\n<\/p>\n
In the recent decision in <\/span>Ierna v Commissioner of Taxation [2024] FCA\u00a0592<\/em> (Ierna), <\/span>Logan J considered the application of the definition of \u2018associate\u2019 for the purposes of section 318 of the Income Tax Assessment Act 1936 (\u2018<\/span>the 1936 Act<\/span>).<\/span>
\n<\/p>\n Whilst not a deciding factor in the outcome of the case, the preferred interpretation of the said rules by Logan J was that an \u2018associate\u2019, in relation to trusts, applies only to a trustee \u2013 not the trust.\u00a0\u00a0<\/span>
\n<\/p>\n That is, under this interpretation, the transactions, assets etc of an entity in the capacity of a trustee of an estate or trust, should not be aggregated with that of a primary entity for the purposes of the respective provisions of the 1936 Act and the Income Tax Assessment Act 1997 (\u2018<\/span>the 1997 Act\u2019<\/span>).<\/span>
\n<\/p>\n What does this mean in the context of Division 7A of the 1936 Act?<\/span>
\n<\/p>\n Ierna<\/strong>
\n<\/p>\n In <\/span>Ierna<\/span>, the decision by Logan J was favourable to the taxpayer.<\/span>
\n<\/p>\n Broadly, the case involved a corporate restructure that was undertaken in 2016 by way of the interposition of a company over a unit trust structure in accordance with Division 615 of the 1997 Act.\u00a0\u00a0<\/span>
\n<\/p>\n The Commissioner argued, that as a result of the restructure, there was the following application of the respective provisions:<\/span>
\n<\/p>\n The taxpayers received a capital benefit that was subject to taxation pursuant to section 45B of the 1936 Act; or<\/span>
\n<\/p>\n<\/li>\n
<\/p>\n (in the alternative) the taxpayers received a tax benefit arising in connection with a scheme pursuant to Part IVA of the 1936 Act.<\/span>
\n<\/p>\n<\/li>\n
\n<\/ul>\n In relation to the application of section 45B of the 1936 Act, the Court rejected the Commissioner\u2019s argument. This was because there was no pattern of distributions of dividends, bonus shares and returns of capital, or share premium on the part of the original trust or its associated entities.\u00a0 This consideration included that of the financial dealings of the interposed entity which had a balance sheet consisting only of an asset (the investment rolled over from the trust) and share capital (the shares held by the previous unit holders).<\/span>
\n<\/p>\n With respect to the application of Part IVA, the Court held that a theoretical possibility is not sufficient and that \u2018what is necessary is a prediction based on evidence.\u2019\u00a0<\/span>
\n<\/p>\n The Court relevantly made the following findings:<\/span>
\n<\/p>\n The Commissioner did not identify a basis on which the Applicants would have been able to fund the Division 7A loans required by his alternate postulate; and<\/span>
\n<\/p>\n<\/li>\n
<\/p>\n The entities that might have provided the funding for any repayment of the loans were required to meet the significant ongoing demands for cash in the business.<\/span>
\n<\/p>\n<\/li>\n
\n<\/ul>\n The question of what is an \u2018associate\u2019 trust?\u00a0<\/strong>
\n<\/p>\n Logan J considers the definition of \u2018associate\u2019 at paragraphs 183-185 in the decision.<\/span>
\n<\/p>\n At 183 he states as follows:\u00a0<\/span>
\n<\/p>\n The point was made for the applicants that a trust has no separate legal personality. This is fundamental. A \u201ctrust\u201d may be described as obligations, enforceable in a court of equity, assumed by a person having legal personality in respect of property or income (or both). The absence of legal personality of a trust is so even though, for the purposes of income taxation, the net income of a trust\u00a0estate\u00a0is treated as if a trust did have legal personality separate from the person who was subject to the relevant trust\u00a0obligation.\u00a0<\/span>From this,\u00a0it was said to follow that,\u00a0although a\u00a0trustee, individual or corporate, of a trust may,\u00a0under s 318,\u00a0be\u00a0such\u00a0an \u201cassociate\u201d,\u00a0the same would not be true for\u00a0a trust itself.<\/span>\u00a0On that construction, <\/span>a unit holder in the CBT might be an \u201cassociate\u201d of a \u201cprimary entity\u201d, which may include a trustee of a trust, but not of a trust.<\/span>
\n<\/p>\n At 184 it is stated:\u00a0<\/span>
\n<\/p>\n The Commissioner\u2019s riposte\u00a0was\u00a0that, in construing s 318, <\/span>a rule of necessity operated\u00a0such<\/span>\u00a0that\u00a0the role of \u201cassociate\u201d was attached to the trustee of the trust in its capacity as such.\u00a0<\/span>This was said to arise by implication such that<\/span>, materially, the \u201cprofit\u201d of a trust was to be regarded as the profit of its trustee.<\/span>
\n<\/p>\n At 185, Logan J summarises as follows:<\/span>
\n<\/p>\n A difficulty with\u00a0any such implication\u00a0is that the text of s 318 draws a distinction between a trustee of a trust and the trust: see s 318(2)(c).\u00a0Moreover,\u00a0and\u00a0further to develop a point\u00a0earlier made as to the taxation of trusts,\u00a0the\u00a0ITAA 1936, by s 96,\u00a0expressly provides that, \u201cExcept as provided in this Act, a trustee shall not be liable as trustee to pay income tax upon the income of the trust estate.\u201d The presence of that expressly stated general position, and the exception to it, suggests that it is unlikely that an exception was intended to arise by implication.<\/span>\u00a0\u00a0<\/span>
\n<\/p>\n \u2026\u2026\u2026.<\/span>I do\u2026\u2026record my preference, for the reasons just given, for the construction promoted by the applicants.<\/span>
\n<\/p>\n That is, the associate rule as defined in section 318 of the 1936 Act only extends to the trustee, not the trust.<\/span>
\n<\/p>\n What are the implications for Division 7A?\u00a0<\/strong>
\n<\/p>\n Whilst the \u2018associate\u2019 rule pervades through respective legislation in both the 1936 and 1997 Acts, it has particular prominence with respect to the \u2018Thin Capitalisation\u2019 rules and that as applied in Division 7A of the 1936 Act.<\/span>
\n<\/p>\n For Division 7A purposes, by way of example, the accepted general position is that a loan provided by a corporate entity to an associate of a shareholder, should be subject to the complying loan rules, if the loan itself is not settled prior to the lodgement day of the company for that respective year of taxation. As such, in the instance the loan is made to the trustee of a trust, the trustee would be required to enter a section 109N loan agreement to avoid a deemed dividend for that year of tax for the sum of the loan.<\/span>
\n<\/p>\n However, under the interpretation made by Logan J there are potential alternative outcomes.\u00a0\u00a0<\/span>
\n<\/p>\n On the basis that the trust is not an associate, a loan provided by a company to a trust and is not passed on by way of payment or a further loan to another associated entity (unless itself is a trust), should not, on the basis of Logan J\u2019s preferred interpretation, give rise to the application of the Division 7A complying loan rules.<\/span>
\n<\/p>\n This could enable certain advantages to be realised.\u00a0<\/span>
\n<\/p>\n For example, the use of the trust as the recipient of a loan without the strict compliance measure of Division 7A (particularly with regard to capital re-payments) may enable more efficient wealth creation than what otherwise might be the case.\u00a0 Income distributions from a family trust realised from such investments may give rise to further material advantages for beneficiaries.\u00a0\u00a0<\/span>
\n<\/p>\n Note that a loan from a private company to a trust which is on-lent to a shareholder or an associate of a shareholder that is not a trust, is likely to be subject to Division 7A in the context of the interposed entity rules in section 109E of the 1936 Act.<\/span>
\n<\/p>\n Further ramifications of the preferred interpretation made by Logan J arise in the context of unpaid present entitlements (UPE) and the potential application of Division 7A (Subdivision EA and EB) to such arrangements.\u00a0\u00a0<\/span>
\n<\/p>\n That is, where a trustee makes a loan or payment of a UPE to a shareholder of a company that is a beneficiary of the said trust (that is, the trust is not therefore an associate of a shareholder of a private company under the Logan J scenario), can there be an application of the Division 7A rules as applied to UPE\u2019s?\u00a0<\/span>
\n<\/p>\n Such consideration may fall to the ATO in the context of Taxation Determination TD 2022\/11 and perhaps to the circumstances as provided for in <\/span>Bendel and Commissioner of Taxation [2023] AATA 3074.<\/span>
\n<\/p>\n Summary<\/strong>
\n<\/p>\n All of the above is based on an interesting interpretation as provided by Logan J and considered in the strict context of Division 7A of the 1936 Act.\u00a0\u00a0<\/span>
\n<\/p>\n Ierna is subject to appeal.\u00a0 The Full Federal Court may not consider the interpretation of Logan J in relation to an \u2018associate\u2019 and determine the material matters of the case only (section 45 B and Part IVA of the 1936 Act).<\/span>
\n<\/p>\n Nevertheless, the continuing story of Division 7A continues its permutations.\u00a0\u00a0<\/span>
\n<\/p>\n Phillip London, senior tax trainer, Tax Banter\u00a0<\/em><\/span><\/p>\n<\/div>\n
<\/p>\n
<\/p>\n