There are a number of tax and stamp duty implications which can arise following the death of an individual, where that individual held interests in related entities.
One scenario we encountered recently involved a loan which had been made by a private company to an individual shareholder, who subsequently died.
As many readers would be aware, division 7A of the Income Tax Assessment Act 1936 (Cth) (Tax Act 1936) sets out the consequences of a private company making payments or lending money to a shareholder or associate of the company.
In broad terms, where a private company with a distributable surplus makes a payment or lends money to a shareholder or their associate, section 109C Tax Act 1936 deems the payment to be an unfranked dividend.
Division 7A contains an exception to the deemed dividend rule where a company lends money to the shareholder or its associate and the loan complies with the terms set out in section 109N Tax Act 1936, including requiring minimal annual interest and principal repayments to be made.
Where the loan is made to a shareholder who has subsequently passed away, it is not uncommon for the shareholder’s legal personal representatives (LPR) to miss one or more of the minimum repayments required under section 109N.
This may be because the LPR does not become aware of the Division 7A arrangement in time to make the necessary repayment or alternatively because the estate does not have sufficient liquidity to allow the minimum repayment to be met.
Section 109E provides that where a debtor has failed to make a minimum repayment on their Division 7A loan, a deemed dividend arises for an amount equal to the shortfall.
However, section 109E refers to the ‘entity’ to whom the loan was made, being the same ‘entity’, which fails to make the minimum repayment.
Where an individual borrower has died, that deceased individual is the ‘entity’ to whom the loan was made while their LPR is the ‘entity’ who has failed to make the minimum repayment.
This disparity means that section 109E cannot apply to trigger a deemed dividend in circumstances where the LPR has failed to make a minimum repayment.
The Tax Office acknowledged this position in ATO Interpretative Decision 2002/741 (ATO ID 2002/741).
The facts in ATO ID 2002/741 were as follows:
‘Under a written agreement entered into in the income year ended 30 June 1998 by the private company and one of its shareholders, the private company made a loan to that shareholder.
The written agreement met the criteria concerning minimum interest rate and maximum term contained in section 109N of the ITAA 1936.
The loan is an amalgamated loan for the purposes of subsection 109E(3) of the ITAA 1936.
The shareholder died during the income year ended 30 June 1999, before any repayments were due to be made under the agreement.
No repayments in relation to the loan were made in the 1998 to 2001 income years be either the shareholder or the executor of his deceased estate.’
The issue and decision of the Tax Office in ATO ID 2002/741 were:
‘Issue: Is a private company taken, under section 109E of the ITAA 1936, to have paid a dividend to the taxpayer, the executor of the deceased estate of a shareholder in the company, in respect of a loan the company made to the shareholder before he died?
Decision: No. The private company is not taken to have paid a dividend to the taxpayer, the executor of the deceased estate of the shareholder.’
In its explanation for the decision, the Tax Office states:
‘The entity to whom the private company is taken to have paid the dividend must be the same entity to whom the private company made the amalgamated loan.
For subsection 109E(1) of the ITAA 1936 to apply, the private company must have made the loan to the executor of the deceased estate.
Accordingly, as the private company made the loan to the shareholder, the executor of the shareholder’s deceased estate is not treated as having received a deemed dividend in respect of the amalgamated loan.’
This means that where an LPR is unable or unwilling to make repayments on a Division 7A loan, the failure to meet the minimum repayment requirements under section 109N Tax Act 1936 should not, of itself, result in a deemed dividend for the estate.
Care is required in this situation as a different outcome can arise if the outstanding amount is forgiven (or deemed to be forgiven) by the private company.
For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.
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