The Australian Taxation Office (ATO) recently released Taxation Determination TD 2018/13 (TD 2018/13) confirming its view that the (often overlooked) interposed entity provisions in section 109T of Division 7A of the Income Tax Assessment Act 1936 can apply to ordinary commercial transactions.
The ATO released TD 2018/13 in draft as TD 2017/D3 (the Draft) in 2017 and the final Determination includes a compendium (TD 2018/13EC) that includes ATO responses to issues raised by external parties on the Draft.
The ATO view in TD 2018/13 is that a payment or loan made by a private company to another entity (the ‘first interposed entity’) in an ordinary commercial transaction can trigger Division 7A. This will be the case when the ATO considers a reasonable person would conclude (having regard to all the circumstances) that the payment or loan to the first interposed entity is made solely or mainly as part of an arrangement involving a payment or a loan to a shareholder or shareholder’s associate (the ‘target entity’) of the private company.
Under section 109T, Division 7A operates as if the private company made the payment or loan directly to the target entity.
The ATO states that a payment or loan made by a private company to the first interposed entity which results in Division 7A treating the amount as a dividend to the first interposed entity is the only kind of transaction between private company and interposed entity to which subsection 109T(1) cannot apply.
Therefore, every transaction outside this scope will require taxpayers to consider whether the reasonable person test outlined in subsection 109T(1)(b) is satisfied, regardless the loan or payment being an ordinary commercial transaction.
Regarding the reasonable person test, the ATO states:
If a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment of the section 44 dividend to the first interposed entity solely or mainly as part of an arrangement involving a payment or loan to the target entity, neither of the following factors prevents Subdivision E of Division 7A from applying:
(a) that the payment of the section 44 dividend is an ordinary commercial transaction, or
(b) that all, or some, of the amount of the payment of the section 44 dividend is included in the first interposed entity's assessable income.
Submissions on the Draft included that the Explanatory Memorandum for the introduction of Division 7A did not state that the payment of an actual dividend can enliven section 109T. The ATO response in TD 2018/13EC is that the Explanatory Memorandum stated “… that Division 7A applies to all distributions of profit 'unless they come within specified exclusions'. There is no provision that excludes (specifically or otherwise) a payment of a dividend to which section 44 applies from forming part of an arrangement to which section 109T applies.”
Furthermore, sections 109U and 109UA of Division 7A consider arrangements where a private company guarantees third party loans to a shareholder or an associate and “it would be anomalous for Parliament to have specifically recognised and dealt with schemes associated with such interposed private companies in relation to the specific arrangements under consideration therein, but not have contemplated the same schemes in relation to the general operation of section 109T.”
Submissions on the Draft also raised concerns on whether the application of section 109T would result in double taxation, as it is contrary to the purpose of Division 7A and established principles of statutory interpretation. The Commissioner’s response was “… while the reasonable person test in paragraph 109T(1)(b) requires that every case be considered having regard to its facts and circumstances, the Commissioner agrees with the general proposition that the total tax payable on the relevant amount of private company profits should be limited to the amount payable if assessed at the target entity's marginal tax rate. However, the Commissioner reserves the right to apply Division 7A on a different basis depending on the nature of the arrangement under consideration.”
Contrary to submissions that TD 2018/13 should apply prospectively from the date of issue, TD 2018/13 applies to years of income beginning both before and after its date of issue.
However, the ATO did go some way to addressing concerns in submissions on the Draft that ‘ordinary family transactions’ may be caught by section 109T. TD 2018/13 does this by including two additional examples (examples 6 and 7) where the Commissioner would reduce the amount of the deemed payment or loan (resulting from a technical application of section 109T) to nil.
The ATO views in TD 2018/13 reinforces the need for taxpayers contemplating transactions between entities within a family group to consider the application of Division 7A (and section 109T) before undertaking those transactions.
Sladen Legal’s tax team has expertise in all aspects of Division 7A including the interposed entity rules in section 109T.
To discuss this article, or for further information please contact:
Patricia Martins
Lawyer
Sladen Legal
T +61 3 9611 0138
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
E: pmartins@sladen.com.au
Neil Brydges
Special Counsel | Accredited specialist in Tax Law
Sladen Legal
M +61 407 821 157 | T +61 3 9611 0176
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
E: nbrydges@sladen.com.au
Daniel Smedley
Principal | Accredited Specialist in Tax Law
Sladen Legal
M +61 411 319 327| T +61 3 9611 0105
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia
E: dsmedley@sladen.com.au
