Division 7A: multiple Subdivision EA loans and section 109Y

Where in an income year, a trustee makes loans to different shareholders (or associates) of a private company beneficiary with unpaid present entitlement, and section 109XB of Subdivision EA of Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) operates on more than one loan, can there be a proportionate reduction of the section 109XB assessable amounts because of the operation of subsection 109XB(2) of the ITAA 1936?

Yes. Where in an income year, a trustee makes loans to different shareholders (or associates) of a private company beneficiary with unpaid present entitlement, and section 109XB of the ITAA 1936 operates on more than one loan, there may be a proportionate reduction in the respective section 109XB assessable amounts because of the operation of subsection 109XB(2).

For the income year, a private company is a beneficiary of a trust which has unpaid present entitlement to net income of $100,000 as at the earlier of the due date for lodgement and date of lodgement of the trust's income tax return for that income year.

During the income year, the trustee made five $100,000 loans to different shareholders of the private company. None of the five loans were repaid or put on a commercial footing by the 'lodgement day' or otherwise constituted excluded loans because of Subdivision D of Division 7A of Part III of the ITAA 1936.

There is no reduction under subsection 109XA(4) of the ITAA 1936 in respect of any of the loans for the purposes of applying section 109XB of the ITAA 1936. But for subsection 109XB(2) of the ITAA 1936, the section 109XB assessable amount for each loan would be $100,000.

The private company's distributable surplus for the income year is $100,000.

Subdivision EA of Division 7A of Part III of the ITAA 1936 came into effect from 12 December 2002 and replaced section 109UB of the ITAA 1936.

Broadly speaking, Subdivision EA of the ITAA 1936 deems certain payments, loans or forgiven debts by a trustee of a trust estate to a shareholder (or associate) of a private company to be included in the shareholder's (or associate's) assessable income as if they were a dividend where the private company is presently entitled to an amount from the net income of the trust estate and that amount has not been fully paid out by the 'lodgement day'.

The 'lodgement day' is the earlier of the due date for lodgement and date of lodgement of the trust's tax return for the income year in which the payment, loan or debt forgiveness occurs.

Subsection 109XA(2) of the ITAA 1936 is the relevant provision that applies to trustee loans. It causes section 109XB of the ITAA 1936 to apply where: a trustee makes a loan (the 'actual transaction') to a shareholder or an associate of a shareholder of a private company (except a shareholder or associate that is a company); and (i) the company is presently entitled to an amount from the net income of the trust estate at the time the loan takes place and that amount has not been paid to the company before the 'lodgement day'; or (ii) the company becomes presently entitled to an amount from the net income of the trust estate after the loan takes place but before the 'lodgement day' and the whole of the amount has not been paid to the company before the 'lodgement day'.

The construction of subsection 109XA(2) of the ITAA 1936 means it is triggered in respect of each discrete loan. The provision is not concerned with whether other loans have been made by the trustee in the income year or whether those loans have been repaid or put on a commercial footing by the 'lodgement day'.

A loan is put on a commercial footing if it is put under a written agreement satisfying the minimum interest and maximum term criteria set out in section 109N of Subdivision D of Division 7A of Part III of the ITAA 1936.

Section 109XB of the ITAA 1936 provides as follows: 109XB Amounts included in assessable income (1) An amount is included as if it were a dividend, in the assessable income of the shareholder or associate referred to in subsection 109XA(1), (2) or (3) if: (a) had the actual transaction been done by a private company (the notional company); and (b) had the shareholder or associate been a shareholder of the notional company at the time the actual transaction took place; an amount (the Division 7A amount) would have been included in the shareholder's or associate's assessable income because of a provision in this Division outside this Subdivision. (2) Subject to section 109Y, the amount that is included under subsection (1) is the Division 7A amount.

Section 109XB of the ITAA 1936 therefore also applies separately to each loan (being the 'actual transaction') and is not concerned with other loans that have been repaid or put on a commercial footing by the 'lodgement day'.

Section 109XC of the ITAA 1936 includes some general and specific modifications to the Division 7A rules that apply to private company loans.

Subsection 109XC(7) of the ITAA 1936 modifies the application of section 109Y of the ITAA 1936 for the purposes of applying subsection 109XB(2) of the ITAA 1936. This in effect allows for the amount included in the shareholder's (or associate's) assessable income under section 109XB of the ITAA 1936 to be determined having regard to the distributable surplus rules contained in section 109Y. A private company's distributable surplus is calculated under subsection 109Y(2) of the ITAA 1936 and the formula for determining any reduction in the amount treated as a dividend is contained in subsection 109Y(3) of the ITAA 1936.

Subsection 109Y(3) of the ITAA 1936 provides: The amount of a dividend that a private company is taken under this Division to pay is worked out using the formula: Provisional dividend x (distributable surplus for the year of income / Total of provisional dividends) where: provisional dividend is the amount of the dividend that the private company would be taken to pay apart from this section. Total of provisional dividends is the sum of all the dividends the private company is taken under this Division to pay at the end of the year of income apart from this section.

Where trustee loans are made to different shareholders (or their associates) of the private company in the same income year and the aggregate of those loans exceeds the private company's distributable surplus, the 'Division 7A amount' for each shareholder (or their associate) is proportionately reduced so the total does not exceed the private company's distributable surplus. This is because of the combined operation of subsection 109XB(2) of the ITAA 1936, subsection 109XC(7) and subsection 109Y(3) of the ITAA 1936.

In the circumstances here, the provisional dividend in respect of each loan is $100,000, the total of provisional dividends is $500,000 and the private company's distributable surplus for the income year is $100,000. Therefore, the amount required to be included in the assessable income of each shareholder under section 109XB of the ITAA 1936 is $20,000 calculated as follows: 100,000 x (100,000 / 500,000) = $20,000.

The assessable amount under section 109XB of the ITAA 1936 for each shareholder is therefore proportionately reduced so the total does not exceed the distributable surplus of the private company with the unpaid present entitlement.