Does a scribble** amount to the acknowledgment of a debt?

Following on from last week’s post, a further issue that often arises in the context of division 7A is whether the accounts of a debtor company can be enough to create an acknowledgement by a debtor.

In the case mentioned in last week’s post (VL Finance Pty Ltd v Legudi [2003] VSC 57), an argument that the annual company return of the creditor company was sufficient to create the relevant acknowledgment was rejected even though the returns were signed by the directors who were debtors and when read with the accounts identified the debts.

A key issue in this regard was the fact that the annual return was not a statement 'made' by the directors in their capacity as debtors 'to' the company in its capacity as the creditor.

Instead, the annual return was simply a statement 'by' the company.

In contrast however, the case of Lonsdale Sand & Metal v FCT 38 ATR 384, a statement in the accounts of a debtor company was accepted as being sufficient to amount to an acknowledgement by a debtor.

Despite the decision in Lonsdale, the better argument appears to be that the financial statements of a creditor company cannot, without more, create a valid acknowledgement by a debtor company via its directors, even if those directors sign the financial statements.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Underworld song 'Scribble’.

View here:

Statute of limitations** and division 7A

Under legislation in each Australian state, there is a prohibition on bringing a claim on certain actions, generally once 6 years have elapsed from the date from which the cause of action arose.

Generally, loans that are the subject of division 7A under the Tax Act will be at call loans.

As the Tax Act deems loans that become unrecoverable due to the expiration of a limitation period to be automatically forgiven, it is important to determine the date on which a loan is deemed to begin.

Historically, there was at least some support for the argument that the start date for limitation period purposes was the date that a demand was made for repayment of the debt or the last date a formal acknowledgement (including by way of part payment) was made.

This position was at least partially due to the fact that under the relevant limitation legislation in each state, an acknowledgement must generally be made in writing by the debtor to the creditor, and be signed by the debtor

The decision in VL Finance Pty Ltd v Legudi [2003] VSC 57, which has been accepted by the Tax Office, confirms however that the limitation period for the purposes of division 7A begins to run immediately on the date that an at call loan is made, not from the time when the first call for repayment is made.

Furthermore, while at law a loan can be 're-established' by an acknowledgement or part payment even after the expiry of the limitation period, for tax purposes, under division 7A, if the limitation period expires the debt is immediately forgiven permanently at that point in time.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Pearl Jam song 'Big wave’.

Listen here:

 

Statute barred** loans and structuring advice

Last week’s post touched on statute barred loans from a Division 7A perspective.

The issues in relation to statute barred loans are often highly relevant in the context of estate planning and asset protection exercises.

In particular, amounts that have often built up over many years can in theory become unrecoverable automatically six years after they were initially made.

In a practical sense, so long as all parties to the arrangement are aware of the automatic forgiveness, steps can normally be taken to ensure that there are no unintended consequences triggered.

For example:

1. If the existence of the loan is acknowledged at any point, this automatically restarts the 6-year period.
2. Acknowledgement can be achieved simply by making even a nominal repayment of the loan or charging of interest.
3. There is also the likelihood that if the parties to the loan have signed the financial statements where the loan is evidenced, this will be sufficient to create the requisite acknowledgement.
4. Care must however be taken in relation to the previous point, for example, if there is a loan between a trust and a beneficiary, and that beneficiary is also a director of the corporate trustee of the trust, then there would appear to be a valid argument that notification has been given.
5. In contrast, if the loan is between the trust and a beneficiary, who is not otherwise in any way involved in the trust, then proving that they were aware of the loan and acknowledged its existence may be impossible.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** for the trainspotters, the title today is riffed from the David Bowie song ‘It’s no Game (Part 2)’. View hear (sic):

Division 7A and (un)forgiven** debts

Where a debt owed by a taxpayer to a company is forgiven, this will generally trigger the operation of Division 7A. This means that the amount will be included in the assessable income for the debtor as a dividend in the year the forgiveness occurs.

Importantly, as the amount will be neither a payment nor a loan, it is not possible to rely on the more standard approach to comply with Division 7A of repaying the balance with the requisite amount of statutory interest.

One way in which a debt can be forgiven is pursuant to the rules that cause debts to become statute barred.

In most states, a debt that is not secured will become automatically unrecoverable after six years, unless steps are taken to acknowledge the existence of the loan.

The Tax Office in practice statement LA 2006/2 confirmed that it did not intend to apply the provisions of Division 7A to loans that became statute barred where the loans were originally made prior to the commencement of Division 7A.

While in the context of Division 7A (given that it was introduced in 1997), there should not be many situations where the issue remains relevant, for loans otherwise not caught by Division 7A, the automatic forgiveness caused by the provisions of the statutes of limitations in each state are often highly relevant.

** for the trainspotters, the title today is riffed from the Metallica song ‘The unforgiven’. View hear (sic):

Some things don’t change – division 7A and contracts 101 **

Following on from last week’s post, today’s post considers another aspect of where company constitutions have the terms of a Division 7A loan or facility agreement embedded in them.

In most circumstances, it is generally the case that the Tax Office will accept that the terms of the facility agreement will regulate any debit loans made by the company from time to time.

One difficulty however that can arise in this regard is that from a simple contractual perspective, these loans will not be effectively created unless the recipient of the loan is in fact a party to the constitution.

Under the Corporations Act, the constitution is a contract between the members and directors.

This means that if, for example, a loan is made to a non- member or director by the company, then the facility agreement contained within the constitution will not be able to be relied on.

** For the trainspotters, ‘Don’t change’ is a song by INXS from 1982, learn more here

Only one thing ? – constitutions + division 7A provisions **

A previous post has considered the various trust deed providers that have from time to time contained a clause which seems to automatically convert an unpaid present entitlement into a loan. This week I was reminded of a similar difficulty with some constitutions offered by similar providers.

In particular, while the Tax Office has for some years accepted the ability for a company's constitution to set out the terms by which any loan by the company is made for Division 7A purposes, care must always be taken to ensure that the provisions of this loan (or facility) agreement do in fact reflect the intent of the parties.

A number of these types of facility agreements require compliance with the Division 7A provisions, regardless of the financial status of the relevant company. For example, even where a distributable surplus does not exist (and therefore the tax rules would not otherwise apply), many of these constitutions can in fact require compliance with the Division 7A rules.

While perhaps not so memorable as the ‘read the deed’ mantra for trusts, similarly we have a mantra of ‘read the constitution (& Tax Act)’ when considering company related issues.

** For the trainspotters, ‘The One Thing’ is a song by INXS from 1982, learn more here  

Insurance premiums & FBT

As many regular readers would be aware, one particular innovation in recent times in relation to insurance funded business succession arrangements is the so-called 'debt reduction' strategy.

One aspect of the arrangement that is often raised concerns the fringe benefits tax (FBT) implications of the premium payments.

Broadly, there are a number of reasons as to why FBT will normally not apply to the payment of insurance policy premiums.

Generally the accountant for the business will always be best placed to give the guidance, however some of the reasons FBT will not apply can include –

1.    the arrangements not having anything to do with employment;

2.    in some instances, the otherwise deductible rule; or

3.    while for administrative ease the premiums might be paid by the business, the actual tax position is that the amount is included as part of other payments made (for example, a dividend).

It is important to remember that aside from FBT, there are a number of other tax issues that may also be relevant (for example division 7A or capital gains tax) so it is also best to ensure the exact circumstances are considered by the accountant for the particular client.

Until next week.

ATO attacks Division 7A planning strategy

In what is only a slight variation of the Division 7A planning approach of trusts distributing income to a limited partnership, in order to attain a capped rate of tax of 30% and avoid any application of Division 7A on loans made by the limited partnership, the ATO has released a further taxpayer alert last week.

The use of limited partnerships to avoid Division 7A was an approach that the ATO was on record as having concerns about long before the legislation in this area was changed a couple of years ago.

Following the change, a number of advisers were quick to realise that companies limited by guarantee could offer a similar pathway to the limited partnership approach – in other words:

1. Potentially receive trust distributions, with the tax payable on those distributions capped at the corporate rate of 30%.

2. The company limited by guarantee could then subsequently make loans that would not, on the face of the legislation, be caught by Division 7A.

In their first taxpayer alert for the year (taxpayer alert TA2011/1), the ATO lists its concerns with the above strategy.

The full alert is set out at the following link - http://law.ato.gov.au/atolaw/view.htm?docid=%22TPA/TA20111/NAT/ATO/00001%22.

Until next week.