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Taxpayer subject to double tax as company deemed to have paid dividend to itself!
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Keith James, Partner |
The Federal Court has dismissed a taxpayer’s claim that the Commissioner had incorrectly assessed the taxpayer in its capacity as trustee of a unit trust under Division 7A and not the unit holders in the recent decision in Di Lorenzo Ceramics Pty Limited v Commissioner of Taxation [2007] FCA 1006. The taxpayer claimed that Division 7A should not have applied on the basis that the unit holders were private companies.
The facts of this case portray a disastrous outcome for the taxpayer as the application of Division 7A resulted in a company being held to have paid an unfranked dividend to itself – with a second round of tax being payable.
The mistake
Division 7A issues never seem to go away. In this instance, there was no complex structure or section 109XA (or old section 109UB) issue. Instead, the matter concerned a simple loan from a private company to an associate in the form of a unit trust. Even the accounts indicated that a loan existed, although the taxpayer later challenged the correctness of the account’s title.
This decision emphasises the importance of getting the structuring right when an entity is expanding through the use of a new separate, but related, entity. This is particularly so when funds are being provided by a company to a non-company entity (ie a trust or partnership).
The facts
Di Lorenzo Ceramics Pty Limited (“the Company”) was a family company that conducted a business of supplying and fixing tiles. Mr and Mrs Di Lorenzo were the only shareholders of the Company.
Following a period of significant growth, the Company sought to relocate to a new purpose built premises. It was decided that the acquisition of the land and construction of the premises would be undertaken by a new unit trust (“the Trust”), and the premises would be leased to the Company on commercial terms. The Company held 75% of the units and Fresta Pty Limited (“Fresta”), a company set up by Mr and Mrs Di Lorenzo’s daughter, held 25% of the units in the Trust.
The Trust obtained finance with the ANZ Bank for the acquisition and development of the premises, with the balance of money required to fund the project being provided by the Company. The advance was recorded in the Company and Trust’s accounts as a loan between the entities. The reason for this was that the Trust did not have its own separate bank account.
Between 30 June 2000 and 30 September 2001, a building was constructed on the land. Receipts and expenses were put through the Company’s loan account as if it were a running loan account.
On 1 October 2001, the Trust leased the property (along with a newly constructed building) to the Company on commercial terms.
On 31 March 2004, the Commissioner issued amended assessments against the Company and Fresta. He contended that:
the Company made loans to the Trust by reason of the payments it made in discharge of the Trust’s liability in connection with the purchase and construction;
by reason of the fact that Mr and Mrs Di Lorenzo were the only shareholders in the Company and the trustee of the Trust, the Trust was an “associate” of the shareholders in the Company for Division 7A purposes; and
in their capacity as unit holders, the Company and Fresta were presently entitled to the income consisting of the deemed dividends, as to three quarters in the case of the Company and one quarter in the case of Fresta.
Despite the lack of evidence to support such claim, the taxpayers argued that the monies that the Company paid to the Trust were not loans, but in fact an “investment”. The taxpayer also argued that if advances were loans, the interposition of the Trust between the Company and the unit holders should be ignored.
The decision
The Court held that there was no agreement that the amounts paid by the Company were subscriptions for units in the Trust. It was not until 2005 that the accountant prepared minutes and made entries in the register of unit holders for the Trust that additional units were issued to the Company dating back to 1999 when the monies were first advanced.
The Court concluded that the taxpayers’ accountant “attempted to rewrite history in an effort to achieve what he considers to be a more fair and just result for his clients, and one that perhaps he thinks they would have agreed to if he had recommended it”.
The Court was of the view that the accountant had established a running loan account in the name of the Trust, treating the payments made by the Company as debits to it, and to treat the advances from ANZ Bank, rental and BAS receipts as repayments by the unit trust. The running loan account recorded advances by way of loan from time to time by the Company to the unit trust.
It was not in dispute whether the trustee of the Trust was an associate of the Company and the Court concluded that the payments were loans to which section 109D of the 1936 Act applied.
Implications
With the taxpayer in this case being subject to double tax, it provides a timely reminder to review any potential Division 7A issues which may exist in light of the Commissioner’s release of the Practice Statement enabling the one-off opportunity to correct past mistakes regarding payments and loans from their private companies and avoid penalties under Division 7A.
FURTHER ENQUIRIES
