Private ruling: Division 7A
Published: April 2014
Ruling period: Years ended 30 June 2014 to 30 June 2029
Date scheme commenced: 1 July 2013

Ruling: Q1: Will section 109C of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deem there to be a dividend paid by either the Private Company or the Private Finance Company (by virtue of the interposed entity rules contained in sections 109T and 109V of the ITAA 1936) to the Taxpayer under the Ground Lease arrangement? | A1: No | Q2: Will section 109D of the ITAA 1936 apply to deem there to be a dividend paid by either the Private Company or the Private Finance Company (by virtue of the interposed entity rules contained in sections 109T and 109W of the ITAA 1936) to the Taxpayer under the Ground Lease arrangement? | A2: No

Relevant facts and circumstances: The Taxpayer owns vacant land (the Land). It is proposed that the Taxpayer will grant a 15 year lease over the Land to the associated Private Company (the Lease). The Lease will allow the Private Company to build, construct, manage and lease a Commercial Building. The key terms of the Ground Lease arrangement can be summarised as follows: (a) The Ground Lease will be for the use of the Land. (b) The Ground Lease period will be for 15 years, with lease payments being at market value. (c) The Private Company will be permitted to construct the Commercial Building on the Land. (d) The Private Company will be permitted to use the Land for permitted use (defined as the use of the Commercial Building) to derive assessable income (such as rental income, management income etc.). (e) The ownership of the Commercial Building will rest with the Private Company. (f) On the expiry of the Ground Lease, the Taxpayer may require the Private Company to sell the Commercial Building to it at an agreed market value price. (g) If the Taxpayer does not give notice to the Private Company to sell the Commercial Building, then the Taxpayer is required to remove it and "make good" the Land. (h) The Private Company cannot assign or transfer the Ground Lease, and nor can it sub-let the Land without the prior consent of the Taxpayer. The Private Company will require finance to construct the Commercial Building. The finance may be sourced internally from the associated Private Finance Company or externally. Any loans provided by the Private Finance Company to the Private Company are to be repaid with interest charged at commercial rates.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109C | Income Tax Assessment Act 1936 Section 109D | Income Tax Assessment Act 1936 Section 109J | Income Tax Assessment Act 1936 Subsection 109L(1) | Income Tax Assessment Act 1936 Section 109T | Income Tax Assessment Act 1936 Section 109V | Income Tax Assessment Act 1936 Section 109W | Income Tax Assessment Act 1936 Section 109Y

Reasons for decision: Summary: Section 109C of the ITAA 1936 will not apply to deem there to be a dividend paid by either the Private Company or the Private Finance Company (by virtue of the interposed entity rules contained in sections 109T and 109V of the ITAA 1936) to the Taxpayer under the Ground Lease arrangement. | Detailed Reasoning - Detailed reasoning: A private company is relevantly taken to pay a dividend to an entity at the end of the private company's year of income under subsection 109C(1) of the ITAA 1936 if: • the private company pays an amount to the entity during the year, and • the payment is made when the entity is a shareholder in the private company, or an associate of such a shareholder. A payment to an entity is relevantly defined under subsection 109C(3) of the ITAA 1936 to mean a payment to the extent that it is to the entity or for the benefit of the entity, and a transfer of property to the entity. Lease payments from the Private Company to the Taxpayer under the Ground Lease Where the Private Company obtains external finance, the lease payments to the Taxpayer under the Ground Lease will be deemed by section 109C of the ITAA 1936 to be dividends paid from the Private Company to the Taxpayer. For the income years in which the Private Company does not have a distributable surplus, section 109Y of the ITAA 1936 will limit the dividends taken to be paid to the Taxpayer under subsection 109C(2) to nil. For the income years in which the Private Company does have a distributable surplus, and depending on whether that distributable surplus is sufficient to cover the lease payments paid to the Taxpayer, the dividends will be taken under subsection 109C(2) of the ITAA 1936 to either equal the amount of the lease payments paid to the Taxpayer or the distributable surplus, unless an exception applies. There are two exceptions that would apply: 1. Section 109J of the ITAA 1936 states that a private company is not taken under section 109C of the ITAA 1936 to pay a dividend because of the payment of an amount, to the extent that the payment discharges an obligation of the private company to pay money to the entity, and 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. As the lease payments are discharging the Private Company's obligation to pay money to the Taxpayer, and they are not more than would have been required to discharge the obligation had the Private Company and the Taxpayer been dealing with each other at arm's length (i.e. at commercial market value), section 109J of the ITAA 1936 will operate to exclude them from being dividends under section 109C of the ITAA 1936. 2. Subsection 109L(1) of the ITAA 1936 relevantly provides that a private company is not taken under section 109C of the ITAA 1936 to pay a dividend because of a payment the private company makes to an entity, to the extent that the payment would be included in the entity's assessable income apart from Division 7A of the ITAA 1936. The Taxpayer will include the lease payments from the Private Company in its assessable income under subsections 6-5(1) and 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997), meaning that the exception under subsection 109L(1) of the ITAA 1936 will apply. Therefore, the Private Company will not be taken to have paid dividends to the Taxpayer under section 109C of the ITAA 1936. Where the Private Company obtains finance from the Private Finance Company, the interposed entity provisions of sections 109T and 109V of the ITAA 1936 will need to be considered. It can be concluded that the Private Finance Company will not be taken to have paid dividends to the Taxpayer under section 109C of the ITAA 1936 (by virtue of the interposed entity rules contained in sections 109T and 109V of the ITAA 1936), because of the following: • Under section 109T of the ITAA 1936 a reasonable person would conclude that the Private Finance Company made a loan to the Private Company (as the first interposed entity) solely or mainly as part of an arrangement involving the making of a payment (i.e. the lease payment) to the Taxpayer (as the target entity) • Under section 109V of the ITAA 1936, either the Private Finance Company will generally be taken to have paid the Taxpayer a payment equal to the amount of the lease payment paid by the Private Company. • However, paragraph 109V(2)(b) of the ITAA 1936 will apply to reduce the amount of the payment to nil, as the Commissioner will take into account the arm's length consideration payable to the Taxpayer (as the target entity) by the Private Company (as an interposed entity) in respect of the lease payments under the Ground Lease. Payments made by the Private Company for the construction of the Commercial Building The payments made by the Private Company for the construction of the Commercial Building will not be to the Taxpayer. Furthermore, as the ownership of the Commercial Building will rest with the Private Company, these payments will be for the benefit of the Private Company and not the Taxpayer. Therefore, where the Private Company obtains external finance, the Private Company will not be taken to have paid dividends to the Taxpayer under section 109C of the ITAA 1936. For completeness, where the Private Company obtains finance from the Private Finance Company, the interposed entity provisions of sections 109T and 109V of the ITAA 1936 do not apply as no payments will be made to the Taxpayer as the target entity. Transfer of the Shopping Centre Complex from the Private Company to the Taxpayer In the event that the Taxpayer exercises its option under the Ground Lease to purchase the Commercial Building from the Private Company, that transfer will be deemed by section 109C of the ITAA 1936 to be a dividend. Assuming that the Private Company has a sufficient distributable surplus under section 109Y of the ITAA 1936 at the end of the Ground Lease, the amount of that dividend is taken to equal the amount paid as per subsection 109C(2) of the ITAA 1936. However, under subsection 109C(4) of the ITAA 1936, the amount of a payment consisting of a transfer of property is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer. As the Taxpayer will be required to purchase the Commercial Building from the Private Company at an agreed market value price, subsection 109C(4) will apply to reduce the amount of the deemed dividend under subsection 109C(2) of the ITAA 1936 to nil. Therefore, where the Private Company obtains external finance, the Private Company will not be taken to have paid a dividend to the Taxpayer under section 109C of the ITAA 1936. The above conclusion will not be altered if the Private Company obtains internal finance, as it can be concluded that the Private Finance Company will not be taken to have paid a dividend to the Taxpayer under section 109C of the ITAA 1936 (by virtue of the interposed entity rules contained in sections 109T and 109V of the ITAA 1936), because of the following: • Under section 109T of the ITAA 1936 a reasonable person would conclude that the Private Finance Company made a loan to the Private Company as the first interposed entity) solely or mainly as part of an arrangement involving the making of a payment (i.e. the transfer of the Commercial Building) to the Taxpayer (as the target entity) • Under section 109V of the ITAA 1936, the Private Finance Company will generally be taken to have paid the Taxpayer a payment equal to the market value of the Commercial Building transferred by the Private Company. • However, paragraph 109V(2)(b) of the ITAA 1936 will apply to reduce the amount of the payment to nil, as the Commissioner will take into account the arm's length consideration payable to the Taxpayer (as the target entity) by the Private Company (as an interposed entity) in respect of the transfer of the Commercial Building from the Private Company to the Taxpayer in exchange for the agreed market value price. | Summary: Section 109D of the ITAA 1936 will not apply to deem there to be a dividend paid by either the Private Company or the Private Finance Company (by virtue of the interposed entity rules contained in sections 109T and 109W of the ITAA 1936) to the Taxpayer under the Ground Lease arrangement. | Detailed Reasoning - Detailed reasoning: A private company is relevantly taken to pay a dividend to an entity at the end of one of the private company's years of income under subsection 109D(1) of the ITAA 1936 if: • the private company makes a loan to the entity during the current year • the loan is not full repaid before the lodgment day for the current year • none of the exclusions in Subdivision D of Division 7A of the ITAA 1936 apply, and • the loan is made when the entity is a shareholder in the private company, or an associate of such a shareholder. For the purposes of Division 7A, the ordinary meaning of loan is expanded under subsection 109D(3) of the ITAA 1936 to include: • an advance of money • a provision of credit or any other form of financial accommodation • a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount, and • a transaction (whatever its terms or form) which in substance effects a loan of money. Lease payments from the Private Company to the Taxpayer under the Ground Lease As the lease payments from the Private Company to the Taxpayer under the Ground Lease will be payments for the purposes of section 109C of the ITAA 1936, they will not be considered loans made to the Taxpayer under section 109D of the ITAA 1936. For completeness, in the event that the Private Company obtains finance from the Private Finance Company, the interposed entity provisions of sections 109T and 109W of the ITAA 1936 will not apply as no loans will be made to the Taxpayer as the target entity. Payments made by the Private Company for the construction of the Commercial Building As the payments made by the Private Company for the construction of the Commercial Building will not be to the Taxpayer, and the ownership of the Commercial Building will rest with the Private Company, they will not be loans made to the Taxpayer under section 109D of the ITAA 1936. For completeness, in the event that the Private Company obtains finance from the Private Finance Company, the interposed entity provisions of sections 109T and 109W of the ITAA 1936 will not apply as no loans will be made to the Taxpayer as the target entity. Transfer of the Commercial Building from the Private Company to the Taxpayer As the transfer of the Commercial Building from the Private Company to the Taxpayer will be a payment for the purposes of section 109C of the ITAA 1936, it will not be considered to be a loan made to the Taxpayer under section 109D of the ITAA 1936. For completeness, in the event that the Private Company obtains finance from the Private Finance Company, the interposed entity provisions of sections 109T and 109W of the ITAA 1936 will not apply as no loan will be made to the Taxpayer as the target entity.