Pitcher Partners challenges ATO’s views on section 109U
The accounting firm has raised issues with the ATO’s recent interpretation of section 109U, warning it may lead to “arbitrary and inconsistent” outcomes for taxpayers.
In a recent submission, Pitcher Partners has disputed the ATO's interpretation of section 109U set out in the recently released in TD 2024/D3.
The draft tax determination outlined that the ATO's view that a deemed dividend can arise Division 7A where a private company guarantees a bank loan made to another private company in the group, where that bank loan is then on-lent or on-paid to a related trust or individual.
The ATO outlined in TD 2024/D3 that the reference to a private company in subparagraph 109U(1)(c)(ii) of the Income Tax Assessment Act 1936 is a reference to the private company that gave the guarantee to another entity and is not a reference to the private company mentioned in subparagraph 109U(1)(c)(i).
Pitcher Partners has rejected this interpretation by the ATO, stating that the second reference to a private company in subparagraph 109U(1)(c)(II) is a reference to the private company mentioned in subparagraph 109U(1)(c)(ii) rather than the company that gave the guarantee in paragraph 109U(1)(a).
"In our view, it is clear that for section 109 to operate, it must involve two separate private companies, one with a sufficient distributable surplus and one with an insufficient distributable surplus," the submission said.
"It is therefore primarily concerned with private companies guaranteeing loans made by other private companies."
The submission said subparagraph 109(1)(c)(i) "merely extends the operation of section 109U where other entities are interposed between the recipient of the guarantee and the target entity".
"It does not replace the main operation of the provision to cover the provision of guarantees given to any kind of entity, related or unrelated.
"In our view, section 109 is intended to be limited to guarantees provided to the private company with the insufficient distributable surplus. Where guarantees are provided to entities other than private companies [such as] banks, these arrangements are expressly dealt with under section 109UA."
The ATO's interpretation in TD 2024/D3, on the other hand, would result in an "arbitrary and inconsistent application of section 109U" and suggested that the drafters did not fully adopt a coherent set of rules when drafting section 1090, the accounting firm said.
"The ATO's interpretation suggests that subparagraph 109U(1)(c)(i) is intended to capture interposed arrangements involving bank guarantees," the submission said.
"However, this paragraph would apply to a very small minority of interposed corporate guarantee arrangements and would not apply to the majority of interposed arrangements."
Pitchers Partners said it would obtain further information about the implementation of Division 7A of Part III of the ITAA 1936 (Division 7A) such as drafting instructions provided by Treasury.
The accounting firm warned that the differences in interpretation of section 109U were "significantly more contentious" due to the fact the ATO has not provided any safe harbour for complying with section 109U, where it is a simple ordinary commercial business arrangement.
It also said it was unacceptable that the ATO has outlined a new view on the operation of section 109U, roughly 26 years after the provision was first introduced, without providing a practical or an administrative way of dealing with the provision.
"Simple business conduit financing arrangements (where a single company obtains finance for the whole of the group) would be caught within TD 2024/D3, without any conclusion as to how section 109V would apply to the arrangement," it said.
"As section 109 is not self-executing and requires a determination by the Commissioner, it is our view that an inconclusive public ruling on this topic would create significant uncertainty for taxpayers and would not be viewed as good administration."
Pitcher Partners said until recently, most practitioners have operated on the understanding that Division 7A only applied where one private company guaranteed (or provided security) for a loan made by a related private company, but not for a loan made by a third party such as a bank.
"It is generally understood that guarantees of bank loans by private companies are governed exclusively by section 109UA, rather than section 109U," it said.
"Accordingly, it is critical that the ATO provide appropriate safe harbours that can be supported by the legislation, rather than just administratively."
