The use of an unrelated trust to access funds of a private company in an attempt to circumvent Division 7A
FOI status: may be released
| Taxpayer Alerts are intended to be an 'early warning' of significant new and emerging higher risk tax planning issues or arrangements that the Australian Taxation Office (ATO) has under risk assessment, or where there are recurrences of arrangements that have been previously risk assessed.
Taxpayer Alerts provide information that is in the interests of an open tax administration to taxpayers. Taxpayer Alerts are written principally for taxpayers and their advisers and they also serve to inform tax officers of new and emerging higher risk tax planning issues. Not all potential tax planning issues that the ATO has under risk assessment will be the subject of a Taxpayer Alert, and some arrangements that are the subject of a Taxpayer Alert may on further examination be found not to be of concern to the ATO. In these latter cases, the Taxpayer Alert will be withdrawn and a notification published which will be referenced to that Taxpayer Alert.
Taxpayer Alerts give the title of the issue (which may be a scheme, arrangement or particular transaction), briefly describe the issue and highlight the features which are of concern to the ATO. These issues will generally require more detailed analysis to provide the ATO view to taxpayers.
Taxpayers who have entered into or are contemplating entering into an arrangement similar to that described in this Taxpayer Alert can seek a formal determination of the ATO's position through a private ruling (noting that the Taxation Administration Act 1953 sets out circumstances where the Commissioner may decline to issue such a ruling). Such taxpayers might also contact the tax officer named in the Taxpayer Alert and/or obtain their own advice.
This Taxpayer Alert is issued under the authority of the Commissioner.
This Taxpayer Alert describes an arrangement where a private company invests funds in an unrelated trust. The trust then on lends the funds to a shareholder, or an associate of a shareholder, of the private company.
This arrangement may be an attempt by the shareholder or associate to access funds of the company without due regard to the application of Division 7A of Part III (Division 7A) of the Income Tax Assessment Act 1936 (ITAA 1936).
Context for the arrangement
Division 7A of ITAA 1936 is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders or their associates. A private company may be taken to pay a dividend to a shareholder or their associate where it directly or indirectly makes a loan to them.
This alert applies to arrangements with features that are substantially equivalent to the following:
- An organiser sets up a trust ('the trust') which purports to offer fixed rate interest yielding investments to allegedly unrelated entities.
- A private company ('the company') invests in the trust.
- The organiser (who may also be the trustee of the trust) or a licensee/franchisee of the organiser, sources borrowers ('the borrowers') to borrow funds from the trust.
- The borrowers may include a shareholder of the company that invested in the trust (or an associate of a shareholder).
- Each borrower enters into a loan agreement ('the loan') with the trust. The loan amount (or total loan amounts of all borrowers associated with the company) may be comparable to the amount the company invested in the trust.
- Terms of the loan may include:
- a range of available interest rates;
- a range of interest payment terms, including flexibility in the repayment date (provided the funds are paid sometime in the future);
- security over the loan in the form of a mortgage, personal guarantee or caveat; and/or
- the use of borrowed funds for multiple purposes, including business, investment or personal use.
- Each borrower makes interest only repayments on the loan to the trust for a substantial period of the loan.
- The trustee of the trust pays the company an interest yield on their purported investment.
- Investment and loan fees payable under the arrangement may be considered excessive.
Diagram of arrangement
The basic structure of the arrangement can be summarised diagrammatically as follows:
FEATURES WHICH CONCERN US
The ATO considers that arrangements of this type give rise to the following issues relevant to taxation laws, being whether:
- the borrowing expense incurred by the borrower (shareholder of the private company or their associate) may be deductible under section 8-1 or section 25-25 of the Income Tax Assessment Act 1997 (ITAA 1997), and the extent to which it is deductible;
- any investment fee purportedly incurred by the company is deductible under section 8-1 of the ITAA 1997 and the extent to which it is deductible;
- any fee or commission received by the trust, licensee/franchisee and/or organiser of this arrangement should be included as assessable income for the relevant income year;
- the provisions of Division 7A of the ITAA 1936 apply to the arrangement, in particular whether the arrangement results in a loan to a shareholder or their associate by virtue of the interposed entity provisions in Subdivision E;
- the general anti-avoidance provisions in Part IVA of the ITAA 1936 may apply to all or part of the arrangement; and
- any entity involved in the arrangement may be a promoter of a tax exploitation scheme for the purposes of Division 290 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953).
The ATO is currently examining these arrangements.
| Note 1:
|| You may have already sought advice from the Tax Office in respect of your arrangement by way of a private ruling. If you have received a private ruling in respect of your arrangement, you can rely on that private ruling. A private ruling is legally binding on the Commissioner who will be bound to act in the way set out in the ruling, even if the private ruling is later found to be incorrect. However, a private ruling only applies to the particular entity identified and the particular scheme described in the ruling. If there is a material difference between the scheme described in the ruling, and the scheme that was actually implemented, the private ruling will not be legally binding on the Commissioner. Also, other entities cannot rely on a private ruling issued in respect of a different entity.
| Note 2:
|| If you have received a private ruling in respect of your arrangement, please check that the application of Part IVA of the ITAA 1936 is considered in that ruling. The applicant may not have sought for us to rule on the application of Part IVA to the arrangement ruled upon, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies to your arrangement, we will first need to obtain and consider all the relevant facts about the arrangement, including (if relevant) the manner in which it has actually been implemented.
| Note 3:
|| Base penalties of up to 50% of the tax avoided can apply where Part IVA is applied. Base penalties of up to 75% of the tax avoided can apply where someone makes a false or misleading statement to the Commissioner. Reductions in base penalty will be available if the taxpayer makes a voluntary disclosure to the Tax Office. If you have any information about the current arrangement, phone us on 13 28 66. Tax agents wanting to provide information about people or companies who may be promoting arrangements covered by this alert should call us on 13 72 86 (and then key 3 and 4 for speed connection).
| Note 4:
|| Penalties of up to 5,000 penalty units for individuals, 25,000 penalty units for bodies corporate or up to twice the amount of consideration received or receivable may apply to promoters of tax exploitation schemes under Division 290 of Schedule 1 to the TAA 1953. At the time of this publication a penalty unit is $110. The Commissioner can also apply to the Federal Court of Australia for restraining and performance injunctions against promoters where prohibited conduct has occurred, is occurring or is proposed.
Date of Issue: 21 October 2010
Date of Effect: 21 October 2010
Private company loans
Income Tax Assessment Act 1936
Income Tax Assessment Act 1997
Taxation Administration Act 1953
Division 290 of Schedule 1
Related Practice Statements:
PS LA 2008/15
Acting Deputy Commissioner
|| Stefan Kovic
|| Aggressive Tax Planning
|| Technical Leadership
|| (02) 6216 6434