Division 7A continues to be a minefield for taxpayers. Even relatively “settled” positions regarding unpaid present entitlements are now being disputed in litigation, with at least some initial success.¹ 

Companies being partners in partnerships, and what if any impacts Division 7A has on that structure has not been considered at length outside of specific limited partnership schemes (which is not the topic of this article). However there are some signs that the there may be Division 7A issues associated with common occurrences with corporate partners.  

While the ATO formerly maintained a “FAQ” regarding Division 7A, which contained some non-binding view of the ATO in respect of how Division 7A interacts with partnerships,² it appears this document has been withdrawn, and some private rulings suggest that the ATO’s position may have shifted.³

Discussing these issues will be assisted by the use of a case study. Consider the following scenario: 

• Ms Bloggs and Bloggs Trading Pty Ltd (BT Co) are partners in a general law partnership that operates a successful business; 
• Ms Bloggs is the sole shareholder in BT Co; 
• BT Co has made no loans or payments to Ms Bloggs, except by way of a properly declared dividend; 
• the profits from the partnership have generally been retained by the partnership to fund future working capital, such that each of the partners have a partnership account owing to the partner; and 
• due to a brief period of financial instability following Ms Bloggs’ separation from her spouse, the partnership loaned funds at a nominal interest rate to Ms Bloggs, and that loan is still outstanding.  

A partnership comprising of one or more private companies and one or more individuals is not an uncommon structure. It is also not uncommon for the individuals to be either shareholders in the company partner or be associates of those shareholders via a trust or other entity.  

Does Division 7A apply to any part of this structure? The answer is frustratingly unclear and has been made more unclear by recent ATO rulings. 

The starting point

There are a few key legal points to understand before delving into this structure. The first is that for most tax purposes a partnership is treated as an entity. This is the case whether it is a “general law partnership” and carries on a business or is a “tax law partnership” and the partners merely receive income jointly.  

The second key point is that a loan for Division 7A purposes is specifically defined in the legislation to include, among other things, a “financial accommodation” or a “transaction (whatever its terms or form) which in substance effects a loan of money”.⁴  

The ATO takes a broad interpretation of financial accommodation in Taxation Determination TD 2022/11 (TD 2022/11), which replaced the ATO’s earlier rulings on this point. The ATO considers that “the phrase ‘financial accommodation’ in paragraph 109D(3)(b) has a wide meaning. It extends to cases where an entity with a trust entitlement has knowledge of an amount that it can demand and does not call for payment.”⁵

This is the basis on which the ATO considers unpaid present entitlements owing to company beneficiaries of trusts to be loans for Division 7A purposes.  

Loans from partnerships 

Turning back to our case study, is there a risk that Division 7A could apply to the loan from the partnership to Ms Bloggs? 

There are potential issues here: whether the company, by virtue of being a partner in a partnership, is owed money by its shareholders, or whether the interposed entity rules in Subdivision E of Division 7A could apply (where the partnership is the interposed entity).  

Has the company made a loan? 

Under general law, a partnership is not an entity. Each partner holds an interest in the assets of the partnership, which can include loan assets. In our case study, BT Co holds an interest in a loan to its shareholder by virtue of being a partner in the partnership that has made a loan. 

There is a reasonable argument that, because the tax entity rules apply to Division 7A,⁶ meaning the partnership is treated as a separate entity for these tax purposes, the only entity which has made a loan for the purposes of Division 7A is the partnership, not BT Co, meaning Division 7A would not apply to the loan from the partnership to Ms Bloggs. It may still apply for other reasons, discussed below.   

The interposed entity rules in Subdivision E of Division 7A apply only where a company makes a payment or loan to the interposed entity.⁷   

In our case study, BT Co has not made a traditional loan or payment to the partnership. But it has an entitlement to an amount by the partnership because BT Co has not fully drawn down its partnership account.  

Under the ATO’s expansive view of financial accommodation, does BT Co make a loan to the partnership (meaning the first step in applying the interposed entity rules is satisfied) when it chooses not to draw on its partnership account? This takes us to our key issue, and one where we are concerned the ATO may take an aggressive approach.  

Can an undrawn partnership account be a loan for Division 7A? 

The ATO has, in private binding ruling PBR 105219530678 made in 2023, set out its view that a deemed dividend arises in circumstances where a company underdraws on its partnership account, while related individuals overdraw their partnership accounts. This is because the ATO considered it to be a financial accommodation between the company and the individuals.  

Further, the ATO considers that a loan made by the partnership to the individual partners represents a financial accommodation from the company to the individuals. 

The ATO’s logic is that by acquiescing to the arrangement (either the unequal drawings, or the loan), and by not calling on the profits owed to it, the company has made a financial accommodation (within the ATO’s broad interpretation of that expression as set out in TD 2022/11) to the other partners. 

There is no particular reason this logic would not equally apply to undrawn partnership accounts even where those partnership drawings are equal between company and non-company partners. In that case, there is still a company that, in its capacity as a partner, is choosing not to demand payment of an amount owing to it. Another entity is then getting the benefit of that money – either the partnership, or the other partners indirectly.  

This would seemingly run contrary to the now withdrawn non-binding “FAQ” the ATO previously published.  

It would seem an absurd outcome that if a company chooses to not call on payment of its partnership profit as to allow the partnership to retain working capital, Division 7A is triggered and a deemed dividend arises. But where the partnership pays out all its profits and concurrently demands working capital contributions from its partners, then Division 7A would not apply because the resulting capital contribution is a discharge of a pecuniary liability and exempt.  

However, that is the necessary conclusion from the line of logic that starts with a position that “a failure to call upon moneys owing is financial accommodation” – which is the ATO’s position in respect of unpaid present entitlements from trusts and appears to be the ATO’s position in respect of partnership accounts, at least where those partnership accounts are uneven.   

It may be that the ATO adopts a position that unpaid partnership accounts are only a Division 7A issue where the accounts are not even, and the company partner has underdrawn its partnership account, and the individual partners have overdrawn their partnership account.  

But this position is not logically consistent with the view that, if a company chooses not to demand payment of an amount owing to it, it has made a financial accommodation (either to the partnership, or to the other partners) – as expressed in PBR 105219530678.  

If the company partner has made a financial accommodation to the partnership by not drawing all its partnership profits, then that financial accommodation can presumably be the first ‘step’ in applying the interposed entity rules for Division 7A to any payment or loan from the partnership. 

To return to our case study to illustrate the result of the ATO’s apparent position:

• BT Co may have made a financial accommodation to Ms Bloggs (its shareholder) by choosing not to demand payment of its partnership profits – which would be a deemed dividend; and 
• BT Co may have made a financial accommodation to the partnership, which may have allowed the partnership (being a separate entity for tax) to make a loan to Ms Bloggs – which would be a deemed dividend to Ms Bloggs under the interposed entity rules for Division 7A. 

What are the arguments against this interpretation? 

It may be possible to argue that because partnership accounts may lack the fundamental component of a loan – the absolute obligation to repay – then having an undrawn partnership account is not a financial accommodation from the company.  

Another approach would be to recognise that a partnership (despite any tax deeming as an entity for certain tax purposes) is not separate from its partners at general law. It, therefore, seems to follow that there can be no debt/no financial accommodation owed for undrawn partnership accounts where, at general law, a partner is dealing with itself regarding that entitlement in the normal course.  

There is precedent for the ATO recognising limits to the effect of a partnership being a deemed entity for tax purposes in the GST position that deemed tax law partnerships cannot have partnership capital⁸. (But note, this reasoning differs from the ATO views noted below from PBR 1051393604802, about capital contributions being payments to the partnership entity.) 

On this basis, only to the extent partnership funds have been lent/draw disproportionately, are there dealings are with other parties – which may then be characterised as loans/financial accommodation by a partner, to that extent.  

We would expect the ATO would contest this interpretation because if it is correct, it could call into question the ATO’s position on unpaid present entitlements. Similarly to partnership accounts, it is possible for an unpaid present entitlement to exist almost perpetually (although a trust may end after 80 years, the trustee could still hold those entitlements for the benefit of the company after vesting).  

This feeds into a broader argument as to whether the ATO’s interpretation of “loan” in the context of Division 7A is correct – a position currently being tested in Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074 where the taxpayer was successful in the Tribunal but (at the date of this publication) the ATO had appealed that Tribunal decision to the Federal Court.  

Due to the particular arguments in Bendel its impact may be limited to whether unpaid present entitlements are financial accommodation – so even a favourable decision on this matter may not provide certainty on the treatment of undrawn partnership accounts.  

But it is submitted that partnership circumstances can/should be recognised as materially different from that of unpaid present entitlements owed from trusts/trustees, regardless of the outcome in Bendel. With unpaid present entitlements, there is typically a legal person (the trustee) separate from the beneficiary. As noted above, this is not the case for partners. Arguably, only to the extent partnership funds have been lent/draw disproportionately should potential Division 7A issues arise. 

How can this risk be managed? 

Given the lack of clarity from the ATO as to how Division 7A interacts with partnerships the remaining question is how best to manage these risks where they operate a partnership that includes at least one company. 

First, taxpayers should test the ownership structure of the company to confirm whether the partnership or the non-company partners are shareholders or associates of shareholders in the company. If they are not (for example, because the partners are all unrelated parties), then Division 7A may not have any operation.  

It is open to a taxpayer to adopt a position that undrawn partnership accounts are not financial accommodation and Division 7A does not apply. But taxpayers should be made aware of the risks associated with adopting this position – while they may ultimately be proven true, it may involve a costly audit, objection and litigation process to arrive at that conclusion. 

Otherwise, as a starting point, it would appear that the partners in a partnership should draw down their partnership accounts at equal rates. If this approach is adopted, then the ATO would not be able to argue that non-company partners had benefitted from the company choosing not to drawdown its partnership account, or that the company has indirectly funded the over-payments to the individuals. 

Where a partnership is intending to make a loan to a partner, you may wish to consider putting it on Division 7A complying terms – that is with a maximum term with interest and minimum principal repayments calculated in accordance with Division 7A. This would resolve any concern that the individuals are somehow “getting access” to company money without that company receiving compensation. Alternatively, the company could make the loan directly to the individuals.  

A genuine contribution of capital is not subject to Division 7A 

Finally we note that the ATO has seemingly kept to its position that a genuine contribution of capital to a partnership by a company partner is not a payment that is a deemed dividend.  

The ATO see the contribution as a payment (to an entity) but accepts it does not cause a deemed dividend because it is s merely the discharge of a pecuniary liability and not more than what an arm’s length party would pay (under the terms of the partnership).⁹ This has been confirmed in one private ruling made in 2018 of which we are aware PBR 1051393604802. 

That PBR also reasons that the capital contribution is not a loan for Division 7A purposes, because it “is made in accordance with the Partnership Agreement and for purposes which are consistent with the purpose of the Partnership”.  

Annexure – ATO FAQ on Division 7A

This copy was extracted from Alex Kokkinos and Leo Gouzenfiter’s Tax Institute paper, “Division 7A – Everything old is new again”:

Footnotes

1. Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074 ↩︎
2. The relevant part has been extracted and replicated in the Annexure to this article ↩︎
3. See for example PBR 105219530678 ↩︎
4. Section 109D(3) ITAA36 ↩︎
5. TD 2022/11 at [6] ↩︎
6. Section 109ZE ITAA36 ↩︎
7. Section 109T(1) ITAA36 ↩︎
8. GSTR 2004/6 paragraph 103 ↩︎
9. Section 109J ITAA36 ↩︎