1 Will any of the transactions described in the facts and circumstances of this private ruling, and summarised in Table 1, give rise to ordinary income for: • Trust A • Trust B • Person C?
No. Question 2 Will any of the transactions described in the facts and circumstances of this private ruling, and summarised in Table 1, have consequences under Division 245 of the Income Tax Assessment Act 1997 for: • Trust A • Trust B • Person C? Answer No. Question 3 Will converting the UPE into the Converted Loan have any consequences for Trust Aunder Division 7A of the Income Tax Assessment Act 1936 ? Answer No. Converting the UPE into the Converted Loan as described in the facts and circumstances of this private ruling won't trigger a deemed dividend under Division 7A. The facts and circumstances don't disclose any private company, so there are no facts that will trigger the primary operative rules, interposed entity rules, or specific rules applying to unpaid trust entitlements. Question 4 Will there be any consequences for Trust A under the CGT provisions in the Income Tax Assessment Act 1997 for converting the UPE into the Converted Loan? Answer No. Converting the UPE into the Converted Loan won't cause a CGT event to happen in a way that will have tax consequences for Trust A. This ruling applies for the following period :
XXXX income year The scheme commenced on: 1 July XXXX
1. Person C loaned money to Trust A. We'll call it Loan 1. Trust A must repay Loan 1 to Person C at call but doesn't have to pay interest. The Loan 1 funds are $X. Trust A used the Loan 1 funds for income-producing purposes. 2. Person C also has unpaid present entitlements from Trust A. We'll call them the UPE. The UPE is for $X. Trust A uses the UPE funds for income-producing purposes. 3. Person D loaned money to Person C. Person D is a relative of Person C. We'll call it Loan 2. The Loan 2 funds total $X. Person C didn't use the Loan 2 funds for income-producing purposes. 4. The parties propose to enter the following transactions. 5. First, Person C and Trust A will convert some of the UPE into a loan (from Person C to Trust A). To be more specific, Person C will agree to lend $X of the UPE funds to Trust A and will agree to set-off Person A's entitlement to be paid the UPE against his or her obligation to advance the loan funds. As a result, Trust A will owe $X to Person C, payable at call, and won't have to pay interest. We'll call this the Converted Loan. Trust A will still owe the balance amount of Person C's UPE.
6. The parties haven't considered the terms of the converted loan, but it will likely be interest-free and repayable at call. 7. Second, Person C will assign Person C's rights to be repaid (by Trust A) under Loan 1 and the Converted Loan to Person D. 8. Third, Person D will assign Person D's right to be repaid as a creditor under Loan 1 and the Converted Loan to Trust E. 9. As an alternative scenario: • Loan 2 could be assigned by Person D to Trust E, and • Person C would later assign Loan 1 and the Converted Loan directly to Trust E (rather than first to Person D, and then Person D making the further assignment to Trust E). 10. Person D lent amounts totalling $X to Person C. They were made as X separate loans over several years. We'll call this the Person D Loan. 11. Person F, who is Person D's spouse, lent amounts totalling $X to Person C. They were made as X separate loans over several years. We'll call this the Person F Loan. 12. Person C used the Person D and Person F Loan funds to pay down business debt, acquire units in Trust B, and on-lend to Trust B at interest.
13. Trust B owed $X to Person C. We'll call this the Person C Loan. 14. Person D and Person F propose to assign the Person D and Person F Loans to Trust E. 15. After that, Person C proposes to assign the Person C Loan: • partly to Trust E • partly to Person D (an amount equal to the Person D Loan) • partly to Person F (an amount equal to the Person F Loan). 16. The proposed assignments are intended to rationalise and simplify the broader group loan arrangements as part of Person C's estate and succession planning goals. 17. Person C, Trust B, and Trust A have always been solvent, and they will continue to be solvent throughout the relevant transactions. 18. Person C is an Australian resident. 19. The proposed transactions aren't part of a broader scheme or course of conduct, other than being part of Person C's estate planning goals, and Person C's desire to rationalise and simplify the group's structure.
20. Person C and Person D are concerned about Person C's estate issues, and Person D and Person F are happy to work with Person C to simplify matters as long as they preserve their right to repayment. 21. All parties always intended that the loans described in this ruling would be repaid. 22. Person C runs an X business as a sole trader. 23. Trust B owns land and buildings and receives rent. 24. Trust A owns real estate and leases to a combination of related party and third party tenants. 25. No entities mentioned in this ruling lend money in the ordinary course of a business. 26. Debt forgiveness and debt assignment aren't regular, routine events for any of the entities described in this ruling. They don't regularly enjoy or rely on debt forgiveness or debt assignment events when managing their everyday affairs (whether in business or not). 27. No loan terms will change as a result of the proposed assignments, other than swapping an existing creditor for a new creditor. For example, loan terms and interest (if applicable) won't be introduced or varied. 28. Person C is a majority unitholder in Trust B.
29. Person D and Person F are directors of Trust B's corporate trustee. 30. Person C is a beneficiary of Trust A. 31. Person D is the effective controlling mind of Trust A. 32. Person D and Person F are beneficiaries of Trust E. 33. Person D and Person F are the effective controlling minds of Trust E. Table 1: Summary of the relevant transactions Table 1: Summary of the relevant transactions Transaction Debtor Current creditor/proposed assignor New creditor/ proposed assignee Loan 1 - initial assignment Trust A Person C Person D Loan 1 - further assignment Trust A Person D Trust E Loan 1 - alternative scenario Trust A Person C Trust E Converting the UPE into the Converted Loan Trust A Person C is the current creditor under the UPE and will be the proposed creditor under the Converted Loan. (There's no assignment.) Converted Loan - initial assignment Trust A Person C Person D Converted Loan - further assignment Trust A Person D Trust E Converted Loan - alternative scenario Trust A Person C Trust E Person C Loan - assignment Trust B Person C Trust E, Person D, and Person F Person D Loan - assignment Person C Person D Trust E Person F Loan - assignment
Person C Person F Trust E Loan 2 - possible assignment Person C Person D Trust E Assumption A. If interest was paid on any of the loans listed in Table 1, except Loan 2, that interest would have been deductible to the payer. B. If Person C paid interest on Loan 2, it wouldn't be deductible to Person C. (Determining whether interest is deductible depends on the facts, but relevant factors include the purpose for the loan and how the funds were used. See, for example, TR 2004/4 [1] at paragraph 6. We don't determine interest deductibility in this ruling.) C. The relevant parties (debtors, current creditors, new creditors) will intend all reassigned loans to be repaid, after the current creditors make the relevant assignments.
Income Tax Assessment Act 1997 Section 6-5 Section 245-10 Section 245-35 Section 345-36 Section 245-40 Section 245-45 Section 245-50 Section 245-55 Section 245-65 Section 245-75 Section 995-1 Income Tax Assessment Act 1936 Section 109C Section 109D Section 109F Section 109T Section 109U Section 109V Section 109W Section 109XA Section 109XF Section 109XG Section 109XI
These reasons for decision accompany the Notice of private ruling for the relevant entities. 1. In these reasons for decision: • all hyphenated legislative provisions (eg, section 6-5, section 245-35) are in the Income Tax Assessment Act 1997 • Division 245 is in the Income Tax Assessment Act 1997 • unhyphenated provisions (eg, section 109C, section 109T) are in the Income Tax Assessment Act 1936 • Division 7A is in the Income Tax Assessment Act 1936 Question 1 Will any of the transactions described in the facts and circumstances of this private ruling, and summarised in Table 1, give rise to ordinary income for: • Trust A • Trust B • Person C? Summary 2. No. The transactions described in the facts and circumstances of this ruling, and summarised in Table 1, won't give rise to ordinary income. Broadly, amounts may be ordinary income if they are a reward for services, are gains from business activity, or are received regularly. The relevant transactions don't give rise to amounts that have those characteristics. Explanation
Amounts may be ordinary income if they are a reward for services or business activity or are received regularly and relied upon. 3. Section 6-5 includes ordinary income in assessable income. 4. Ordinary income isn't defined, but case law has established guidelines for determining whether a receipt is income or capital. (Broadly, capital transactions don't have an income character.) We'll summarise some of those guidelines from ATO guidance [2] and an academic work by Parsons. [3] • Payment is determined objectively, by examining the character of the payment in the recipient's hands, considering all facts, taking a business conception, and taking a broad view considering the taxpayer's total situation. • Payments that are consideration for services, or are received periodically, regularly, or recurrently, may be income. • Gains arising from an act in carrying on business or an isolated profit-making transaction may be income. • Payments provided for a purpose outside the recipient's business won't usually be income.
• Payments that compensate for lost income or substitute for lost income may be income. • Gifts or subsidies to replenish or augment capital aren't income under ordinary concepts - they aren't a product or incident of income producing activity. • Parsons suggests that items of income character must have 'come home' to the taxpayer, and the taxpayer must have made a gain. • Capital gains and windfall gains don't have the character of income. The relevant transactions won't be ordinary income because they don't share the relevant characteristics. 5. Here, several loans and corresponding debts will be assigned between entities in the group. Rights to receive payment from the debtors will be transferred or redirected to other entities. The original debtors will still have obligations to make equal payments to other entities within the group. See Table 2. Table 2: Summary of debtor's obligations to pay, before and after the proposed assignments Table 2: Summary of debtor's obligations to pay, before and after the proposed assignments Loan Debtor Debtor's original obligation to pay (on demand)
Debtor's obligation to pay (on demand) after the proposed assignment Loan 1 - initial assignment Trust A $X to Person C $X to Person D Loan 1 - further assignment Trust A $X to Person D $X to Trust E Loan 1 - alternative scenario Trust A $X to Person C $X to Trust E Converting the UPE into the Converted Loan Trust A $X to Person C (out of the original $X) $X to Person C under the Converted Loan (and the balance of $X as a UPE to Person C) Converted Loan - initial assignment Trust A $X to Person C $X to Person D Converted Loan - further assignment Trust A $X to Person D $X to Trust E Converted Loan - alternative scenario Trust A $X to Person C $X to Trust E Loan 2 - alternative scenario Person C $X to Person D $X to Trust E Person C Loan - assignment Trust B $X to Person C $X to Person D $X to Person F $X to Trust E Person D Loan - assignment Person C $X to Person D $X to Trust E Person F Loan - assignment Person C $X to Person F $X to Trust E 6. We don't think any of the transactions covered in this ruling would cause amounts to be recognised as ordinary income for the relevant debtors (Trust A, Trust B, and Person C). They don't have the characteristics of ordinary income.
• The assignment can't be income for the debtors because they haven't gained in a substantive sense. Their obligation to repay the current creditor has been swapped with an obligation to pay the same amount to a new creditor. The facts don't suggest the new creditor will waive the debt or not require repayment. The assignment hasn't improved their position - they haven't received any economic benefit or advantage. • The assignment has no link to services or business activity. The debtors aren't having their debts assigned as consideration for anything. None of the debtors lend money in the ordinary course of a business. • The periodic and reliance indicia of income aren't present here. Debt forgiveness or debt assignments aren't regular events for the debtors, and they don't rely on those events when managing their everyday affairs. • The assignments don't compensate for or replace amounts that would themselves be ordinary income.
7. The proposal to convert Person C's UPE into a loan is slightly different. The UPE is an obligation for Trust A to pay Person C. Under the proposed conversion, Person C will treat his or her entitlement to the UPE has having been satisfied if Trust A agrees to pay Person C the same amount on demand. 8. The proposal to convert Person C's UPE from Trust A into a loan won't cause amounts to be assessed to Trust A for similar reasons to the proposed assignments. • Trust A hasn't gained because it still has an obligation to pay the same amount to Person C on substantively the same terms. • The conversion doesn't reward Trust A for services or business activity. We don't see any link to business activity or services on these facts. Trust A doesn't carry on a money lending business. Trust A's only income earning activities are rent from real estate. • Trust A doesn't regularly receive or rely on debt forgiveness or debt assignment events when managing its affairs. • Trust A isn't being compensated for or replacing amounts that would themselves be ordinary income.
Conclusion on Question 1: the assignment or conversion events won't be ordinary income for the relevant entities. 9. Therefore, the assignment or conversion events described in Table 1 of this ruling won't cause amounts to be assessed as ordinary income under section 6-5 for Trust A, Trust B, or Person C. Question 2 Will any of the transactions described in the facts and circumstances of this private ruling, and summarised in Table 1, have consequences under Division 245 of the ITAA 1997 for: • Trust A • Trust B • Person C? Summary 10. No. The transactions described in the facts and circumstances of this private ruling won't have consequences under the commercial debt forgiveness rules. The assignments will be treated as forgiven debts under Division 245. However, the offset rules will apply to reduce the forgiven amount by the amount assigned to a new creditor. The gross forgiveness amount will be nil. Explanation A brief introduction to the commercial debt forgiveness rules.
11. Very broadly, the commercial debt forgiveness rules eliminate certain tax benefits for taxpayers who have had debts forgiven under qualifying circumstances. 12. We'll briefly sketch the commercial debt rules. • The rules (in Division 245) apply to debts that are 'commercial' - in the sense that interest was deductible or would have been deductible if paid. • The debts need to be forgiven for the purposes of Division 245. • There are exclusions - including where amounts are otherwise assessable, or debts are forgiven for natural love and affection. • The rules deem assigned debts to be forgiven in some circumstances. • There are rules for working out the amount of forgiven debts, including where forgiven debts are offset against other amounts. • If the rules apply, you apply forgiven debt amounts to reduce tax losses, net capital losses, certain deductible amounts, and cost bases of CGT assets. The debt forgiveness rules apply to all loans except Loan 2: interest would have been deductible to the debtor if it was paid.
13. The commercial debt forgiveness rules apply where interest on the loan was, or could have been, deducted. Section 245-10 says the operative rules (in subdivisions 245-C to 245-G) apply if either of three threshold tests are met. • Paragraph (a): you deducted (or can deduct) interest (or amounts in the nature of interest) paid or payable by you in respect of the debt. • Paragraph (b): interest wasn't payable, but it would have been deductible had you paid it. • Paragraph (c): interest could have been deductible if it wasn't excluded by a specific provision (other than under the first three 'negative limbs' of the general deduction provision in section 8-1). 14. Here, the commercial debt forgiveness rules will apply to all loans except Loan 2. Interest isn't payable under any of these loans. However, all of them were applied for income producing purposes except for Loan 2. We've assumed that if the relevant debtors paid interest, interest on: • Loan 2 wouldn't have been deductible • all the remaining loans would have been deductible. Therefore, paragraph 245-10(b) is met, but not for Loan 2.
The debts will be treated as 'forgiven' for Division 245 purposes: they've been assigned to new creditors. 15. There are provisions in Subdivision 245-B explaining when debts are treated as 'forgiven' under the debt forgiveness rules. Debts will be treated as forgiven where: • the debtor's obligation is released, waived, extinguished other than by full repayment: paragraph 245-35(a) • they become statute barred: paragraph 245-35(b). 16. But assigned debts are also treated as being forgiven. Section 245-36 applies where three conditions are met: • the creditor assigns the right to receive payment to a new creditor • either the new creditor is the debtor's associate or the assignment occurred under an arrangement [4] to which the new creditor and debtor were parties: paragraph 245-36(a) • the new creditor didn't acquire the right to receive payment in the ordinary course of trading on a securities market [5] : paragraph 245-36(b).
17. Debts may also be treated as forgiven if they enter an arrangement under which the debtor's obligation will cease at a particular time, without incurring other obligations. See section 245-45. 18. The transactions described in Table 1, except for the UPE conversion, will be treated as forgiven under the assigned debt rule in section 245-36. • The first condition is met. For each transaction, the original creditor (Person C, Person D, or Person F) is assigning rights to receive payment to a new creditor (Person D, Person F, or Trust E).
• The second condition is met. Each assignment is occurring as part of an understanding or agreement between Person C, Person D, Person F. Person C is a majority unitholder in Trust B, and Person D and Person F are directors on Trust B's corporate trustee. Person D controls Trust A, and Person D and Person F together control Trust E. We think that Person C, Person D, and Person F between them are the controlling minds for all the other entities covered by this ruling (Trust A, Trust B, and Trust E). It follows that all new creditors and all debtors are parties to an 'arrangement', in the broad sense that term is used in tax legislation. • The third condition is also met: the debts are being reassigned between family members and related trusts, not through trading on a securities market. • It follows that the assigned debts will be deemed to be 'forgiven' for Division 245 purposes. • This doesn't apply to the mere conversion of Person C's UPE into the Converted Loan. Person C isn't assigning his or her UPE from Trust A to a new creditor.
19. It follows that Division 245 will potentially apply to all transactions, except: • the mere conversion of Person C's UPE into the Converted Loan, and • the assignment of Loan 2. 20. The facts don't disclose any arrangement where the parties agreed that the relevant debtors' obligations will stop without incurring additional obligations. All obligations to repay creditors are being swapped with obligations to pay the same amount to a new creditor, or the same creditor in the case of the UPE conversion. The facts say these transactions aren't part of a broader scheme or course of conduct, other than being part of Person C's estate planning goals. The parties always intended all loans to be repaid. The rule in section 245-45 therefore isn't relevant. The exceptions to the debt forgiveness rules aren't relevant. 21. There are exceptions for the debt forgiveness rules. Section 245-40 says the operative rules don't apply to debt forgiveness where the debt is: • waived, and that waiver is a fringe benefit • included in the debtor's assessable income
• forgiven under bankruptcy law, under a will, or for reasons of natural love or affection • a tax-related liability or civil penalty. 22. None of these exclusions seem relevant. The debts aren't being formally forgiven or waived - rather, they're being assigned, reassigned, or converted into another form. The facts don't suggest the transactions have any link to employment (so it's unlikely to be a fringe benefit), bankruptcy, death, or tax liabilities. Rules about calculating the debt forgiveness amount. 23. There are rules for working out forgiven debt amounts debts in subdivisions 245-C and 245-D. • Broadly, the value of the forgiven debt is determined by the debt's market value at the forgiveness time: see section 245-55. • Paragraph 245-55(1)(a) includes an assumption that the debtor is able to pay the debt, but that doesn't apply where the conditions in subsection 245-55(3) apply. It won't apply where the creditor was an Australian resident, [6] the debtor and creditor weren't dealing at arm's length in respect of incurring the debt, and the debt wasn't a moneylending debt. [7]
• If the debtor paid consideration for the debt forgiveness, that doesn't reduce the amount of the forgiven debt - see section 245-50. • However, there are rules for offsetting in section 245-65. The offsetting rules allow amounts to be 'offset' against the value of a forgiven debt, to produce the gross forgiven amount. We'll apply the offsetting rules at paragraphs 26 through 39 . • The gross forgiven amount of a debt is reduced by any offset amount under section 245-65: see section 245-75. • Gross forgiven amounts may be reduced further in subdivision 245-D to produce a 'net forgiven amount'. 24. Subdivision 245-E applies net forgiven amounts to reduce tax losses, net capital losses, specified deductions, and cost bases of CGT assets. 25. The offsetting rules in section 245-65 are about working out the amount offset against the debt when working out the gross forgiven amount of the debt. A table in subsection 245-65(1) lists 6 items, covering different circumstances. The amount offset varies depending on which item applies.
Item 5 will apply because we think the relevant parties weren't dealing with each other at arm's length. 26. Two items in the table in subsection 245-65(1) can be dismissed immediately. • Item 1 isn't relevant. One of the criteria is that the relevant debt must be a moneylending debt. Here, none of the entities covered by the ruling carry on a moneylending business, so the relevant debts can't be moneylending debts as defined. • Item 6 isn't relevant either. It applies where the debt is forgiven by subscribing for shares in a company. The assignments described in this private ruling don't involve subscribing for shares. 27. Items 2, 3, and 4 in the table only apply where Item 5 doesn't apply, so we'll address Item 5. 28. Item 5 applies where: • the debt is assigned under section 245-36, and • the debt isn't a moneylending debt, and • the creditor and new creditor weren't dealing with each other at arm's length in connection with the assignment.
29. The first and second conditions are met for all loans covered by the debt forgiveness rules. (That excludes the UPE and Loan 2.) The relevant debts have been assigned under section 245-36 - see paragraph 18. The debts aren't moneylending debts because none of the entities covered by these rulings carry on moneylending businesses. 30. The third condition in Item 5 applies where the creditor and new creditor weren't dealing with each other at arm's length in connection with the assignment. 31. Section 995-1 says that in determining whether parties deal at arm's length, you should consider any connection between them and any other relevant circumstances. 32. There's ATO guidance about whether parties are dealing with each other at arm's length. TR 2014/5 [8] (at paragraphs 97 through 104) and TR 2006/7 [9] (at paragraphs 76 through 78) state some considerations about determining whether parties are acting at arm's length. (While these rulings were about dealing with each other at arm's length for the purposes of other provisions, we think they're relevant to determining whether parties are acting at arm's length for debt forgiveness purposes.)
• Determining whether parties deal at arm's length requires assessing the way parties conducted their dealing. • That dealing must be consistent with how independent third parties would act, applying their minds and wills to the transaction. • Acting at arm's length means there must be real bargaining. • Determining whether parties deal at arm's length requires measuring what happened against an alternative hypothesis in which parties dealt at arm's length. • The dealing itself is critical, rather than the relationship between the parties. • Parties that aren't at arm's length can deal at arm's length, and parties that are at arm's length can deal in a way that isn't at arm's length. • Influence and control may suggest parties aren't dealing at arm's length, but this isn't decisive. 33. Here, we don't think the relevant creditors and new creditors are acting at arm's length for each assignment for four reasons.
• First, the assignments are between family members, to serve family objectives rather than commercial objectives. Person D is a relative of Person C, and Person F is Person D's spouse. Between them, Person C, Person D, and Person F control the relevant trusts - Trust A, Trust B, and Trust E. The parties are carrying out the proposal to allow Person C to achieve estate planning objectives. • Second, there's no evidence of bargaining between the parties. The proposal allows Person C to achieve estate planning objectives. Person D and Person F are happy to go along with the arrangement since they don't think it disadvantages them and may perhaps benefit from Person C's estate plans. They haven't negotiated. • Third, we don't think an arm's length party would have consented to this arrangement. An arm's length party outside the family would likely have demanded something in return to help Person C out with his or her estate planning objectives.
• Fourth, the assignments don't vary the original terms, which are non-commercial. The original loans are at-call loans and non-interest bearing. The new creditors won't be compensated for delayed repayment, or any risk of non-repayment. 34. The three conditions for Item 5 in the table in subsection 245-65(1) are met. Theremaining Items in that table (2, 3, and 4) aren't relevant because Item 5 applies. The offset amount under Item 5 will be equal to the face value of the debt. 35. Column 2 in the table in subsection 245-65(1) says that the amount offset for Item 5 is the market value of the debt at the time of the assignment. 36. 'Market value' isn't defined in tax legislation in a sense that's relevant to this context. [10] 37. Very broadly, ATO guidance in other contexts suggests 'market value' means the price that fully informed buyers and sellers would reach, if bargaining at arm's length. See TD 2007/1 [11] at paragraphs 12 through 14, TD 97/1 [12] , and the ATO website. [13]
38. We think the market value of the assigned loans would be equal to their face value. All assigned loans are non-interest, at-call loans. This means the new creditor can demand payment at any time. The relevant debtors are all solvent - meaning they have capacity to pay, so there's no risk of non-payment. A new creditor acting in their own interests would demand immediate payment. Therefore, the face value of the loan wouldn't need to be adjusted for risk or the time value of money. 39. It follows that for the relevant loans, the amount offset under section 245-65 will be the face value of the loan, which is equal to the forgiven amount. There won't be consequences under Division 245 because the offset amount is equal to the forgiven amount. 40. For the loans to which Division 245 applies, there will be no consequences for each assigned debt for the following reasons. • The forgiven amount under subdivision 245-C will be the face value of each assigned loan. • The offset amount under subdivision 245-C will be equal to that forgiven amount. • The gross forgiven amount will be nil - see paragraph 245-75(2)(a).
• Since there's no gross forgiven amount, the rules for working out the net forgiveness amount (in subdivision 245-D) aren't relevant. • It follows that there will be no net forgiven amount to apply against losses, deductions, or cost base under subdivision 245-E. 41. This reasoning doesn't extend to the mere conversion of Person C's UPE into the Converted Loan, and the possible assignment of Loan 2, as Division 245 doesn't apply to those transactions. Conclusion on Question 2: the commercial debt forgiveness rules won't apply. 42. There are no consequences under the commercial debt forgiveness rules in Division 245 for assigning the loans described in Table 1. Question 3 Will converting the UPE into the Converted Loan have any consequences for Trust A under Division 7A? Summary
43. No. Converting the UPE to the Converted Loan in the manner described in the facts and circumstances of this private ruling won't be a deemed dividend under Division 7A. The facts and circumstances don't disclose any private company, so there are no facts that will trigger the primary operative rules, interposed entity rules, or rules applying to unpaid trust entitlements. Explanation 44. Very broadly, Division 7A treats some transactions involving private companies and their shareholders as dividends for tax purposes. The relevant transactions are payments, loans made by, or debts forgiven by the private company, where the recipient or forgiven debtor is a shareholder (or their associate). [14] Those concepts have expanded meanings for Division 7A purposes. The private company doesn't need to be a party to a direct transaction if specific rules applying to interposed entities or trust entitlements apply. There are exceptions and qualifying rules (in subdivisions D and F) [15] which aren't immediately relevant. The primary operative rules treat payments, loans, and forgiven debts as dividends.
45. The primary operative rules apply to payments, loans, and forgiven debts. The provisions apply where: • the private company pays an amount to an entity: section 109C • the private company makes a loan to an entity: section 109D • a debt the entity owed the private company is forgiven: section 109F. 46. The transactions must relate to a shareholder or their associate. The effect of those provisions is that the payment, loan, or forgiven debt must have either: • happened when the entity was a shareholder, or an associate of a shareholder, or • a reasonable person would conclude that the relevant transaction happened because the entity was a shareholder (or associate) at some time. The primary Division 7A rules won't apply because private companies aren't parties to the transactions.
47. The primary operative rules won't apply because private companies aren't parties to any of the relevant transactions. Those rules (without considering the interposed entity rules) would only apply where the loan, payment, or forgiveness was made by a private company to a shareholder or their associate. Here, all parties to the relevant transactions are either individuals or trustees acting in their trustee capacity. They aren't private companies - if any trustees are private companies, that's irrelevant when they're acting in their trustee capacity. [16] It follows that the conditions in sections 109C, 109D, and 109F aren't met. The extended rules for interposed entities and UPEs. 48. There are also rules which extend Division 7A to other arrangements, including interposed entities and trust UPEs. We'll briefly describe them. 49. The interposed entity rules treat some payments and loans from interposed entities to shareholders (or associates) as having been made directly by the private company. To loosely paraphrase section 109T, it says Division 7A operates as if a private company made a payment or loan to a target entity, where:
• a private company made a payment or loan to an interposed entity, and • the interposed entity (or one of a chain of interposed entities) made a loan or payment to the target entity, and • a reasonable person would conclude the private company made the payment or loan as part of an arrangement involving a payment or loan to the target entity. There's a similar rule in section 109U which applies where the private company guarantees a loan by the interposed entity. Where those interposed entity rules apply, the Commissioner determines the amount of the payment or loan under sections 109V or 109W. 50. Some trust UPE transactions may have consequences under Division 7A. Broadly, section 109XA applies where: • a trustee makes a payment, loan to (or forgives a debt owed by) a shareholder of a private company (or associate of a private company) which • discharges a present entitlement from an unrealised gain, and • the private company is (or becomes) presently entitled to an amount of the trust estate's net income, which is unpaid.
51. Very broadly, there are extended rules (sections 109XF, 109XG, and 109XI) which apply section 109XA to payments, loans flowing through interposed entities, or UPEs owed to the private company through interposed trusts. Where section 109XA applies, an amount is included in the shareholder or associate's income. Applying the extended rules: the interposed entity and UPE rules won't apply because the facts don't disclose any private companies. 52. There are no facts disclosed in this private ruling application that will trigger the interposed entity rules. The proposed arrangements will assign loans between individuals and trusts to other individuals or trusts in the family group. The facts don't disclose any private companies as having made payments, loans, or guarantees to the relevant trusts or individuals in circumstances which helped them to assign the relevant loans (or converting the UPE). Therefore, circumstances stated in the facts won't allow a reasonable person to conclude that any relevant transaction was part of an arrangement that would trigger sections 109T or 109U.
53. The UPE rules won't apply to these facts for similar reasons. Trust A owes Person C a UPE, and the parties propose to discharge that UPE by converting it into a loan. But the facts don't say that Trust A, or any other interposed trust, owes a UPE to any private company. The interposed entity rules won't operate to the facts disclosed in this private ruling. Conclusion on Question 3: Division 7A won't apply on these facts. 54. Division 7A won't apply to deem a dividend on the facts disclosed in this private ruling. Question 4 Will converting the UPE into the Converted Loan have any consequences for Trust A under the CGT provisions in the Income Tax Assessment Act 1997 ? Summary 55. No. Converting the UPE into the Converted Loan won't cause a CGT event to happen in a way that will have tax consequences for Trust A. Explanation 56. Very broadly, the CGT rules calculate capital gains and losses from CGT events, which usually relate to CGT assets, and include net capital gains in assessable income. 57. There are many CGT events, but we'll describe a few potentially relevant to this scenario. See Table 3. Table 3: Relevant CGT events
Table 3: Relevant CGT events CGT event It happens when: CGT event A1 - disposing a CGT asset. Section 104-10. You dispose of a CGT asset. You dispose of a CGT asset when a change of (beneficial) ownership occurs from you to another entity. Subsections 104-10(1) and (2). CGT event C2 - cancellation, surrender, and similar endings. Section 104-25. Your ownership of an intangible [17] CGT asset ends by the asset ending in any of a list of circumstances including being released, discharged, or satisfied. Subsection 104-25(1), particularly paragraph (b). CGT event D1 - creating contractual or other rights. Section 104-35. You create a contractual right or other legal or equitable right in another entity. Subsection 104-35(1). It doesn't happen in a list of circumstances - including where you borrow money or obtain credit from another entity. Subsection 104-35(5), especially paragraph (5)(a). CGT event E6 - disposal to beneficiary to end income right. Section 104-80.
The trustee of a trust (except a unit trust or estate covered by Division 128) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's right, or part of it, to receive ordinary or statutory income from the trust. Subsection 104-80(1). 'Dispose of a CGT asset' still has the meaning given by subsection 104-10(2) - change of ownership from you to another entity. See section 995-1. CGT event H2 - receipt for event relating to a CGT asset. Section 104-155. An act, transaction, or event occurs in relation to a CGT asset that you own which doesn't result in an adjustment to the asset's cost base or reduced cost base. Subsection 104-155(1). It doesn't happen in a list of circumstances - including where you borrow money or obtain credit from another entity. Subsection 104-155(5), especially paragraph (5)(a). 58. CGT assets include property, and legal or equitable rights which aren't property. See section 108-5. Note 1 to that section lists debts owed to you or rights to enforce contractual obligations as examples of CGT assets. Applying these rules: no CGT event will happen to Trust A.
59. No CGT events will happen in a way that will have tax consequences for Trust A when the UPE is converted to the Converted Loan. • CGT event A1 isn't relevant to Trust A. The right to be paid the UPE and the Converted Loan aren't CGT assets for Trust A. Trust A never owned the right to be paid the UPE, so converting it to a loan won't change ownership. Trust A didn't own the Converted Loan before it was created either. Therefore, ownership for either CGT asset won't change from Trust A to another entity. • CGT event C2 isn't relevant to Trust A for the same reason. The UPE isn't a CGT asset for the Trust A - from Trust A's perspective, it's merely an obligation to pay Person C. Converting it to a loan won't cause Trust A's ownership of any CGT asset to end. • CGT event E6 won't happen - there's no disposal of a CGT asset from Trust A to Person C. The transaction won't involve the trustee transferring ownership of the UPE and Converted Loan to Person C - rather the UPE would end, and the Converted Loan would be created.
• CGT event D1 won't apply to Trust A. The trustee created rights in Person C to repayment of the loan debt; that's creating contractual or legal rights in another entity. But that right involved obtaining credit from Person C, so the exception in paragraph 104-35(5)(a) applies. • CGT event H2 won't apply to Trust A for the same reason. The right involved obtaining credit from Person C, so the exception in paragraph 104-155(5)(a) applies. 60. Since a CGT event won't happen in a way that will have tax consequences for Trust A when it converts Person C's UPE into the Converted Loan, it won't have a capital gain or loss. Conclusion for Question 4: there will be no CGT consequences for Trust A for converting Person C's UPE. 61. It follows that there will be no CGT consequences for Trust A as a result of converting Person C's UPE into the Converted Loan. > [1] Taxation Ruling 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities. [2] Taxation Ruling TR 2006/3
Income tax: government payments to industry to assist entities (including individuals) to continue, commence, or cease business at paragraph 85, Taxation Ruling TR 2002/7 Income tax: deductibility of payments to strike funds at paragraphs 25, and Taxation Determination TD 2016/18 Income tax: is a redemption payment received by a worker under the Return to Work Act 2014 (SA) assessable income of the worker? at paragraph 15. [3] Parsons, RW (1985) Income Taxation in Australia: Principles of Income, Deductibility, and Tax Accounting, The Law Book Company, Sydney, p. 26 [2.7]. [4] Section 995-1 says 'arrangement' means any arrangement, agreement, understanding, promise, or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) in legal proceedings. [5] More specifically, a market, exchange, or other place, or facility where offers to sell, buy, or exchange securities are made or accepted. [6] Or alternatively, forgiveness of the debt was a CGT event involving a CGT asset that was taxable Australian property. See subparagraph 245-55(3)(a)(ii). [7]
Section 995-1 says moneylending debt means a debt resulting from a loan of money in the ordinary course of a business of lending money carried on by the creditor. [8] Taxation Ruling TR 2014/5 Income tax: matrimonial property proceeding and payments of money or transfers of property by a private company to a shareholder (or their associate). [9] Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund, or a pooled superannuation trust in relation to the year of income. [10] Subdivision 960-S modifies the general meaning of 'market value' but the modifications aren't relevant here. That subdivision has rules about the effect of GST, the market value of non-cash benefits, and using methods approved by the Commissioner to determine market value. [11] Taxation Determination 2007/1 Income tax: consolidation: in working out the market value of the goodwill of each business of an entity that becomes a subsidiary member of a consolidated group, should the value of related party transactions of each business of the entity be recognised on an arm's length basis? at paragraphs 12 through 14. [12]
Taxation Determination TD 97/1 Income tax: property development: if land, originally acquired as a capital asset, is later ventured into a business of development, subdivision and sale, how is the market value of the land calculated at the time it is ventured into the business? [13] ATO (Oct 2022), 'Capital gains tax: Market valuation of assets' (QC 66067) accessed at www.ato.gov.au on 3 April 2023. [14] The shareholder doesn't necessarily need to be a current shareholder - they may have merely been a shareholder at some time. [15] Just for example, arm's length loans (section 109M), complying Div 7A loans (section 109N), or where the company has no distributable surplus (section 109Y). [16] For completeness, tax legislation treats trustees of trusts as a separate 'trust' entity for tax purposes. See section 960-100. [17] Intangible asset isn't defined, but general usage suggests an intangible asset would be an asset without a physical form. The phrase isn't listed in section 995-1. Meanings listed by the Macquarie Dictionary and the Australian Oxford Dictionary
for 'intangible' include things which can't be touched/incorporeal or immaterial things, or assets that only exist in connection with something else. See Macquarie Dictionary Publishers (2003) The Macquarie Dictionary online, accessed at https:www.macquariedictionary.com.au on 3 April 2023 (entry for 'intangible'); Oxford University Press (2004) The Australian Oxford Dictionary, 2 nd edition,accessed at https://www.oxfordreference.com on 3 April 2023 (entry for 'intangible').