay a dividend to an entity at the end of one of the private company's years of income (the current year ) if: (a) the private company made an amalgamated loan to the entity in an earlier year of income; and (b) the amalgamated loan is not repaid at the end of the current year; and (c) the amount (if any) paid to the private company during the current year in relation to the amalgamated loan falls short of the minimum yearly repayment of the amalgamated loan worked out under subsection (5) for the current year; and (d) section 109Q does not apply in relation to the current year. Note: The amalgamated loan does not give rise to a dividend for that year if the minimum yearly repayment is not made and the entity satisfies the Commissioner that treating the loan as a dividend would cause hardship. See section 109Q. Amount of dividend (2) The amount of the dividend is taken to be the amount of the shortfall mentioned in paragraph (1)(c), subject to section 109Y. Note: Section 109Y limits the total amount of dividends taken to have been paid by a private company under this Division to the company's distributable surplus. What is an amalgamated loan? (3) For the purposes of this Division, a private company is taken to make a loan (the amalgamated loan) to a single entity during a year of income if the private company makes one or more loans (constituent loans) to the entity during the year, each of which: (a) is not fully repaid before the lodgment day for the year; and (b) would cause the company to be taken under section 109D to pay a dividend to the entity at the end of the year, apart from section 109N; and (c) has the same maximum term for the purposes of that section. The amount of the amalgamated loan is the sum of the amounts of the constituent loans that have not been repaid before the lodgment day for the year of income in which the amalgamated loan is made. … The Borrowers failed to make the minimum yearly repayment on the loan in the relevant income year. In accordance with section 109E of the ITAA 1936, the shortfall amount (the total minimum yearly repayment) will be treated as an unfranked dividend paid by the Company to the Borrower at the end of the relevant income year; section 109Q of the ITAA 1936 will not apply to prevent the shortfall from being treated as an unfranked dividend. In circumstances where Division 7A of the ITAA 1936 is enlivened with the result that a private company is taken to pay a dividend to a shareholder or their associate, subsection 109RB(2) of the ITAA 1936 provides the Commissioner with discretion to either disregard the operation of Division 7A, or allow the deemed dividend to be franked, where the operation of Division 7A arose because of an honest mistake or inadvertent omission by either the recipient, the private company, or any other entity whose conduct contributed to that result (subsection 109RB(1)). The operation of Division 7A of the ITAA 1936 was enlivened by a failure of the recipients (Borrower) to make the minimum yearly repayment by the end of the relevant income year (30 June). Honest mistake or inadvertent omission A mistake in the context of Division 7A of the ITAA 1936 is an incorrect view or opinion or misunderstanding about how division operates; about facts that are relevant to its operation; or about other matters that affect its operation. An omission is a failure to take action that is relevant to, or affects, the operation of Division 7A. Taxation Ruling TR 2010/8 Income tax: application of subsection 109RB(1) of the Income Tax Assessment Act 1936 requires a consideration of the following matters when determining if Division 7A operated as a result of an honest mistake or inadvertent omission: 7. In each case, it is a question of fact whether an honest mistake or inadvertent omission has occurred. All the facts and circumstances must be considered to determine whether an honest mistake or inadvertent omission occurred. … 10. In determining whether a person has made an honest mistake or an inadvertent omission, that person's actual state of mind or belief is in issue. However, the available evidence may provide an indication of the person's actual state of mind. It is accepted that the operation of Division 7A of the ITAA 1936 was enlivened by an honest mistake or inadvertent error on the part of Borrower. Applying the factors in subsection 109RB(3 )of the ITAA 1936 to determine whether the discretion should be exercised Subsection 109RB(3) of the ITAA 1936 provides that the Commissioner must have regard to the following relevant factors when making a decision on whether to exercise the discretion in subsection 109RB(2) of the ITAA 1936: (a) The circumstances that led to the mistake or omission; (b) The extent to which the recipient, the private company, or other entity whose conduct contributed to Division 7A operating, has taken action to correct the mistake or omission, and if so, how quickly the action was taken; (c) Whether Division 7A has operated previously in relation to the recipient, the private company, or other entity whose conduct contributed to Division 7A operating, and if so, the circumstances in which it occurred (d) Any other matters that the Commissioner considers relevant. The Company, as Lender, has taken reasonable care to ensure that Division 7A of the ITAA 1936 would not operate; they engaged relevant professionals and ensured that the Borrower was aware of their minimum repayment obligations, the Borrower took action to correct the mistake or omission the day after they became aware of the mistake or omission, and Division 7A of the ITAA 1936 has not previously operated in relation to the Company or Borrower. In these circumstances, the Commissioner will exercise the discretion under subsection 109RB(2) and disregard the operation of Division 7A of the ITAA 1936.