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Where a shortfall in a minimum yearly repayment gives rise to a deemed dividend under section 109E of the Income Tax Assessment Act 1936 (ITAA 1936), can a deemed dividend also arise under section 109D of the ITAA 1936 in respect of the proportion of the shortfall comprising unpaid interest?

No. Where a shortfall in a minimum yearly repayment gives rise to a deemed dividend under section 109E of the ITAA 1936, a deemed dividend does not also arise under section 109D of the ITAA 1936 in respect of the proportion of the shortfall comprising unpaid interest.

During the 2008-09 income year a private company made an unsecured loan to the taxpayer, an individual and the company's sole shareholder.

The loan was made under a complying section 109N of the ITAA 1936 agreement, with a maximum term of 7 years and with interest payable equal to the benchmark interest rate for each income year.

No repayment was made on the loan for the income year ended 30 June 2010 and a deemed dividend arose under section 109E of the ITAA 1936.

A private company may be taken to pay a dividend to an entity at the end of one of the private companies years of income under subsection 109D(1) of the ITAA 1936 where: (a) the private company makes a loan to the entity during the current year; and (b) the loan is not fully repaid before the lodgment day for the current year; and (c) Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and (d) either: (i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or (ii) a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time.

Subdivision D of Division 7A of the ITAA 1936 contains a number of exclusions to the application of subsection 109D(1) of the ITAA 1936. Section 109N of Subdivision D prevents a private company from being taken to pay a dividend where: • the loan is made under a written agreement and the rate of interest payable on the loan for the income year after the year in which the loan is made, equals or exceeds the benchmark interest rate for that income year, and • the term of the loan does not exceed the maximum term, which is seven years in the case of unsecured loans (refer to subsections 109N(1) and 109N(3) of the ITAA 1936).

Where a loan is put under a complying section 109N of the ITAA 1936 loan agreement by the private company's lodgment day for the income year in which the loan is made, a deemed dividend does not arise in the year the loan is made but rather in each future year in which the minimum yearly repayment under section 109E is not made by the end of the income year.

Subsection 109E(5) of the ITAA 1936 provides that the minimum yearly repayment for an amalgamated loan for a year of income is the amount worked out using the formula in subsection 109E(6) of the ITAA 1936, unless it is worked out under the regulations (if they provide for working it out). The effect of this formula is that the amount of the minimum yearly repayment comprises both principal and interest.

Therefore, where the minimum yearly repayment is not made for an income year, and a deemed dividend arises under subsection 109E(1) of the ITAA 1936, the amount of the deemed dividend will correspond in part to the non-payment of principal due under the contract of loan and in part to the non-payment of interest.

Subsection 109D(3) of the ITAA 1936 provides that for the purposes of Division 7A, a loan includes: (a) an advance of money; and (b) a provision of credit or any other form of financial accommodation; and (c) 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 (d) a transaction (whatever its terms or form) which in substance effects a loan of money.

The phrase 'provision of credit' involves allowing time to pay a debt (including by granting a right to defer payment of a debt). A loan itself amounts to the provision of credit (see, for example, the decision of the High Court in Herbert v R [1] where lending money, which necessarily involved allowing time for it to be repaid, was held to be the provision of credit). The provision of credit extends to allowing time to pay any debt, not just that arising under a loan agreement, as is evident from the judgments in Herbert v R

The following principles for interpreting the phrase 'any other form of financial accommodation' are set out in paragraph 62 of Taxation Determination TD 2022/11 Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'? : • any other form of financial accommodation is to be construed broadly [2] • there must be a consensual arrangement between the parties [3] • failure to call for payment of a UPE constitutes a benefit to the trustee. [4]

The non-payment of interest under a consensual agreement between the private company and shareholder (or their associate) may satisfy the requirements of either (i) 'a provision of credit' or (ii) 'any other form of financial accommodation'.

The non-payment of interest may involve the private company 'allowing time to pay a debt including by granting a right to defer payment of a debt', where the debt is the interest due and payable. In such cases, there may be 'provision of credit' in terms of section 109D of the ITAA 1936.

The non-payment of interest may also involve the private company conferring a benefit on the shareholder (or their associate) in not calling for (or enforcing payment of) interest contractually due and payable. In such cases, there may be financial accommodation in terms of subsection 109D(3) of the ITAA 1936.

The non-payment of interest contractually due under a complying section 109N of the ITAA 1936 loan agreement, may therefore amount to a loan within the meaning of subsection 109D(3) of the ITAA 1936.

However, the generalia specialibus non derogant rule provides that the specific provision overrides the general, and it is not within the statutory scheme of Division 7A for the same underlying amount to be treated as a deemed dividend twice.

The specific provision within Division 7A of the ITAA 1936 aimed at treating non-payment of interest on a complying section 109N of the ITAA 1936 loan agreement as a deemed dividend is subsection 109E(1) of the ITAA 1936.

Therefore, in the circumstances here, subsection 109E(1) of the ITAA 1936 prevails over subsection 109D(1) of the ITAA 1936, meaning only the minimum yearly repayment shortfall in terms of subsection 109E(2) of the ITAA 1936 may give rise to a deemed dividend under Division 7A of the ITAA 1936. Note : unpaid interest which forms part of a minimum yearly repayment shortfall in terms of subsection 109E(2) of the ITAA 1936 should not be added to the closing balance of the constituent loan for the applicable income year.

Date of Amendment Part Comment 10 August 2022 Reasons for decision Removed reference to TR 2010/3 from explanation of 'provision of credit' and updated explanation for 'any other form of financial accommodation' following withdrawal of TR 2010/3. This version was published on 10 August 2022, with effect from 13 July 2022. 27 February 2015 Case References Updated case citation.

Date of Amendment | Part | Comment

10 August 2022 | Reasons for decision | Removed reference to TR 2010/3 from explanation of 'provision of credit' and updated explanation for 'any other form of financial accommodation' following withdrawal of TR 2010/3. This version was published on 10 August 2022, with effect from 13 July 2022.

27 February 2015 | Case References | Updated case citation.