In Abichandani V FCT [2019] AATA 4296 (‘Abichandani’s case’), the Administrative Appeals Tribunal (‘AAT’) held that loans made by a company to its shareholders and the transfer of property to an associated entity gave rise to deemed dividends under Division 7A of the Income Tax Assessment Act 1936.
This case illustrates the danger of using a private company to conduct business activities and fund the private affairs of those that control the company (i.e., there the private and business affairs of a taxpayer are intermingled with the accounts of the private company). It is also a good reminder of the importance of preparing all necessary documentation when it comes to dealing with Division 7A, which proved to be a costly oversight for the taxpayers in this case.
Note, all legislative references in blogs relating to this topic are to the ITAA 1936 unless otherwise state.
Loans
Section 109D(1) provides that a private company (including a non-resident company) is taken to pay a dividend to an ‘entity’ if all the following requirements are satisfied:
- The private company makes a ‘loan’ to the entity during the income year and the entity is either a shareholder (or associate of a shareholder) at the time the loan is made (or a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time).
‘Loan’ is defined in S.109D(3) and, in addition to including a loan within ordinary meaning of this term, includes an advance of money, a transaction (whatever its terms or form) which in substance effects a loan of money, the provision of credit or any other form of financial accommodation, and a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount.
- The loan is not fully repaid before the ‘lodgement day’ for the income year. (‘Lodgement day’ is defined as the earlier of the due date of lodgement and the actual day of lodgement, of the company’s tax return for the income year in which the loan in question was made. It is an important concept that is often used to establish the day by which certain actions must be taken to avoid Division 7A consequences arising (e.g., a loan that is fully repaid by ‘lodgement day’ does not trigger Division 7A)).
- None of the exclusions provided for in Subdivision D prevent the private company from being taken to pay a dividend. There are a number of potential exclusions that may apply, however, the most relevant to the topic is the exclusion for commercial loans. A dividend will not arise in respect of a loan where the loan is made under a complying loan agreement. Among other things, the agreement must be in writing, be entered into by the ‘lodgement day’ and minimum interest and principal repayments must be made in respect of the loan.
If a company is taken to have paid a dividend under S.109D(1), S.109D(1AA) then provides that the amount of the dividend taken to have been paid is the amount of the loan that has not been repaid before the ‘lodgement day’ for the current year. Importantly, this amount is also capped at the level of the company’s distributable surplus, as calculated under S.109Y.