Law Australasia 2017 Richard Friend Balena Tassa Pty Ltd - - PDF document

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Richard Friend Balena Tassa Pty Ltd www.balenatassa.com.au

Law Australasia 2017

Topics

• Downsizer contributions
• CGT SB concessions: There goes the “sweet spot”
• What is carrying on a business?
• Which companies are eligible for 27.5% tax rate? What is the effect on imputation
• Divorce structuring for companies with retained earnings
• Division 7A and interposed entities: Things that “concern” the ATO
• Rental property rorts attacked
• CGT SB concessions: The problem with different share classes
• Corporate beneficiaries: Sub-trusts which end in 2018
• Family Trust Distribution Tax on benefits to non-beneficiaries
• Division 7A: Who or what is an associate?

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Contributing proceeds of downsizing to super

$300,000 outside contribution caps

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Downsizer contributions

Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No 1) Bill 2017

• Legislation will allow an individual to use the proceeds in relation to one sale of their main

residence to make contributions (downsizer contributions) of up to $300,000 to their super fund if they are 65 years of age or over

• Downsizer contributions can be made regardless of the other contributions caps and

restrictions that might apply to making voluntary contributions

• No work test
• Date of effect: The amendments apply to proceeds from contracts for the sale of a main

residence entered into (exchanged) on or after 1 July 2018

• The Bill also includes First Home Super Saver Scheme, to enable first home savers to make

voluntary contributions into the superannuation system and to withdraw those contributions and associated earnings for the purposes of purchasing their first home

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Downsizer contributions

For a contribution to qualify as a downsizer contribution, the following conditions must be met:

• The contribution is made to a complying superannuation fund in respect of you when you

are aged 65 years or over;

• The contribution is an amount equal to all or part of the capital proceeds received from the

disposal of an ownership interest (the old interest) in a dwelling

• Note: Dwelling could be part business but no apportionment of proceeds
• You or your spouse held the “old interest” just before the disposal;
• Note: Effectively, downsizer contributions can be made in respect of an individual if

they or their spouse held an ownership interest in the dwelling, whether that ownership interest was held solely, jointly or as tenants in common

• Therefore, even if property only in one name, a couple can each make up to $300,000

contribution if they would otherwise have qualified had they both been on the title

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Downsizer contributions

Conditions continued:

• Any capital gain or capital loss from the disposal of the old interest would have been

wholly or partially exempt under the main residence exemption (or would have if it had been post-CGT) Note: This includes if it would have been wholly or partially exempt through use of the absence election or any other concession in the main residence rules

• The dwelling is located in Australia, and is not a caravan, houseboat or other mobile home
• The contribution is made within 90 days, or such longer period as the Commissioner

allows, after the time the change of ownership occurs as a result of the disposal [ie 90 days after settlement, not after contract date]

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Downsizer contributions

Conditions continued:

• There is not already a contribution covered under this section, and made to a complying

superannuation plan in respect of you, from an earlier choice you made in relation to the disposal of:

• another ownership interest in the dwelling that was not a related spousal interest to the
• ld interest; or
• an ownership interest in another dwelling
• You satisfy the 10-year ownership condition [see next slide]

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Downsizer contributions

10-year ownership condition

• The condition is met if either or both of the following paragraphs applies:

(a) at all times during the 10 years ending just before the disposal: (i) the old interest was held by you, your spouse or your former spouse; or (ii) an ownership interest in the land on which the dwelling is situated was held by you, your spouse or your former spouse (b) [Special rules if original dwelling destroyed or compulsorily acquired]

• Note: For these purposes the holding period of an ownership interest is settlement to

settlement, not contract dates

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The cap

The cap is the lesser of:

• $300,000; and
• The sum of the capital proceeds from the disposals of:
• The old interest; and
• Any related spousal interest to the old interest

A related spousal interest is another ownership interest if:

• Sold at the same time; and
• Just before the disposal, you held one ownership interest and your spouse held the other

Effectively cap is on lesser of $300,000 and your share of the proceeds

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The election

• Will only qualify if you make a downsizer election
• To make the election, you must:
• Make the choice in the approved form; and
• Give the form to your superannuation provider at or before the time when the

contribution is made

• Can make multiple contributions (eg to different funds) but only in respect of one sale

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Example: Only one spouse on title

Example 2.7 – contribution for spouse that did not hold an ownership interest

• Amy has owned the dwelling that is her main residence since 2005. In 2015, her new

spouse Laze moves in with her

• Laze lives in the dwelling as his main residence from 2015
• Amy turns 65 in 2019 and decides to sell the dwelling – capital proceeds are $500,000
• Laze is also 65 at that time
• Amy chooses to make a downsizer contribution in respect of herself of $300,000 and also

in respect of Laze of $200,000

• The downsizer contributions in respect of Amy and Laze are both valid, assuming all the
• ther criteria are also met

12 November 2017 Balena Tassa Pty Ltd Law Australasia 11

Death

Example 2.5 - transfer ownership interest between spouses

• In 2015, Andrew and Tara are both 70 years old and have lived in their family home for the

40 years. The title for their home is solely in Andrew’s name.

• Andrew passes away in mid-2015. He leaves the family home to Tara
• On 1 December 2016 the title for the home formally passes to Tara, however for CGT

purposes, Tara is taken to have acquired the asset on the day Andrew died.

• Tara sells the home on 1 December 2019.
• Tara satisfies the 10 year ownership test: At all times over the period starting on 1

December 2009 and 1 December 2019, the ownership interest in the home was held by Andrew (for the first 5 and a half years) or Tara (for the last 4 and a half years).

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Making multiple contributions

Example 2.8 - making multiple contributions

• Nisha is aged 72 and has $400,000 from selling her main residence
• She makes a $200,000 downsizer contribution Super Fund 1
• She also attempts to make an additional $200,000 downsizer contribution to Super

Fund 2

• The Commissioner forms a view that the second contribution is only a downsizer

contribution to the extent it does not exceed the $300,000 cap when combined with the first contribution

• After being notified by the Commissioner, the provider assesses whether Nisha could have

made that $100,000 contribution as a non-concessional contribution

• As Nisha was employed part-time and was under 75 years old, the $100,000 is able to be

retained in the fund

• If that was not the case, the fund must refund the amount to Nisha

12 November 2017 Balena Tassa Pty Ltd Law Australasia 13

CGT SB concessions

There goes the “sweet spot”

The issue

• Assume Steve is selling shares in TechGuru Pty Ltd for $7m. For Steve to get the CGT SB

concessions:

• Steve must be an SBE for CGT purposes or he must satisfy the $6m net assets test
• But based on value of the shares he fails the $6m test
• The shares must satisfy the active asset test (assume they do)
• He must be a CGT concession stakeholder (which generally means he has to have a 20%
• r greater interest)
• For Steve to be an SBE for CGT purposes, he must
• Carry on a business in the year of the gain
• Have an aggregated turnover of less than $2m

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The issue

• Aggregated turnover includes the turnover of any business carried on by an entity

connected with Steve

• TechGuru Pty Ltd will be connected with Steve if he has at least a 40% interest
• TechGuru Pty Ltd has turnover of $30m
• Therefore, for Steve to get the CGT SB concessions:
• He starts a business in his own name which has turnover under $2m
• Ensures he has at least a 20% shareholding (so he can be a CGT concession stakeholder)

but less than 40%

• Therefore the turnover of TechGuru Pty Ltd is NOT aggregated with Steve’s own

business

• If this is the case, Steve is an SBE and is entitled to the concessions

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The ATO’s concerns

• TIA conference early 2017: ATO “has concerns” about taxpayer seeking to exploit the

“sweet spot”

• ATO have had two cases before the GAAR Panel for Part IVA where a taxpayer liked Steve

started a business in order to get the concessions:

• In one it was found there was no actual business, so therefore did not even get into Part

IVA

• The other involved significant restructuring AFTER contract date to get below 40% and

to start a business

• GAAR Panel wanted further info before making decision

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Federal Budget May 2017

Tax Integrity Package: Improving [?] the small business capital gains tax concessions

• Some taxpayers are able to access these concessions for assets which are unrelated to

their small business, for instance through arranging their affairs so that their ownership interests in larger businesses do not count towards the tests for determining eligibility for the concessions

• The Government will amend the small business capital gains tax (CGT) concessions to

ensure that the concessions can only be accessed in relation to assets used in a small business or ownership interests in a small business

• This measure will take effect from 1 July 2017

Nothing has been seen so far

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When is a company carrying on a business?

TR 2017/D7

The issue

• Concessions available for an SBE include:
• CGT SB concessions
• SBE capital allowance regime – instant write-off and pooling
• Deduction for prepayments
• Two-year amendment period instead of four
• The small business roll-over relief [relatively useless]
• In all cases, the entity needs to be carrying on a business to come within the definition of

SBE and satisfy the aggregated turnover test

• Aggregated turnover is based on the ordinary income derived in the ordinary course of

carrying on a business ($2m for CGT but $10m for the others above)

• Also, until latest proposed amendments, to get the 27.5% corporate tax rate in FY18
• nwards, the company needed to be carrying on a business

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The issue

• The changes to the company tax rate sparked discussion on what is carrying on of a

business

• Issue: Is there a lower threshold for a company to be carrying on a business than an

individual or trust?

• ATO’s original response: Whether a company is carrying on a business is a question of fact

and depends on the circumstances [which is absolutely correct]

• Government/Treasury response: Companies earning passive income do not deserve 27.5%

rate

• ATO put out draft ruling on what is a business in the context of a company for purposes of

the tax rate changes

• Treasury changes definition of entity eligible to use 27.5% and legislation introduced which

removes requirement about carrying on a business

• Ruling was supposed to be relevant to tax rate, now to be relevant to SBE generally

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TR 2017/D7: Carrying on business

• ATO views on what is needed to constitute a business are set out in TR 97/11 – and Federal

Court in Nelson’s case [2014] FCA 57 confirmed they “reflected legal principles articulated in many relevant cases in this area of law”

• Whether an entity is carrying on a business is a question of fact and circumstances
• In American Leaf Blending case the Court observed that any gainful use to which a

company puts its assets will, on its face, amount to the carrying on of a business (though this is a rebuttable presumption)

• Where a company aims to make, and has a prospect of, profit, it is presumed that the

company intends to, and does in fact, carry on a business

• However, the presumption can be rebutted if it can be shown that, on the facts, the

company had no aim or prospect of making a profit

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The issue with American Leaf Blending case

• Company was a public company which raised money from shareholders for investment in

business

• When the business failed, the company decided to rent out its buildings to provide income

for shareholders

• To use its losses to offset rental income, company needed to derive rent in the carrying on
• f a business
• Privy Council (on appeal from Malaysia) decided it was
• Company had capital to invest and had significant business infrastructure
• Contrast with $2 company with no business infrastructure and not paying dividends (eg
• perates at break even)

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TR 2017/D7: Carrying on business

Start with the indicia of a business (from TR 97/11):

• Nature of the activities and whether they have a profit-making purpose
• Whether the entity intends to carry on a business
• Whether the activities are
• Repeated and regular
• Organised in a business like manner eg keeping books and records
• The amount of capital employed in those activities
• Whether the activity is better described as a hobby or recreation

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TR 2017/D7: Carrying on business

Why is a company different to other entities?

• Where a company's activities have a significant commercial nature or purpose and are

conducted in a commercially viable manner, they are likely to amount to the carrying on of a business

• A company cannot have a personal or domestic motive – cannot have a hobby
• Though there can be cases where a company’s activities have a non-commercial nature:
• Holding land to secure beach access
• Providing social and recreation facilities for members without distributing profit
• [Owning boat without prospect of profit – see later]

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TR 2017/D7: Carrying on business

Intention to carry on business

• Whether a person has an intention to carry on a business is relevant to determining

whether a person or entity carries on a business

• It is not necessary, however, that they have an express intention to do so. The intention

may be inferred objectively from the circumstances

• Companies are typically formed for the purpose of carrying on a business
• In Westleigh and American Leaf , it was observed that a where a company aims to make

and has a prospect of profit, it is presumed that it intends to, and does in fact, carry on a business

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TR 2017/D7: Carrying on business

Repetition and regularity

• While there is a need for activity, this may be satisfied even if it is irregular or there are

periods of inactivity, or the company does nothing but receive rent on its investments

• A company that holds assets which generate ongoing returns will still be engaged in

activity sufficient to amount to the carrying on of a business, even though there is little work for it to do in managing those income-producing activities and assets

• Its activities may be limited to its ongoing management, receipt and distribution of

income and other matters of an administrative nature

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TR 2017/D7: Carrying on business

Repetition and regularity A company has been held to carry on business where its ongoing activities are relatively limited and its key activities consist of:

• letting the company's premises for rent on an ongoing basis [Leaf Blending]
• leasing its plant to its subsidiaries for no fee [but this was part of a large business with

employees and significant other related activities]

• providing secretarial, budgeting and financial services to its subsidiaries that carry on

active businesses [case re assessability of keyman insurance payout re an employee of a sub], and

• holding shares in subsidiary companies which are engaged in trading

12 November 2017 Balena Tassa Pty Ltd Law Australasia 28

TR 2017/D7: Carrying on business

Organisation of activities in a systematic and business-like manner

• Companies are formal business entities typically formed for the purpose of carrying on a

business

• A company's formal structure and the statutorily imposed requirements regarding how

they must be managed and run are a point of difference to the activities of an individual

• As a consequence, the activities of a company will, typically, be systematic, organised

and carried on in a business like manner

• They will normally support a conclusion that the activities of a company undertaken for

the purpose of making a profit will amount to carrying on a business

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TR 2017/D7 Example 1

Dormant company with retained profits

• DormCo carried on a trading business, but was wound up in FY13
• DormCo has $300,000 retained earnings in a bank account.
• In FY14 and later years, its only income is interest of less than $100 pa
• DormCo pays an annual company review fee of $254 to ASIC. The company's expenses

have been consistently greater than its interest income. As a result, the company has had no income tax liability since FY13

• It has no intention of resuming business and no objective purpose or prospect of profit
• Therefore DormCo is not carrying on a business

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TR 2017/D7 Example 3

Property investment company

• InveproCo owns a commercial property, which it rents to a third party at a market rate rent
• n normal commercial terms
• Does not engage an agent to manage the rental property and its directors find tenants
• All maintenance and inspections are carried out by its directors
• InveproCo has produced a profit each year
• InveproCo is engaged in ongoing activities that have a purpose and prospect of profit,

including letting out the property, maintaining the property and conducting inspections, collecting rent and distributing profits to its shareholders

• InveproCo carries on a business

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Issues with example 3

• What if company used an agent?
• What if the property was rented to related party (not a subsidiary) at break even?
• What if company does not itself do anything – no employees, no infrastructure?
• Without all these things, and if it is only breaking even, there would be a strong argument

against it being held to be carrying on a business

• But if it is a business, the rent is now taken into account in determining aggregated

turnover

• Note: CGT SB concessions say asset cannot be active if main use is to derive rent
• So even if there is a business, it does not get you into the CGT SB concessions on the

building

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TR 2017/D7 Example 4

Share investment company

• ShareCo holds a portfolio of listed shares worth $400,000
• The shares generate $20,000 in income a year after expenses
• ShareCo does not engage a third party to manage its portfolio of shares
• ShareCo was formed for the purpose of investing in shares with the intention of earning

income from dividends. Its portfolio was selected with this in mind

• ShareCo has applied its assets in ongoing activities that have both a purpose and a

prospect of profit. ShareCo has also invested a substantial amount of capital, and the dividend income is received by way of periodic payments

• ShareCo carries on a business

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Issues with example 4

• What if use broker with discretionary investment powers?
• If it is a business, does this mean dividends classed as turnover for aggregated turnover

definition?

• If the company is deemed to be carrying on a business then the dividends would be
• rdinary income derived in the course of carrying on that business – so yes

12 November 2017 Balena Tassa Pty Ltd Law Australasia 34

TR 2017/D7 Example 5

Corporate beneficiary

• FamCo is a beneficiary of the Pail Family Trust. It otherwise has no income or assets
• The Pail Family Trust carries on a profitable trading business and distributes $50,000 of the

trust income to FamCo. It remains as a UPE

• Possibility A - FamCo does not reinvest its UPE (therefore has a Div 7A issue)
• FamCo's income consists only of the trust entitlement. FamCo's only asset is the UPE from

the Pail Family Trust. FamCo has no entitlement to receive interest on the UPE

• FamCo has not invested its assets in any activity that has a purpose or prospect of profit
• Therefore, FamCo does not carry on a business

12 November 2017 Balena Tassa Pty Ltd Law Australasia 35

TR 2017/D7 Example 5 continued

Corporate beneficiary

• Possibility B: FamCo reinvests its UPE [ie does something in accordance with TR 2010/3 re

Div 7A]

• FamCo enters a written loan agreement on commercial terms with the trustee of the Pail

Family Trust. Under this agreement, FamCo loans the money back to the trust in return for a commercial rate of interest secured against the assets of the trust

• The interest income received is then either distributed to FamCo's shareholders by way of

annual dividends, or reinvested back in the trust by way of further loans made on the same terms under written loan agreements

• FamCo's activities consist of investing its assets in a business like way with both a purpose

and prospect of profit

• Therefore FamCo carries on a business

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TR 2017/D7 Example 5 continued

Corporate beneficiary

• Possibility C: FamCo receives trust distributions in cash
• FamCo distributes part of these distributions to its shareholders and retains the balance
• Its only assets are the part of the trust distributions it retains and holds in a bank

account, pending distribution to its shareholders. This account does not bear interest

• FamCo has not applied its assets in any activity that has a purpose or prospect of profit
• FamCo does not carry on a business

12 November 2017 Balena Tassa Pty Ltd Law Australasia 37

TR 2017/D7 Example 7

Holding company

• HoldCo owns all the shares in SBE Co, which carries on a profitable trading business in

Australia.

• HoldCo's activities consist of investing in shares in SBE Co and managing the company

group

• HoldCo's activities are carried on with a purpose and prospect of profit and reflect a normal

commercial business structure

• HoldCo carries on a business

12 November 2017 Balena Tassa Pty Ltd Law Australasia 38

Issues with example 7

• How important are the following
• HoldCo's activities consist of …managing the company group
• HoldCo's activities … reflect a normal commercial business structure
• What if Holdco has no employees and no business infrastructure?
• Is Holdco really doing anything?
• If it has no “activities” can it really be carrying on a business?
• If it is carrying on a business, dividends will prima facie be included in turnover
• Though you exclude income derived from an entity connected with you

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TR 2003/4: Charter boats

Contrast discussion in TR 2017/D7 with TR 2003/4, which notes that:

• Not everything that a company does amounts to the carrying on of a business
• For a boat charter activity carried on by a company to amount to the carrying on of a

business, it must still have the characteristics of a business

• In London Australia Investment Co Ltd v. FC of T … Jacobs J noted that '...business has in it a

notion of profit making rather than loss making...’.

• Consequently, where a company's boat hire activities lack a significant commercial

purpose and are carried on with an intention of making losses rather than profits, it is unlikely that these activities would amount to the carrying on of a business

12 November 2017 Balena Tassa Pty Ltd Law Australasia 40

Company carrying on a business

• Be careful what you wish for
• Aggregated turnover includes ordinary income derived in the ordinary course of carrying on

a business

• Based on ATO view, taxpayers will often now need to include rent, dividends and interest

in the turnover if it is derived by a company which is deemed to be carrying on a business

• Trust distributions from a discretionary trust still arguably not included as they are not
• rdinary income, but statutory income
• But interest on Div 7A loan/sub-trust is likely to be included

12 November 2017 Balena Tassa Pty Ltd Law Australasia 41

Company tax rate and imputation

Confusion reigns

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Story to date

• New 28.5% applied in FY16 to a company which was an SBE in that year
• SBE definition for FY16 required
• Company must be carrying on a business; and
• Company must satisfy $2m aggregated turnover test in either year under review or

prior year

• Maximum franking credit which can be allocated to dividends was still 30% for SBEs in

FY16

• Company tax rate for an SBE reduced for FY17 to 27.5%
• But definition of SBE in FY17 changed to refer to aggregated turnover of $10m
• Franking rules change for dividends paid during FY17

12 November 2017 Balena Tassa Pty Ltd Law Australasia 43

Government’s Enterprise Tax Plan (2016 Budget)

• From FY18 onwards, 27.5% rate to continue to apply, but to base rate entities with

different turnover thresholds

• For FY18: Aggregated turnover of less than $25m
• For FY19: Aggregated turnover of less than $50m
• Government plan for Stage 2 (rejected by Senate when initial legislation introduced):
• Turnover progressively increases to $1billion in Fy23 for base rate entities
• Then rate falls from 27.5% to 25% from Fy24 by FY27 for all companies (no business

needed)

• 2017 proposed amendments: Companies generating predominantly passive income will

not be eligible to be a base rate entity

12 November 2017 Balena Tassa Pty Ltd Law Australasia 44

Original structure of legislation

• Once a company was an SBE (ie was carrying on a business), the low rate applied to all its

income regardless of type

• EG A company may carry on a business for only 1 month at a loss, but have non-business

income for the rest of the year, and would still be subject to 27.5%

• Also a company which carried on a small business with turnover of $1m but derived non-

business investment income of $50m was still an SBE

• Issues:
• When is a company carrying on a business?
• If it is carrying on a business and satisfies the turnover threshold, is it eligible for lower

tax rate on all income?

12 November 2017 Balena Tassa Pty Ltd Law Australasia 45

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Base rate entity

• From 1 July 2017 (FY18), the rate of 27.5% will apply to a base rate entity (rather than an

SBE)

• If amendments in TLA (Enterprise Tax Plan Base Rate Entities) Bill 2017 are passed:
• An entity is base rate entity for a year of income if
• It carries on a business, and
• No more than 80% of its assessable income for the year of income is base rate entity

passive income; and

• Its aggregated turnover for the year of income, worked out as at the end of that

year, is less than $25m

12 November 2017 Balena Tassa Pty Ltd Law Australasia 46

Base rate entity

Differences arising from definition of base rate entity rather than SBE:

• A base rate entity does not have to be carrying on a business
• SBE definition looked at turnover for prior year, current year actual or current year

estimate – base rate entity is current year actual only

• A company which was a partner in an SBE partnership was not itself an SBE (s328-110(6))

but could be a base rate entity

• New concept of base rate entity passive income

But definition still uses concept of aggregated turnover from the SBE rules

• Turnover is ordinary income derived in ordinary course of carrying on a business;
• Aggregated turnover is the turnover of the taxpayer, plus any entity which is an affiliate of,
• r connected with, the taxpayer in the relevant year

12 November 2017 Balena Tassa Pty Ltd Law Australasia 47

Base rate entity passive income

Income is base rate entity passive income if it is:

• A dividend or other distribution from a corporate tax entity other than a non-portfolio

dividend

• Interest income, as defined
• A royalty
• Rent
• A capital gain
• An amount that flows through a trust or partnership to the extent that it is attributable to

an amount that is base rate entity passive income of one of the types above

12 November 2017 Balena Tassa Pty Ltd Law Australasia 48

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What is a non-portfolio dividend?

• A non-portfolio dividend (not passive income) is a dividend paid by a company in which

you have a voting interest amounting to at least 10% of the voting power of that company

• Therefore:
• Dividends from companies where you have less than a 10% interest are passive income:

Bad

• Dividends from companies where you have a 10% or greater income are not passive

income: Not bad

• Dividends from wholly owned subs (or any company where you own 10% or more) are not

base rate entity passive income

12 November 2017 Balena Tassa Pty Ltd Law Australasia 49

Interest income

For the purposes of the base rate entity passive income definition, interest is defined as

• income consisting of interest, or a payment in the nature of interest, in respect of:
• money lent, advanced or deposited; or
• credit given; or
• any other form of debt or liability;
• whether security is given or not, other than:
• interest derived by the taxpayer from a transaction directly related to the active

conduct of a trade or business [eg interest charged to debtors]; or

• interest derived by the taxpayer from carrying on a banking business or any other

business whose income is principally derived from the lending of money

12 November 2017 Balena Tassa Pty Ltd Law Australasia 50

Rent

TD 2006/78 (re “main use to derive rent” exclusion for active asset test)

• The modern conception of rent is a payment which a tenant is bound by contract to make

to his landlord for the use of the property let ie from a lease

• A key factor in determining whether an occupant of premises is a lessee is whether the
• ccupier has a right to exclusive possession
• If premises are leased to a tenant under a lease agreement granting exclusive possession,

the payments involved are likely to be rent

• If the arrangement allows the person only to enter and use the premises for certain

purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent

• Owners of motels, boarding houses, commercial storage facilities will generally not be

deriving rent

12 November 2017 Balena Tassa Pty Ltd Law Australasia 51

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Capital gains

• The amount of a capital gain which goes into the 80% calculation is the gross capital gain

before any capital losses, discounts or other concessions

• If the gross gain is more than 80% of the assessable income, the company is not a base

rate entity

• Example: Crouch Pty Ltd has gross trading income of $4m
• Crouch Pty Ltd sells its building for a $3.5m capital gain, which is eligible for the CGT SB

concessions and the taxable gain is reduced to nil

• Therefore assessable income is till $4m
• Crouch Pty Ltd is not a base rate entity because its capital gain of $3.5m is more than 80%
• f its assessable income

12 November 2017 Balena Tassa Pty Ltd Law Australasia 52

Examples: Dividends and rent

Example:

• Snap Pty Ltd owns 50% of shares in Crackle Pty Ltd as well as owning the property from

which Crackle carries on its business

• Crackle has turnover of $8m and pays a franked dividend in FY18 of $500,000 to Snap Pty

Ltd (franking credit at 27.5% $189,655)

• Snap Pty Ltd derives rent on the building of $50,000
• Snap’s total assessable income is $739,655
• The only passive income is the rent and it is less than 80% of assessable income
• Therefore Snap’s income taxed at 27.5%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 53

Examples: Dividends and rent

Variation 1:

• Snap Pty Ltd owns 20% of shares in Crackle Pty Ltd as well as owning the property from

which Crackle carries on its business

• Crackle has turnover of $30m and pays a franked dividend in FY18 of $500,000 to Snap Pty

Ltd (franking credit at 30% $214,285)

• Snap Pty Ltd derives rent on the building of $50,000
• Snap’s total assessable income is $764,286
• The only passive income is the rent and it is less than 80% of assessable income
• Therefore Snap’s income taxed at 27.5% even though it is getting dividends franked at 30%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 54

11/21/2017 19

Examples: Dividends and rent

Variation 2:

• Snap Pty Ltd owns 50% of shares in Crackle Pty Ltd as well as owning the property from

which Crackle carries on its business

• Crackle has turnover of $8m and pays franked dividend in FY18 of $5,000 to Snap Pty Ltd

(franking credit at 27.5% $1897)

• Snap Pty Ltd derives rent on the building of $50,000
• Snap’s total assessable income is $56,897
• The rent is more than 80% of assessable income
• Therefore Snap’s income taxed at 30% even though it is getting dividends franked at 27.5%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 55

What this means for imputation

Just to keep things simple

Imputation

• When the rate was reduced to 28.5% in FY16, maximum franking credit which could be

allocated to dividends was still 30% for SBEs

• But given increase in turnover threshold means more companies are eligible for lower rate

“it is not feasible to continue to operate the imputation system at the headline corporate rate of 30% for all corporate tax entities” [per EM]

• From FY17 imputation system will be based corporate tax rate for imputation purposes:
• The entity’s corporate tax rate for the income year, worked out on the assumption that

the entity’s aggregated turnover for the income year is equal to its aggregated turnover for the previous income year

• For dividends paid during FY17, they franked to 27.5% if still carrying on a business in FY17

and had aggregated turnover in FY16 of $10m or less

12 November 2017 Balena Tassa Pty Ltd Law Australasia 57

11/21/2017 20

Corporate tax rate for imputation purposes

For FY18, with the new concept of base rate entity passive income, corporate tax rate for imputation purposes to be defined as the corporate tax rate for the income year of the dividend worked out on the assumptions that:

• The entity’s aggregated turnover for the current year is equal to its aggregated turnover

for the previous year; and

• The entity’s base rate entity passive income for the current years is equal to its base rate

entity passive income for the previous year; and

• The entity’s assessable income for the current year is equal to its assessable income for the

previous year If company did not exist in prior year, the rate is 27.5%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 58

WTF does all this mean?

Examples

Eligibility and imputation

Year Company tax rate Eligibility Franking percentage if eligible FY16 28.5% SBE: Business with less than $2m aggregated turnover 30% FY17 27.5% SBE: Business with less than $10m aggregated turnover 27.5% FY18 27.5% Base rate entity with aggregated turnover less than $25m and less than 80% base rate passive entity income 27.5% FY19 27.5% Base rate entity with aggregated turnover less than $50m and less than 80% base rate passive entity income 27.5%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 60

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Implications for FY16 and FY17

FY16 returns

• If lodged company return on basis that it was not an SBE because not carrying on a

business, but TR 2017/D7 says it is a business, amend company return?

• EG Corporate beneficiaries which have UPEs earning interest go back and amend
• No impact on dividends paid in FY16 because franking was still 30%

FY17 returns

• If adopt TR 2017/D7 approach, many companies with passive income only (eg rent,

dividends or interests) eligible for 27.5%

• But, any dividends paid during the year must be franked at 27.5%

And then FY18: Companies only earning rent and interest are back to 30%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 61

ATO approach

From website (QC 48880):

• We understand that there has been some uncertainty about the “carrying on a business”

test and so we will adopt a facilitative approach to compliance in relation to the “carrying

• n a business” test for the 2016-17 year
• That is, we will not select companies, or their shareholders, for audit based on the

company’s determination of whether they were carrying on a business in the 2016-17 years….

• …. unless that decision was plainly not reasonable

12 November 2017 Balena Tassa Pty Ltd Law Australasia 62

Imputation example 1

• In FY16, Company A had aggregated turnover of $18m (ie not an SBE)
• Paid tax at 30%
• For dividends paid in FY17
• If it had $18m turnover in FY17, it would be still taxed at 30% in FY17
• Therefore corporate tax rate for imputation purposes during FY17 is 30%
• In FY17, actual turnover is $20m
• For dividends paid in FY18
• If it had $20m turnover in FY18, would be eligible for 27.5%
• Therefore, the tax rate for imputation purposes for dividends paid in FY18 is 27.5%

regardless of what turnover company actually has in FY18

12 November 2017 Balena Tassa Pty Ltd Law Australasia 63

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Imputation example 2

• Company A is carrying on business, and in FY17, has
• Aggregated turnover of $8m
• Base rate entity passive income of $7.5m
• Assessable income of $8m
• For FY17, was an SBE and paid tax at 27.5%
• While passive income was 92.59% in FY17, passive income was not a relevant concept in

that year

• Company wants to pay a dividend in FY18
• Will frank at 30% because applying FY17 figures to FY18, would fail base rate passive

income test – but this assumes it has enough franking credits

12 November 2017 Balena Tassa Pty Ltd Law Australasia 64

Imputation example 3

• Company A is carrying on business, and, in FY17, has
• Aggregated turnover of $20m (same as FY16)
• Base rate entity passive income of $7.5m
• Assessable income of $20m
• For FY17, the company was not an SBE (turnover above $10m)and paid tax at 30%
• Company wants to pay a dividend in FY18: If we assume same turnover as FY17 and same

passive income, but apply FY18 turnover threshold, tax rate for franking will be 27.5%

• If FY18 turnover actually turns out to be $30m, will pay tax at 30% on its income for the

year

12 November 2017 Balena Tassa Pty Ltd Law Australasia 65

Imputation example from EM (amending bill)

• Investment Co only derives passive dividend income: Tax rate 30%
• In Fy18 Investment Co pays $70,000 franked dividend to its 100% shareholder, Mountain

Gear Co

• Mountain Gear Co has no base rate entity passive income: Tax rate is 27.5%, but assume it

has losses and therefore has no net income

• Mountain Gear Co receives $30,000 franking credit from dividend
• Mountain Gear Co is to pay $70,000 dividend in FY19
• Franking rate in FY19, based on its FY18 income, is 27.5% - so can only frank the dividend

to $26,616

• Company has unused franking credits of $3,384

12 November 2017 Balena Tassa Pty Ltd Law Australasia 66

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Corporate beneficiaries: Scenario 1

Assume:

• Hudson Pty Ltd has a UPE of $1m owing to it from FY14
• UPE is on Div 7A terms and is therefore earning interest (and receiving annual

repayments of the UPE)

• Hudson has no other income, and only nominal expenses
• Based on TR 2017/D7 Hudson will be carrying on a business
• Hudson has aggregated turnover of $1m each year
• Hudson is paying dividends in FY16, FY17 and FY18

12 November 2017 Balena Tassa Pty Ltd Law Australasia 67

Corporate beneficiaries: Scenario 1

Year Company tax rate Franking percentage for dividends paid during the year FY16 28.5% 30% FY17 27.5% 27.5% FY18 30% [interest income only and therefore fails 80% passive test] 30%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 68

Corporate beneficiaries: Scenario 2

Assume:

• Hudson Pty Ltd has a UPE of $1m owing to it from FY14
• UPE is on Div 7A terms and is therefore earning interest (and receiving annual

repayments of the UPE)

• Hudson has no other income, and only nominal expenses
• Based on TR 2017/D7, Hudson Pty Ltd is carrying on a business
• Hudson has aggregated turnover of $5m each year
• Therefore, not an SBE in FY16, but if for FY17
• Hudson is paying dividends in FY16, FY17 and FY18

12 November 2017 Balena Tassa Pty Ltd Law Australasia 69

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Corporate beneficiaries: Scenario 2

Year Company tax rate Franking percentage for dividends paid during the year FY16 30% [not an SBE] 30% FY17 27.5% [SBE] 27.5% FY18 30% [fails 80% passive test] 30%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 70

Corporate beneficiaries: Scenario 3

Assume:

• Hudson Pty Ltd has a UPE of $1m owing to it from FY14
• UPE is on Div 7A terms and is therefore earning interest (and receiving annual

repayments of the UPE)

• Interest is $70,000 pa
• Hudson Pty Ltd has aggregated turnover of $5m each year
• Hudson Pty Ltd continues to receive trust distributions each year from the Hudso Trust
• Distribution of $100,000 of business income
• Based on TR 2017/57, Hudson Pty Ltd is an SBE in FY17
• Hudson is paying dividends in FY16, FY17 and FY18

12 November 2017 Balena Tassa Pty Ltd Law Australasia 71

Corporate beneficiaries: Scenario 3

Year Company tax rate Franking percentage for dividends paid during the year FY16 30% 30% FY17 27.5% 27.5% FY18 27.5% [passive income less than 80% of total assessable income] 27.5%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 72

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Corporate beneficiaries: Scenario 4

Assume:

• Hudson Pty Ltd has a UPE of $1m owing to it from FY14
• UPE is on Div 7A terms and is therefore earning interest (and receiving annual

repayments of the UPE)

• Interest is $70,000 pa
• Hudson Pty Ltd has aggregated turnover of $5m each year
• Hudson Pty Ltd continues to receive trust distributions each year from the Hudso Trust
• Distribution of $100,000 of business income in FY16 and Fy17
• Distribution of $10,000 business income in FY18
• Hudson is paying dividends in FY16, FY17 and FY18

12 November 2017 Balena Tassa Pty Ltd Law Australasia 73

Corporate beneficiaries: Scenario 4

Year Company tax rate Franking percentage for dividends paid during the year FY16 30% 30% FY17 27.5% 27.5% FY18 30% [passive income is more than 80% of total assessable income] 30%

12 November 2017 Balena Tassa Pty Ltd Law Australasia 74

Divorce structuring

Case studies

11/21/2017 26

Dealing with Div 7A loans and future tax

Example

• Bucket company with $5m of UPEs from trust on Div 7A terms
• On divorce, Husband is to take over the trust and the bucket company
• Husband says he has tax liability of $1.215m – top rate of tax applied to franked dividend of

$5m

• But Wife says this does not take into account time value of money and income may not

always come out to person on top tax rate

• Wife expects to be on lower rate for many years
• Consider whether Wife gets half the profits of the company?
• If company just gives Wife $2.5m she is immediately assessed under Div 7A on this $2.5m

(franked if done as part of Orders)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 76

Dealing with Div 7A loans and future tax

• Proposal: Company pays $2.5m to new trust established by Mum and she will deal with the

future tax on her share

• Payment from company to trust is deemed to be a Division 7A dividend, but is frankable
• Trust distributes the $2.5m to a new company owned by Mum (or by Mum trust)
• No tax payable as franked dividend
• Mum can then drip-feed the $2.5m out to her as dividend over time and manage the tax

rate from her side

• Or could use Div 7A loan and manage herself
• Note: If payment was made direct to a company instead of to the new trust, not a deemed

dividend and no franking

12 November 2017 Balena Tassa Pty Ltd Law Australasia 77

Splitting ownership with interposed company

Example 2

• Empire Pty Ltd, a trading company, has $10m of retained earnings but limited cash
• Empire Pty Ltd owned by trust
• Husband and Wife divorce but wish to move forward owning 50/50
• Trust could transfer shares in Empire to Wife with CGT roll-over (assuming part of Orders),

but Wife has shares in own name

• Mum does not want to own shares directly as wants to take dividends and manage tax as

suits

12 November 2017 Balena Tassa Pty Ltd Law Australasia 78

11/21/2017 27

Using roll-over to split

• Proposal: Trust transfers 50% of shares in Empire Pty Ltd to Newco 1 and 50% to Newco 2,

which are wholly owned by the Trust

• Transfer is eligible for Div 122A roll-over if the only consideration for transfer is the

issue of shares in Newco to Trust (no other tests to be met)

• Empire Pty Ltd declares $10m dividend to its new shareholders, which then lend funds

back to Empire Pty Ltd (loan interest free but has specific repayment terms)

• Court orders then transfers shares in Newco 2 to Mum – eligible for CGT roll-over
• Mum now has 50% of company with loan owing from Empire Pty Ltd and 50% of future

profits

• As Empire Pty Ltd earns future profits and pays further dividends, she has Newco as

dividend trap

12 November 2017 Balena Tassa Pty Ltd Law Australasia 79

Division 7A and interposed entities

Focus of ATO attention

The issue

• Division 7A can deem any loan or payment by a company to a shareholder, or to an

associate of a shareholder, as a dividend

• However, given that Division 7A is meant to address shareholders accessing company

profits taxed at 27.5%/30% without paying top-up tax, the amount of any deemed dividend is limited to the profits of the company

• Though for these purposes, the relevant limitation is defined as the distributable surplus of

the company which looks at the market value of all the assets of the company

• Therefore, can include unrealised profits
• But for anti-avoidance rules, a simple way to bypass Division 7A would be for a company

with a surplus to route a payment or loan through an entity which does not have a surplus

• r is not otherwise subject to Division 7A

12 November 2017 Balena Tassa Pty Ltd Law Australasia 81

11/21/2017 28

The anti-avoidance provisions: Subdivision E

Operative provision of subdivision E is section 109T, which has following key elements:

• A private company makes a loan or payment to a second entity, referred to as the

interposed entity; and

• The interposed entity makes a loan or payment to a third entity (the target); and
• A reasonable person would conclude that the two steps above are part of an arrangement

which results in the loan or payment to the target If 109T applies:

• The loan or payment to the target is effectively deemed to have come from the original

private company

• Therefore, if this private company has a distributable surplus, the loan or payment from

the interposed entity is deemed to have come from the original private company with the normal Division 7A consequences which flow from that

12 November 2017 Balena Tassa Pty Ltd Law Australasia 82

Basic example

• Basic example
• Private Coy A (which has a distributable surplus) makes a loan to Private Coy B (which

does not have a distributable surplus)

• Private Coy B makes a loan to Mr A, a shareholder of Private Coy A
• Without the operation of Subdivision E, this structure easily avoids the operation of

Division 7A which would have applied if Private Coy A had made the loan direct to Mr A

• However if a reasonable person would conclude that the two loans were all part of an
• verall arrangement to make a loan to Mr A via Coy B, then the Subdivision will apply to

deem a notional loan to have been made from Private Coy A

• Unless loan from Private Coy B is put on complying Division 7A terms (or loan is repaid by

lodgement date), there is a deemed dividend to Mr A

12 November 2017 Balena Tassa Pty Ltd Law Australasia 83

109T and timing/amounts

Subsection 109T(2): For the purposes of the application of 109T, it does not matter

• Whether the interposed entity made the payment or loan to the target entity before, after
• r at the same time as the interposed entity received the payment or loan from the private

company; or

• Whether or not the interposed entity paid or lent the target entity the same amount as the

private company paid or lent the first interposed entity However, 109T will not apply if the payment or loan to the interposed entity is itself a deemed dividend for Division 7A purposes

12 November 2017 Balena Tassa Pty Ltd Law Australasia 84

11/21/2017 29

109T and payments

• While the loan examples are relatively easy to follow, 109T can also apply whenever a

private company makes a payment to an interposed entity

• Payment is defined very broadly for Division 7A purposes and includes a transfer of

property

• While certain types of payments are excluded from being deemed dividends, that does not

stop them being payments which count under 109T

• EG A payment which meets a financial obligation and is not more than an arm’s length

amount can not be a deemed dividend, but it is still a payment for other purposes

• EG A payment which is otherwise assessable, such as an actual dividend, will not be a

deemed dividend, but can still be a payment for 109T purposes

• TD 2017/D3 recently released regarding payments which count

12 November 2017 Balena Tassa Pty Ltd Law Australasia 85

TD 2017/D3

• TD sets out a number of examples of different types of payments made by a private

company to another entity where the funds then flow to a shareholder of the company

• ATO states that the reasonable person test in 109T would apply to each of these to cause

there to be a deemed dividend

• Main purposes of TD appears to be to just show that payments can count
• There is no analysis of the reasonable person test or any of the other elements of Division

7A, particularly the provisions of Subdivision E which state how much of the payment or loan will be deemed to be a dividend

12 November 2017 Balena Tassa Pty Ltd Law Australasia 86

Example 1 from TD 2017/D3

• Private Company A has two classes of shares:
• Class A shares held by Mr A
• Class B shares being held by Private Company B
• Private Company B has no distributable surplus
• Private Company A pays a fully franked dividend of $100,000 on the B class shares ie to

Company B

• On the same day, Private Company B uses that dividend to make an interest-free loan of

$100,000 to Mr A

• Mr A does not repay the loan made by Company B by Private Company A's lodgement day

for the year of income and it is not documented as a Division 7A complying loan

• ATO says deemed dividend to Mr A

12 November 2017 Balena Tassa Pty Ltd Law Australasia 87

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Example 1 from TD 2017/D3

12 November 2017 Balena Tassa Pty Ltd Law Australasia 88

Example 1 from TD 2017/D3

Key points:

• The fact that the payment from Private Company A was an assessable dividend does not

stop section 109T being brought into consideration as a payment

• The fact that the cash flowed straight from Private Company A through Private Company B

to the shareholder makes it difficult to come to a conclusion that the reasonable person test in section 109T would not apply

• Similarly, the fact that there were two classes of shareholders and the dividend was paid to
• ne without a distributable surplus in order to route the payment to the other shareholder

is also rather “obvious”

• For the individual to avoid a deemed dividend, the loan from Private Company B would

need to be put on terms of a section 109N compliant loan (ie Div 7A loan)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 89

Example 1 from TD 2017/D3

• Query what difference it would make if:
• There were not two classes of shareholders and Private Company B was the only

shareholder;

• There was a history of dividends being paid each year to the shareholder of an

equivalent amount

• Further, what if Private Company B had made a loan to the individual prior to the dividend

being paid

• Even though 109T(2) states that this does not of itself take you out of section 109T, this

combination of facts could make it far less likely that the reasonable person test would be met

12 November 2017 Balena Tassa Pty Ltd Law Australasia 90

11/21/2017 31

Example 2 from TD 2017/D3

• Private Company C has a significant distributable surplus
• S Family Trust is the sole shareholder of Private Company C
• Beneficiaries of the S Family Trust are Mr S, a resident, and Mrs T who is a non-resident
• Private Company C pays a fully franked dividend of $100,000 to the S Family Trust
• On the same day, the S Family Trust uses that dividend to make an interest-free loan of

$100,000 to Mr S (the resident)

• On 30 June, the S Family Trust makes Mrs T (the non-resident) presently entitled to 100%
• f the trust income (the fully franked dividend of $100,000) - no tax
• Mr S does not repay the loan made by the S Family Trust by Private Company C's

lodgement day for the year of income and is it not put on section 109N complying terms

12 November 2017 Balena Tassa Pty Ltd Law Australasia 91

Example 2 from TD 2017/D3

12 November 2017 Balena Tassa Pty Ltd Law Australasia 92

Example 2 from TD 2017/D3

Key points from example 2:

• The fact that the payment from Private Company C was an assessable dividend does not

stop section 109T being brought into consideration for 109T

• The fact that the cash flowed straight from Private Company C through S Family Trust to

the Mr S makes it difficult to come to a conclusion that the reasonable man test in section 109T would not apply

• Similarly, the fact that the income was distributed to a non-resident such that there would

have effectively been no tax on the income while the cash went to Mr S is rather “obvious”

• For Mr S to avoid a deemed dividend, the loan from S Family Trust would need to be put on

a section 109N compliant loan

12 November 2017 Balena Tassa Pty Ltd Law Australasia 93

11/21/2017 32

Example 2 from TD 2017/D3

• The questions which flow from this example include whether, if the cash flow was not so
• bviously done as part of one arrangement, would that make a difference?
• More importantly, if Mrs T was a resident who was fully assessable on the distribution,

could that alter the conclusion in respect of the reasonable person test?

• Even if 109T can apply, the amount of any deemed dividend is stated to be the amount (if

any) determined by the Commissioner

• Given the purpose of Division 7A (avoiding profits emerging untaxed) if the dividend is
• therwise assessable, no amount should be a deemed dividend

12 November 2017 Balena Tassa Pty Ltd Law Australasia 94

Example 3 from TD 2017/D3

• Private Company D has a significant distributable surplus
• The H Family Trust is the sole shareholder of Private Company D
• Mrs H is a beneficiary of the H Family Trust and is the trustee of the H Unit Trust
• Private Company D subscribes for two units in the H Unit Trust and pays $50,000 for each

unit

• The H Unit Trust uses those funds to make an interest-free loan of $100,000 to Mrs H
• Mrs H does not repay the loan made by the H Unit Trust by Private Company D's

lodgement day for the year of income and it is not put on section 109N complying terms

12 November 2017 Balena Tassa Pty Ltd Law Australasia 95

Example 3 from TD 2017/D3

12 November 2017 Balena Tassa Pty Ltd Law Australasia 96

11/21/2017 33

Example 3 from TD 2017/D3

• Key points include
• A subscription for units is a payment for the purposes of section 109T
• The flow of funds makes it easy for the reasonable person test to be applied
• From the ATO’s “What’s attracting out attention”:
• We've identified cases where a private group seeks to extinguish unpaid present

entitlements (UPEs) and/or avoid obligations under Division 7A … by implementing an arrangement where a private company subscribes for units in a unit trust. The unit trust may then provide payments or loans to other entities within the private group.

• These arrangements have attracted our attention and we are concerned that they may

give rise to various income tax consequences, such as the application of Division 7A, Section 100A and/or Part IVA

12 November 2017 Balena Tassa Pty Ltd Law Australasia 97

ATO and unitisation arrangements

• This item of “concern” would reflect a basic variation of Example 3 where the funds for

Private Company D to subscribe for the units come from a trust distribution from a discretionary trust

• The consequences of TR 2010/3 regarding UPEs is avoided through the actual payment
• f the UPE to the company which then flows the payment through the unit trust as a

subscription for units, and the unit trust is making loans to related parties.

• In such circumstances, the 109T issue again is relevant if a reasonable person concludes

that that the subscription for units (being the relevant payment for 109T purposes) is made as part of an arrangement whereby the unit trust then uses those funds to make loans to related parties

• Issue also if the subscription price is greater than market value (straight Div 7A issue)
• Query difference if company already a unitholder in a unit trust which makes loans and

unitholder reinvests distributions in more units

12 November 2017 Balena Tassa Pty Ltd Law Australasia 98

Interposed entity rules and private use

• Division 7A can also apply if a company owns assets which are available for private use of

shareholders

• Example: Company A (which has a distributable surplus) makes a loan to Company B

(which does not have a distributable surplus)

• Company B uses the loan to acquire assets which are made available for the private use
• f shareholders/associates (eg cars or boats) for no payment
• Private use of the equipment would constitute a payment as defined
• But because Company B has no surplus, then subject to the operation of Subdivision E,

there would be no deemed dividend

• However, 109T has prima facie application because:
• Company A has made a loan to an interposed entity, being Company B
• Company B has made a payment to the target entities (the shareholders/associates)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 99

11/21/2017 34

Summary

• Division 7A is still high on ATO’s watch list
• In any HNW review, it will be on the agenda
• The ATO are paying particular attention to interposed entity arrangements
• Therefore need to take care in how loans and funds are routed if there are companies in

the group with distributable surpluses

12 November 2017 Balena Tassa Pty Ltd Law Australasia 100

Non-residents lose main residence exemption

From 1 July 2019

Main residence exemption for non-residents

ED for Treasury Laws Amendment (Housing Tax Integrity) Bill 2017

• Released for consultation in July - consultation period now closed
• An individual who is a non-resident at the time of selling a dwelling is not eligible for the

main residence exemption, in full or in part

• Test is at the time of the CGT event ie date of contract, not settlement
• New rules apply from 9 May 2017, except for
• If the dwelling was owned as at 9 May 2017, the exemption remains until 30 June 2019
• Exemption (or non-exemption) is based on tax residence, not citizenship
• No pro-rata exemption for people who used to be resident
• No pro-rata loss of the exemption for people who used to be non-residents

12 November 2017 Balena Tassa Pty Ltd Law Australasia 102

11/21/2017 35

Example 1: Non-resident with no exemption

• Vicki acquired main residence as a resident in September 2010 and moved in immediately
• n acquisition
• In July 2018, she moves to US and becomes a non-resident
• Australian house is rented out and then sold under contract signed on 15 October 2019

(while still a non-resident)

• Prior to the changes, Vicki would be entitled to full exemption by using the absence

election to treat the dwelling as her main residence while being rented

• Under new rules, no exemption at all
• Therefore need to determine the gain

12 November 2017 Balena Tassa Pty Ltd Law Australasia 103

Example 1 continued

• Vicki’s acquisition cost was $1.2m and sold for $1.8m
• But, for any property acquired after 20 August 1991, you can include in the cost base the

following costs to the extent they were not otherwise deductible (ie when the property was not rented):

• Interest
• Repairs
• Insurance
• Rates and land tax
• Strata levies

12 November 2017 Balena Tassa Pty Ltd Law Australasia 104

Example 1 continued

• Assume gross gain (after holding costs) is $300,000
• As she is a non-resident, she is not entitled to full CGT discount
• Discount is a pro-rata of the 50% general discount, based on number of days she was a

resident as proportion of total days of ownership period

• If she had become a non-resident before 8 May 2012 (when changes made to the discount)

special formula applies to give full discount on gain up to 8 May 2012 (provided you have a valuation)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 105

11/21/2017 36

Example 2: Former non-resident

• Amita acquired dwelling as resident on 20 February 2003 and lived there until 1 October

2007

• From 2 October 2007 until 5 March 2011, she was a non-resident and rented the property
• ut (less than 6 years, and so absence election applies)
• Moves back to Australia and property again become main residence from 6 March 2011

until 15 April 2012

• Became non-resident again from 16 April 2012 until 10 June 2017 and again rented it out
• Moved back in on 11 June 2020 (resumed residency) and sold 12 September 2020
• Full exemption available
• If she had not resumed residency, no exemption available

12 November 2017 Balena Tassa Pty Ltd Law Australasia 106

Example 3: No partial exemption either

• Terry acquired dwelling on 20 August 2010 and rented it out until 5 June 2011
• He then moved in until 17 June 2019
• He then became a non-resident and property remained vacant until contract for sale on 13

November 2019

• Without the new rules, Terry would have got a partial exemption based on period 5 June

2011 until sale

• Under new rules, whole of gain is taxable gain – no partial exemption

12 November 2017 Balena Tassa Pty Ltd Law Australasia 107

Rental property rorts

Travel and depreciation

11/21/2017 37

Changes re travel and depreciation

Treasury Laws Amendment (Housing Tax Integrity) Bill 2017

• “The amendments improve the integrity of the tax system by addressing concerns that

some taxpayers have been claiming travel deductions without correctly apportioning costs, or have claimed travel costs that were for private purposes”

• For expenses incurred on or after 1 July 2017
• Amends the ITAA 1997 to deny income tax deductions for the decline in value

[depreciation] of ‘previously used’ depreciating assets used in gaining or producing assessable income from the use of residential premises for the purposes of residential accommodation

• Applies from 1 July 2017 except for items acquired under contract before 9 May 2017
• This Bill has passed and awaits Royal Assent

12 November 2017 Balena Tassa Pty Ltd Law Australasia 109

Travel

New rule: You cannot deduct a loss or outgoing incurred, to the extent that it is related to travel, if:

• It is incurred to gain or produce assessable income from the use of residential premises as

residential accommodation; and

• It is not necessarily incurred in carrying on a business for the purpose of producing

assessable income [Examples: an entity that carries on a business of property investing or property management] New rule does not apply to:

• A company
• A superannuation fund that is not an SMSF
• A managed investment trust or public unit trust; or
• A unit trust or partnership where each member is one of the above

Non-deductible costs cannot be included in CGT cost base or as blackhole costs

12 November 2017 Balena Tassa Pty Ltd Law Australasia 110

Travel

• Residential premises definition uses GST definition: Land or a building that
• Is occupied as a residence or for residential accommodation ; or
• Is intended to be occupied, and is capable of being occupied, as a residence or for

residential accommodation

• regardless of the term of the occupation or intended occupation, and includes a

‘floating home’

• Cases in GST context have found that broadly, land or a building is residential premises if it

provides, at a minimum, shelter and basic living facilities and is either occupied by a person (the first limb) or designed for occupation (the second limb).

• Whether premises are capable of being occupied as a residence or for residential

accommodation is to be ascertained by an objective consideration of the character of the

• property. The purpose for which an entity may hold the property is not relevant

12 November 2017 Balena Tassa Pty Ltd Law Australasia 111

11/21/2017 38

Travel – per EM

• Travel expenditure includes travel for activities undertaken to gain or produce rental

income from an entity’s residential investment property, such as, but not limited to, inspecting, maintaining, or collecting rent for the property

• Travel expenditure would include motor vehicle expenses, taxi or hire car costs, airfares,

public transport costs, and any meals or accommodation related to the travel

• The travel is not restricted to travel to the property itself
• For example, travel undertaken to attend a Body Corporate meeting or to visit a

property manager to discuss the property is also not deductible

12 November 2017 Balena Tassa Pty Ltd Law Australasia 112

Business example

Example 1.3 from EM

• Mirela operates a business of leasing holiday flats in Coffs Harbour
• She undertakes various tasks such as cleaning, laundry, greeting guests and topping up

provisions on a daily basis

• Mirela uses a car to travel between the flats and her garage at home where she keeps her

equipment and stock

• Her travel expenditure is incurred in the course of carrying on a business for the purpose of

producing assessable income and therefore remains deductible

12 November 2017 Balena Tassa Pty Ltd Law Australasia 113

Mixed use business example

Example 1.4 from EM

• Anna owns multiple workshops across Australia as part of her business operations. She
• wns a two-storey brick shop-house in Melbourne. The building comprises a workshop on

the ground floor and an apartment on the first floor

• The apartment is rented out separately to a couple, Leon and Michelle. Therefore, Anna

derives assessable income from both her workshop and the apartment

• Anna travels from her home town in Canberra to her property in Melbourne for the

purpose of carrying out maintenance to the floor of the workshop. This maintenance activity is solely related to gaining or producing assessable income from the workshop

12 November 2017 Balena Tassa Pty Ltd Law Australasia 114

11/21/2017 39

Mixed use business example continued

Example 1.4 from EM

• Anna incurs airfare costs associated with this travel re the workshop
• Anna will be able to deduct her travel expenditure as it relates to gaining or producing

assessable income in the course of carrying on her business from her workshop, not from gaining or producing assessable income from the use of her apartment as residential accommodation

• Anna takes a second trip from her home town in Canberra to her property in Melbourne for

the purpose of carrying out maintenance to the wall of her apartment

• This time Anna will not be able to deduct her travel expenditure as it relates to gaining
• r producing assessable income from the use of her apartment as residential

accommodation.

12 November 2017 Balena Tassa Pty Ltd Law Australasia 115

Depreciation changes

The issue:

• Taxpayers acquire rental properties and while no amount is allocated to plant and

equipment in the contract, they claim depreciation based on QS report which does an allocation

• When sell property, no amount allocated to depreciating items and so claim loss for

balance of write-off

• New purchaser has then has QS report done and makes claims accordingly
• When new purchaser sells, no recoupment if nothing in contract

12 November 2017 Balena Tassa Pty Ltd Law Australasia 116

Depreciation changes

Legislation amends Division 40 and Subdivision 328-D (SBE depreciation) to reduce the amount of a depreciation deduction to the extent that the asset:

• Is used or installed for the purposes of gaining or producing assessable income from the

use of residential premises to provide residential accommodation; but

• Not in the course of carrying on a business

IF

• You did not own the asset (other than as trading stock) when it was first used by any entity

(ie second hand or “previously used”); or

• At any time during the year, or an earlier year, the asset was used, or installed ready for

use, either

• In residential premises that were one of your residences at the time; or
• For a purpose that was not a taxable purpose, and in a way that was not occasional

12 November 2017 Balena Tassa Pty Ltd Law Australasia 117

11/21/2017 40

Depreciation changes

New rules do not apply to:

• A company
• A superannuation fund that is not an SMSF
• A managed investment trust or public unit trust; or
• A unit trust or partnership where each member is one of the above
• Certain assets in new residential premises (see later)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 118

Example 2.1 from EM

• Craig acquired a 3yo old apartment to be rented out
• A number of depreciating assets come with the apartment, including carpet that was

installed by the previous owner

• He also acquires separately:
• Curtains, which he purchases new from Retailer Co; and
• Washing machine, that he purchases used from a friend; and
• A new fridge, but rather than place this in the apartment, he uses it to replace his

personal fridge, that he acquired a number of years ago for use in his residence. He instead places his old fridge in the new apartment

• Only item he can claim depreciation on is curtains

12 November 2017 Balena Tassa Pty Ltd Law Australasia 119

Supply of new residential premises

The amendments do not apply to an asset held by that entity that was installed in premises supplied as new residential premises (definition includes substantially renovated premises) if:

• No entity has previously been entitled to any deduction for depreciation of the asset; and
• Either:
• No-one resided in residential premises in which the asset has been used before it was

held by the current owner; or

• The asset was used or installed in new residential premises (or related real property)

that were supplied to the entity within six months of the premises becoming new residential premises, and the asset had not been used or installed in a residence before that use or installation Intention of second category s to not disadvantage buyer of a tenanted, but new, apartment See GSTR 2003/3 for discussion of new residential premises and substantial renovations

12 November 2017 Balena Tassa Pty Ltd Law Australasia 120

11/21/2017 41

Example

• Hannah purchases two apartments off the plan from Developer Co
• The apartments are supplied three months after completion – one is already tenanted

and the other is vacant

• In addition to the construction of the apartments, Developer Co has included curtains and

furniture in the deal

• Developer Co has also fitted out the common areas, installing ready for use a range of

deprecating assets that are common property

• All of these assets are new at the time of installation
• While the assets were new at the time of installation, they were first installed by Developer

Co, not Hannah, and are therefore second hand or “previously used” and ineligible under the general rules

12 November 2017 Balena Tassa Pty Ltd Law Australasia 121

Example continued

However, a deduction is still available to Hannah for the depreciating assets (including Hannah’s share of the assets in common areas) because

• The assets have been installed ready for use in premises that were supplied as new

residential premises, or in other real property supplied as part of the supply of residential premises (ie the common property);

• Developer Co has not claimed any deduction for depreciation (and nor has any other

entity);

• For assets in the tenanted apartment, the assets were only used or installed in the

apartment, which was supplied as new residential premises, within six months of the apartment first becoming residential premises;

• For assets in the vacant apartment, no entity has resided in residential premises in which

the assets have been installed before Hannah held the assets

12 November 2017 Balena Tassa Pty Ltd Law Australasia 122

The problem with different share classes

CGT SB concessions

11/21/2017 42

The issue

• The issue with the CGT SB concessions: Company needs to have individuals who are CGT

concession stakeholders if:

• Shareholders are selling shares and the shareholders want to use concessions
• Company is selling its business and wants to use CGT SB 15-year exemption or CGT SB

retirement exemption – both of them can only work if the company has CGT concession stakeholders

• If a company wants to claim CGT SB 15-year exemption, needs to have had a significant

individual for at least 15 years (where a significant individual is a subset of CGT concession stakeholders)

• Facts: Company has two (or more) classes of ordinary shares and the company has the

ability to pay dividends on one class to the exclusion of the other

• Shares otherwise have same voting rights and rights to capital/surplus on winding up

12 November 2017 Balena Tassa Pty Ltd Law Australasia 124

The issue

• For someone to be a CGT concession stakeholder, there needs to be a shareholder who has

a right to at least 20% of:

• Voting rights; and
• The right to receive any dividend the company pays; and
• The right to receive distribution of surplus on winding up

Note: You can ignore redeemable shares (ie they do not count)

• If company can pay dividends on one class of shareholders to the exclusion of another,

then there is no-one with the right to receive 20% of any dividend the company pays

• Can you fix it by changing the rights attaching to the shares so that any dividend must be

paid to all shareholders pro-rata?

12 November 2017 Balena Tassa Pty Ltd Law Australasia 125

Example

• Parrott Pty Ltd has following shares on issue
• Dad

1 Ordinary

• Mum

1 Ordinary

• Parrott Trust

2 A class shares

• A class have same voting and capital rights as Ordinary, but the company can pay

dividends on Ordinary without paying on A Class, and vice versa

• In this scenario, no-one is a CGT concession stakeholder
• Proposal: Amend Constitution so that dividends have to be paid equally on all classes (or A

class otherwise become ordinary shares)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 126

11/21/2017 43

Value shifting

• When considering amending rights attaching to shares, must consider value shifting rules,

which can trigger capital gains for shareholders who shift value to other shareholders

• For value shifting to apply, there must be (amongst other things) both:
• Some shares which go up in value (up interests); and
• Some shares which go down in value (down interests)
• If amend Parrott Pty Ltd’s constitution as proposed, you do not have up interests and down

interests – everyone is affected the same

• Ordinary could have got no dividends but now could get 50%
• A Class could have got no dividends but now could get 50%
• Therefore there should be no value shift in this situation

12 November 2017 Balena Tassa Pty Ltd Law Australasia 127

Dividend access share

• What if the A class is solely dividend only – no voting and no capital rights
• If change so that A gets equal dividends, Mum and Dad will be CGT concession

stakeholders (25% of dividends and 100% of voting and capital)

• Value shifting: Still no up or down interests and still no value shifting
• Alternative: Convert A class to redeemable shares but still same discretionary dividend

rights

• Arguably making a share redeemable does not cause the shares to go down in value
• Company could have always cancelled the shares anyway and so making them

redeemable should not decrease their value?

12 November 2017 Balena Tassa Pty Ltd Law Australasia 128

Corporate beneficiaries: Dealing with sub-trusts in 2018

PCG 2017/13

11/21/2017 44

The issue: Corporate beneficiaries

• When the Commissioner released TR 2010/3 and PS LA 2010/4, an option to avoid having

to deal with the UPE as a Division 7A loan was to have the UPE put on sub-trust and treated as a 7 year interest only loan (Option 1) – as compared to having a Division 7A loan which is repaid on an P&I basis

• Under Option 1, the terms of the sub-trust/loan had to be documented and there was a

requirement that the loan must be repayable in full at the end of the 7-year term

• For UPEs which arose in the year ended 30 June 2010, the sub-trust and loan agreement

had to be in place by 30 June 2011

• Therefore for those who took Option 1 in that year, the loan is going to be repayable by 30

June 2018

• At the time when PS LA 2010/4 was issued, questions were asked as to whether, when the

term of a sub-trust expired, the sub-trust loan could be repaid by way of a Division 7A loan – ATO had indicated “no”

12 November 2017 Balena Tassa Pty Ltd Law Australasia 130

PCG 2017/13

• The ATO has engaged in consultation on the issue which culminated with the release of

PCG 2017/3 on 19 July 2017

• What PCG 2017/3 effectively says on this matter is as follows:
• If the sub-trust loan arising from the 30 June 2010 UPE is not repaid on 30 June 2018,

the UPE becomes financial accommodation at that time (where financial accommodation is within the definition of loan for Division 7A purposes)

• Because financial accommodation is deemed to be a loan for Division 7A purposes, the

UPE has become a deemed loan from the company as at 30 June 2018

• As with any other loan from a company as at 30 June 2018, if the loan is put on section

109 compliant terms by the lodgement date of the company’s FY18 income tax return, there will be no deemed dividend

• PCG refers to 7-year loan, but in principle a 25-year loan with proper security should also

be ok

12 November 2017 Balena Tassa Pty Ltd Law Australasia 131

PCG 2017/13: Other matters

• The Commissioner will not accept that the rolling over of all or part of the investment Option 1

that is not repaid into a further investment option described in PS LA 2010/4 will prevent the provision of financial accommodation to which Division 7A may apply.

• Consequently, the approach in PS LA 2010/4 will cease in respect of existing (original) sub-

trust arrangements at the time the investment Option 1 matures

• Where the facts and circumstances indicate that there has never been an intention to repay

the principal of the loan at the end of the 7-year interest only loan, the sub-trust arrangement was not entered into in accordance with PS LA 2010/4 and this may lead the Commissioner to consider that the purported arrangement was a sham, and/or that there was fraud or evasion. In these circumstances, the Commissioner may go back beyond the standard period of review

12 November 2017 Balena Tassa Pty Ltd Law Australasia 132

11/21/2017 45

PCG 2017/13

• This appears to be stating that even if the sub-trust is converted to a Division 7A loan, if

the Commissioner was to have evidence that the sub-trust was never intended to be repaid, he could go back and deem the UPE to have been a loan back in 2011

• The situation in the PCG merely considers a situation where the taxpayers do nothing to

the UPE other than document its terms under a compliant Section 109N loan

• Alternative: Another company in a family group makes a new loan to the trust to enable

the trust to pay out the UPE on sub-trust to the original corporate beneficiary

• In this case the sub-trust loan will have actually been repaid and so no issue should arise

with the terms of the original sub-trust

• PCG only talks about the sub-trust loans due for repayment by 30 June 2018. However, the

PCG is merely stating legal principles – and as such should apply equally to other years

12 November 2017 Balena Tassa Pty Ltd Law Australasia 133

Family trust distribution tax and distributions to non- beneficiaries

TD 2017/20

The issue

• If a trust has made an Family Trust Election (FTE) or an Interposed Entity Election (IEE),

any distribution (as defined) outside of the family group of the nominated Test Individual is subject to Family Trust Distribution Tax (FTDT)

• FTDT is a tax on the trustee at top marginal rate (directors of a corporate trustee are

personally liable)

• Distribution is tax-free to recipient
• Issue: Is a person who is not a beneficiary capable of having a distribution made to them

for these purposes?

• Before 7 June 2017, Commissioner had said no
• TD 2017/20 now says yes
• ATO has separately advised that TD 2017/20 "will have no adverse impact on those trusts

being used appropriately to benefit members of the relevant family group"

12 November 2017 Balena Tassa Pty Ltd Law Australasia 135

11/21/2017 46

The legislation: Distribution

Basic definition of distribution in trust loss rules states: A trust distributes income or capital of the trust to a person if it:

• pays or credits the income or capital in the form of money to the person; or
• transfers the income or capital in the form of property to the person; or
• reinvests or otherwise deals with the income or capital on behalf of the person or in

accordance with the directions of the person; or applies the income or capital for the benefit of the person; in the person's capacity as a beneficiary of the trust Under this definition, only actual beneficiaries could ever receive a distribution But there is then an extended definition …

12 November 2017 Balena Tassa Pty Ltd Law Australasia 136

The legislation: Extended definition

A company, partnership or trust (an entity) also distributes income or capital to a person if it:

• pays (including by way of a loan) or credits money of the entity to the person, or reinvests

such money for the person; or

• transfers property of the entity to, or allows use of property of the entity by, the person; or
• deals with money or property of the entity for or on behalf of the person or as the person

directs; or

• applies money or property of the entity for the benefit of the person; or
• extinguishes, forgives, releases or waives a debt or other liability owed by the person to

the entity The amount of distribution is limited to the extent that amount or value of benefit exceeds the amount of value given in return

12 November 2017 Balena Tassa Pty Ltd Law Australasia 137

The ruling

• Where a person who is not a beneficiary receives a benefit from a transaction of a kind

described in the extended definition, that benefit is a distribution to the extent that its amount or value exceeds the amount or value of any consideration given in return

• In practice the Commissioner will infer that the amount or value of a benefit provided does

not exceed the amount of value or consideration given in return when the relevant transaction:

• Occurs on arm’s length terms; and
• Is an ordinary incident of a business being carried on by the trust

12 November 2017 Balena Tassa Pty Ltd Law Australasia 138

11/21/2017 47

Example from ruling

Example 2 from ruling: Use of holiday home

• Wonder Family Trust has made an FTE and owns a holiday home
• Home is used by friends of the test individual for no consideration
• The value of the use is a distribution
• Therefore, trustee will be assessed on that value!

12 November 2017 Balena Tassa Pty Ltd Law Australasia 139

Further examples

• Mario Trust has made an FTE with Mario as Test Individual
• Mario Trust makes an interest-free loan to Sam, a cousin of Mario
• Cousins are not members of the family group of Mario
• Therefore, as loan is not an arms’ length terms or made in the course of business, the loan

is a deemed distribution

• Trustee of Mario Trust is subject to FTDT on the amount of the loan
• Variation: Loan made on commercial terms but later forgiven at a time when Sam could

have repaid if required

• Trustee of Mario Trust is subject to FTDT on the amount of the forgiven loan
• If Sam could not have repaid, no value of the loan and no FTDT issue

12 November 2017 Balena Tassa Pty Ltd Law Australasia 140

Division 7A: Who or what is an associate?

11/21/2017 48

The issue

• Division 7A can apply when a private company:
• Makes a loan
• Makes a payment, where payment includes transfer of, or private use of, property
• Forgives debt
• But it can only apply where the entity which benefits from any of the above:
• A shareholder, or
• An associate of a shareholder
• An entity which is a former shareholder or associate and receives the benefit because

they were formerly a shareholder or associate

12 November 2017 Balena Tassa Pty Ltd Law Australasia 142

Who is an associate?

• Need to first identify who are the shareholders in the relevant company
• Shareholders are those:
• On the register of members; or
• Entitled to be on the register
• Associate rules used for Div 7A are the CFC definitions in section 318 (very complex)
• Different associate rules depending on type of entity which is the shareholder
• That is, the definition of associate differs whether the primary entity (the shareholder)

is an individual, trust or company

• So always important to be clear as to which is the relevant company and who the

shareholders are of that company

• The associates of an individual shareholder can be different from the associates of a trust

shareholder even if both of them are associates of each other

12 November 2017 Balena Tassa Pty Ltd Law Australasia 143

Who is an associate?

Associates of an individual shareholder include:

• A relative of the individual;
• A partner of the individual;
• Where a partner of the individual is another individual – the spouse or a child of that

partner

• A partnership of which the individual is a member [but not necessarily partnerships with an

associate of the individual (eg a trust) as a member]

• A trustee of a trust where the individual, or another entity that is an associate of the

individual because of another definition, benefits under the trust

• A company where a majority interest is held by the individual and/or their associates, or

which acts, or could be reasonably be expected to act, in accordance with the directions or wishes of the individual and/or their associates

12 November 2017 Balena Tassa Pty Ltd Law Australasia 144

11/21/2017 49

Who is a relative?

• Definition of relative

relative of a person means: (a) the person's spouse [which includes de facto and same sex]; or (b) the parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendent or adopted child of that person, or of that person's spouse; or (c) the spouse of a person referred to in paragraph (b)

• Key point: this is an exhaustive definition, not an inclusive definition.
• Not based on what the term relative might mean in ordinary usage
• You are only a relative for Division 7A purposes if you come within this definition
• The definition also does not include every individual that would be a member of a person’s

family for FTE purposes

12 November 2017 Balena Tassa Pty Ltd Law Australasia 145

Who is not a relative?

The following are not relatives of an individual and are therefore not associates of the relevant individual

• Cousins of the individual or of the spouse of the individual
• Great-grandparents of the individual or of the spouse of the individual
• Children of nieces and nephews of the individual or of the spouse of the individual

12 November 2017 Balena Tassa Pty Ltd Law Australasia 146

Associates of an individual

• The definition also includes partners of an individual shareholder
• The term partner would include not only partners in a general law partnership, but also
• ther entities which are tax law partners of the individual ie they are in receipt of income

jointly

• For example:
• Tommy and James are not relatives of each other
• Tommy and James acquire a rental property together
• Tommy and James are a partnership for tax purposes
• Therefore, James is an associate of Tommy for Division 7A purposes

12 November 2017 Balena Tassa Pty Ltd Law Australasia 147

11/21/2017 50

Who is an associate of a company?

Associates of a company include:

• A partner of the company
• A partnership in which the company is a partner
• A trust where the company benefits under the trust
• An entity in respect of whose directions, instructions or wishes the company, or its

directors, are accustomed to act or could reasonably be expected to act

• An entity that has a greater than 50% right to the votes that might be cast at a general

meeting of the company

12 November 2017 Balena Tassa Pty Ltd Law Australasia 148

Who is an associate of a trust?

• Associates of a trust include:
• Any entity that benefits under the trust
• If a natural person benefits under the trust – any entity that, if the natural person were

the test entity, would be an associate of that person because of the definition of associates of individuals

• If a company benefits under the trust, or is an associate of a natural person who

benefits under the trust- any entity that would be an associate of the company under the definition of associates of a company

• An entity benefits under a trust if the entity is capable – whether by the exercise of a power
• f appointment or otherwise – of benefiting under the trust either directly or through any

interposed companies, partnerships or trusts

• There is no minimum % interest – if capable, that is enough

12 November 2017 Balena Tassa Pty Ltd Law Australasia 149

General example: Other discretionary trusts

• Minder Trust has pre-2009 UPE owing to Flash Pty Ltd.
• Shareholders of Flash Pty Ltd and Jack and Jill Flash
• Minder Trust makes loan to Tricky Trust
• Is Tricky Trust an associate of Jack or Jill (so apply the definition of associate as it relates to

individuals?)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 150

11/21/2017 51

General example: Other discretionary trusts

Tricky Trust will be an associate of Jack and Jill Flash if either:

• Jack Flash is a potential beneficiary of Tricky Trust.
• If Jill Flash is a potential beneficiary of Tricky Trust.
• If any relative of Jack or Jill is a potential beneficiary of Tricky Trust
• In this case, the trust is an associate of Jack or Jill, because an associate of Jack or Jill,

being one of their relatives, is capable of benefiting under the trust

• If any company in which either of them has a greater than 50% interest is a potential

beneficiary

• In this case, Tricky Trust is an associate of the individuals, because the company, which

is an associate of theirs, is capable of benefiting under the trust

12 November 2017 Balena Tassa Pty Ltd Law Australasia 151

Unit trust example

• Assume
• Fox Pty Ltd owns 100% of the units in Sam Unit Trust
• The shareholders in Fox Pty Ltd are John and Janet Fox
• Fox Pty Ltd makes a loan to Sam Unit Trust
• Is the loan a loan to an associate of the shareholders of Fox Pty Ltd?
• The issue is whether Sam Unit Trust is an associate of John or Janet Fox
• The Sam Unit Trust will be an associate of John or Janet if they are capable of benefiting,

directly or indirectly, under the Sam Unit Trust

• On these facts, Sam Unit Trust distributes to Fox Pty Ltd and John and Janet are the

shareholders of Fox Pty Ltd

• Therefore the individuals are capable of benefiting indirectly from Sam Unit Trust
• As such, the unit trust is an associate of the shareholders of the company

12 November 2017 Balena Tassa Pty Ltd Law Australasia 152

Unit trust example: Variation

• What difference would it make if Fox Family Trust owned the shares in Fox Pty Ltd (ie not

the individuals)?

• The question is whether Sam Unit Trust is an associate of Fox Family Trust
• Is Sam Unit Trust capable of benefiting under the Fox Family Trust?
• This will require a review of the trust deed for the Fox Family Trust.
• Under many modern deeds, this is likely to be the case – but not necessarily
• Even if Sam Unit Trust is not capable of benefiting under FFT, if an individual is capable of

benefiting under FFT and Sam is an associate of the individual, Sam is an associate of FFT

12 November 2017 Balena Tassa Pty Ltd Law Australasia 153

11/21/2017 52

Unit trusts and unrelated parties

Example

• A group of unrelated individuals set up a unit trust to acquire an investment property in

which they will jointly invest

• There are 25 unitholders each with a 4% interest
• Each unitholder will provide funds by way of a subscription for units as well as a loan to the

unit trust

• The unitholders include both companies and discretionary trusts

Will Division 7A have application to the debt funding of the unit trust by the companies and/or the discretionary trusts?

12 November 2017 Balena Tassa Pty Ltd Law Australasia 154

Company unitholders

• In respect of any company making a loan to the unit trust, the question is whether the unit

trust is an associate of a shareholder of the company

• If the shareholders of the company are individuals, the unit trust will be an associate of the

individuals because the individuals are capable of benefiting under the trust (indirectly via their company unitholder)

• Therefore Division 7A has prima facie application to the loans from the companies with

individual shareholders, even though they may only be 4% unitholders

• If the company is owned by a discretionary trust, the unit trust will be an associate of that

shareholder if the unit trust is capable of being a beneficiary of that discretionary trust shareholder – which again depends on the deed for the shareholder trust

• In any case, if company is an eligible beneficiary of the discretionary trust then because

it capable of benefiting under the Unit Trust, the Unit Trust is an associate of the family trust

12 November 2017 Balena Tassa Pty Ltd Law Australasia 155

Discretionary trust unitholders

• Where the unitholder is a discretionary trust, Division 7A can apply via Subdivision EA if

that trust has a UPE owing to a corporate beneficiary

• Where a trust has such a UPE owing to a corporate beneficiary, Division 7A can apply to the

loan made to the unit trust if:

• The shareholders of the corporate beneficiary are individuals; or
• The shareholder of the corporate beneficiary is a discretionary trust and the unit trust is

capable of benefiting directly or indirectly from the discretionary trust

• While this would necessitate the identification of the shareholders of the corporate

beneficiary and whether they are also potential beneficiaries of the discretionary trust unitholder, in most family situations, this would be the case

• Therefore, the debt funding from discretionary trust unitholders which have UPEs owing

to corporate beneficiaries is also likely to be subject to Division 7A

12 November 2017 Balena Tassa Pty Ltd Law Australasia 156

11/21/2017 53

The issue

• While it is clear that Division 7A would apply in these circumstances, it is illustrative of the

unwarranted breadth of the provisions as they can apply to normal commercial situations

• That is the unit trust can be assessed on a deemed dividend in respect of its debt funding

from a group of unrelated unitholders to the extent those unitholders are companies, or trusts with UPEs owing to corporate beneficiaries and the unit trust comes within the broad definition of associate as set out in the previous slides

• Note: There is no discretion for the Commissioner not to apply Division 7A in this case

12 November 2017 Balena Tassa Pty Ltd Law Australasia 157

Partnership as borrower

• Issues can arise when loans are made to partnerships by a company (or by a trust which has

a UPE owing to a company)

• While for common law purposes a partnership is not a legal entity, it is deemed to be a

separate entity for tax purposes

• If a company makes a loan to a partnership, is that loan deemed to be to each partner or

to the partnership?

• It is submitted that in the context of the application of Division 7A, and the operation of

the Tax Act generally, the loan is considered to be a loan to the partnership (as a deemed entity)

• This is consistent with the treatment by the Commissioner of loans made by

partnerships of which one or more members is a company

12 November 2017 Balena Tassa Pty Ltd Law Australasia 158

Partnership as borrower

Question: Is the partnership an associate of the company’s shareholders?

• If the shareholders of the company are one or more individuals, the partnership will be an

associate of a shareholder if the individual is a partner in the partnership

• But what if the partnership is a partnership of trusts?
• Nothing in the definition of associate in respect to individuals deems a partnership to

be an associate of the individual unless the individual personally is a member of the partnership

• On this basis, the partnership would not be an associate of an individual shareholder of the

company and therefore Division 7A should not apply to the loan

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Partnership as borrower

Alternative: Assume the shareholder of company is a trust

• The partnership is an associate of the trust if the partnership is capable of benefiting under

the trust.

• A review of most trusts deeds would find that they do not contemplate partnerships as

potential beneficiaries

• Therefore, as the partnership is an entity for tax purposes, and assuming that the correct

approach is to consider the partnership as the borrower, the partnership will not be an associate of the shareholder

• Therefore Division 7A could not apply to that loan

12 November 2017 Balena Tassa Pty Ltd Law Australasia 160

Partnership as borrower

• On the other hand, where the shareholder of the company lender is a trust, and the

partnership borrower includes individuals who are capable of benefiting under the trust, the partnership would be an associate of a shareholder

• This is because:
• The partnership itself is an associate of any individual partner in that partnership; and
• The second element of the definition of associate of a trust includes, where an

individual is a possible beneficiary of the trust, any other entity which is deemed to be an associate of that individual (being the partnership in this case)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 161

Former shareholders: Marital breakdown

• Definition of an associate of an individual includes any relative of that individual, which in

turn includes spouses

• However a reference to the spouse of a person does not include:
• a spouse who is legally married to the person but living separately and apart from the

person on a permanent basis

• In a divorce or marital breakdown situation, a loan to a spouse or a former spouse is often

an issue to be dealt with

• Example:
• DD Pty Ltd is 100% owned by Dick. Dick is married to Dora.
• Dick and Dora separate and as part of a property settlement, DD Pty Ltd is to transfer a

property it owns to Dora.

• Will Dora be subject to tax on the value of the property as a deemed dividend?

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Former shareholders: Marital breakdown

• Assume at the time of the transfer Dora is either no longer married to Dick or is living

separately and apart from him on a permanent basis

• Therefore, she is no longer a spouse of Dick and is not an associate of any shareholder
• Does that mean that there will be no deemed dividend to Dora on the transfer of the

property?

• The application of Division 7A is not limited to payments to shareholders and associates of
• shareholders. It can also apply to a payment made to an entity where
• a reasonable person would conclude (having regard to all the circumstances) that the

payment is made because the entity has been such a shareholder or associate at some time.

• Commissioner’s view is that Division 7A can apply in this situation (TD 2008/14)

12 November 2017 Balena Tassa Pty Ltd Law Australasia 163

Combined example: Individual shareholders

• Poulos Properties Pty Ltd is a successful property development company. It has two

shareholders, George and Irene Poulos.

• A review of the balance sheet of the company shows the following loans (assets) all used

by the borrowers to acquire rental properties:

• 1. Loan to Alex Vallis (Irene’s cousin)
• 2. Loan to partnership of Poulos Family Trust and Vallis Family Trust
• 3. Loan to partnership of George and Irene, along with Irene’s sister Maria Conias and her

husband Nick

• 4. Loan to partnership Poulos Family Trust (50%) and Alex and his wife Christine (25%

each)

• 5. Loan to unit trust in which PFT is a 5% unitholder – all other unitholders unrelated

12 November 2017 Balena Tassa Pty Ltd Law Australasia 164

Analysis: Shareholders are individuals

1. Loan to Alex: A cousin is not a relative. Therefore Division 7A has no application to the loan to Alex.

• Note: If Alex happened to be in any partnership with either George or Irene personally,

he would be deemed to be an associate regardless.

• 2. Loan to partnership of trusts: A partnership can only be an associate of an individual if

that individual is a member of the partnership. Therefore Division 7A has no application to the loan to the partnership of two trusts

• 3. Partnership including individual shareholders: As both the individual shareholders are

member of this partnership, the partnership is an associate of the shareholders and Division 7A has prima facie application to this loan

• 4. Partnership of trust and cousin: Because neither shareholder is a partner in this

partnership, this loan is not a loan to an associate of a shareholder

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Analysis: Shareholders are individuals

5: The unit trust will be an associate of George and/or Irene if they are capable of benefiting under the trust, either directly or through any interposed companies, partnerships or trusts In this case, assuming either of them can benefit under the terms of the Poulos Family Trust (being the unitholder in the unit trust), they are capable of benefiting indirectly under the unit trust and so the unit trust is an associate of theirs

12 November 2017 Balena Tassa Pty Ltd Law Australasia 166

Variation: Trust shareholder

Assume shareholder of Poulos Properties Pty Ltd is Georene Trust where George and Irene are primary beneficiaries 1. Loan to cousin: A review of the trust deed of the Georene Family Trust would be required to determine if a cousin of a primary beneficiary was capable of benefiting under the

• trust. If so, the loan to Alex would be prima facie subject to Division 7A
• 2. Loan to partnership of trusts: If this loan is to the partnership as an entity, the first

question is whether the partnership is an eligible beneficiary in its own right

• If not, the partnership could still be an associate if the partnership would be an

associate of any individual or corporate beneficiary of the trust

• This partnership of trusts would not come within the definition of associate of an

individual or of a company

12 November 2017 Balena Tassa Pty Ltd Law Australasia 167

Variation: Trust shareholder

3: Loan to partnership of individuals: While there is the same issue as with 2 as to whether the partnership itself can benefit, there is the separate issue that an associate of the trust will include any partnership of which any individual beneficiary of the trust is a partner Accordingly, this partnership would be an associate of the shareholder trust and as such Division 7A would have prima facie application 4: Loan to partnership of trust and cousin: The issue with this loan is that if Alex (as a cousin) is an eligible beneficiary of the Georene Family Trust, this partnership will be an associate of a shareholder for the same reason as in 3 above.

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Variation: Trust shareholder

5: Unit trust

• Is it capable of benefiting under the terms of the Georene Family Trust. This will depend
• n how broadly defined the beneficiary clause is in the Georene Family Trust
• However, if the unit trust is regarded as an associate of any individual who is a

beneficiary of Georene Family Trust, this could also bring the unit trust into the definition of associate

• In this case, as George and Irene are capable of benefiting, indirectly under the unit

trust, the unit trust is an associate of theirs

• This in turn will make the unit trust an associate of Georene Family Trust such that this

loan from Poulos Properties Pty Ltd will be brought into the Division 7A net

12 November 2017 Balena Tassa Pty Ltd Law Australasia 169

Questions