Issue
Is a loan made by a private company to a shareholder (or shareholder's associate) excluded from the operation of section 109D of the Income Tax Assessment Act 1936 (ITAA 1936) by reason of the private company also having funds in a 'current account' with a financial institution?
Decision
No. A loan made by a private company to a shareholder (or shareholder's associate) is not excluded from the operation of section 109D of the ITAA 1936 by reason of the private company also having funds in a 'current account' with a financial institution, as a deposit of monies in a 'current account' and a loan of money are not similar loans within the meaning of paragraph 109M(b) of the ITAA 1936.
Facts
In the year ended 30 June 2004, a private company makes a loan of money to a shareholder of the private company. The private company makes no other loans to parties at arms length except for a deposit of monies in a 'current account' with a bank.
The relevant features of the loan of money are: • the lender advances funds to a borrower • the funds are to be repaid by a given date • the borrower may repay the funds earlier than the due date; and • interest is payable at a rate determined by the lender.
The relevant features of the 'current account' are: • monies are held on deposit at a variable interest rate determined by the bank (the borrower) • withdrawals of funds by the lender are made on demand in accordance with terms and conditions set by the bank; and • if no demand is made by the lender, no repayment is made.
Reasons for Decision
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 of the ITAA 1936 provides that such a loan is not taken to be the payment of a dividend for the purposes of section 109D of the ITAA 1936 if the loan meets the two requirements set out in section 109M of the ITAA 1936. Both these requirements need to be satisfied for section 109M of the ITAA 1936 to have application.
The two requirements of section 109M of the ITAA 1936 are as follows:
(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.
(b) Similar loans made to parties at arms 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.
The word 'similar' is not defined for the purposes of section 109M of the ITAA 1936 and therefore adopts its ordinary meaning. The Macquarie Dictionary (Third Edition, 2001, The Macquarie Library, Australia) defines 'similar' in the relevant context as follows: having likeness or resemblance, especially in a general way
A comparison of the terms of loans made to parties at arm's length is required to determine if the loans are similar.
It is well established that funds deposited with a financial institution constitute a loan between the customer and financial institution (see for example, Foley v. Hill (1848) 9 ER 1002 and Joachimson v. Swiss Bank Corporation [1921] 3 KB 110, [1921] All ER Rep 92).
In Joachimson v. Swiss Bank Corporation , Bankes LJ indicated that a loan between a customer and banker has peculiar features in comparison to an ordinary debtor and creditor relationship. At All ER Rep 96 he said: Having regard to the peculiarity of that relation , there must be, I consider, quite a number of implied superadded obligations beyond the one specifically mentioned in Foley v. Hill (1) and Pott v. Clegg (2). Unless this were so, the banker, like any ordinary debtor, must seek out his creditor and repay him his loan immediately it becomes due - that is to say, directly after the customer has paid the money into his account - and the customer, like any ordinary creditor, can demand repayment of the loan by his debtor at any time and any place. [emphasis added]
The Commissioner considers there are other material differences between the 'current account' and the loan between the private company and the shareholder. The other relevant differences are: • the rate of interest payable on the 'current account' is set by the banker (the borrower) whereas with the shareholder loan it is set by the lender • a loan of money to the shareholder specifies a term over which the funds are to be repaid. This is not the case with the 'current account'; and • the shareholder may repay the loaned monies prior to term whereas a bank does not repay monies from a 'current account' to a customer except on demand.
On this basis, the Commissioner considers, having regard to the material differences which exist between the 'current account' and the loan of money to the shareholder, that the 'current account' is not similar to the shareholder loan for the purposes of paragraph 109M(b) of the ITAA 1936.
Accordingly, a loan made by a private company to a shareholder (or shareholder's associate) will not be excluded from the operation of section 109D by reason of the private company also having funds in a 'current account' with a financial institution.