Week 1: Additional features of companies
and dividend imputation: consolidation and
deemed dividends
Introduction
In this topic, we will be building on your previous studies of the taxation system as it applies to
companies keeping in mind the differences between the individual and company tax determinations
and operations. In addition, next week the dividend imputation system will be studied, examining the
treatment of dividends paid by companies to company shareholders or to individual shareholders.
Objectives
On completion of this week, you should be able to:
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
explain the effect of consolidation on companies
discuss what constitutes a deemed dividend and the effect of this.
Consolidation
Consolidation measures have been brought about to alleviate the necessity of intragroup transactions which have caused numerous problems for the taxation of
wholly-owned groups e.g. increased compliance costs and double taxation.
Textbook
Master Tax Guide
[8 000]–[8 020]
Although consolidation is optional, if a group decides to consolidate, all of its
wholly-owned Australian resident group entities must consolidate. A consolidated group is then
treated as a single entity for income tax purposes with a single common head company.
The treatment of losses in the consolidated group is rather complex. In general, limits have been set as
to the extent to which a loss brought to a group by an entity can be offset against group income. This
is to prevent takeovers of loss companies with the intention of reducing the taxable income of the
group and in turn the tax liability. Essentially the provisions are designed to restrict the deduction for
losses that an entity brings to the group to the notional income that the entity contributes to the group.
The major changes for a consolidated group will be:
 the lodgment of a single income tax return
 the payment of a single PAYG instalment
 the maintenance of a consolidated franking account, and
 the removal of all transactions between group members for income tax purposes.
There are a set of core rules set out in Division 701 that contain the fundamental features of the
consolidation regime. These core rules are:
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
Single entity rule—where the choice to consolidate is made all members of the group are
treated as a single entity for tax purposes rather than as separate income tax entities. The
ATO’s view of this rule is set out in Ruling TR 2004/11.
Entry history rule—anything that happens to a subsidiary member prior to joining the group is
taken to have happened to the head company. Therefore, the head company may be able claim
deductions for expenses incurred by the subsidiary member before it became a member of the
group.
Exit history rule—when a subsidiary member leaves a consolidated group it takes with it the
history of the assets, liabilities and businesses that cease to be part of the head company as a
consequence of its leaving.
 Entry and exit history rules and choices—the head company of a consolidated group will not
be bound by the choices made by a joining entity. These choices will be withdrawn and the
head company is able to make a choice that is effective from the time of consolidation or
joining. On leaving, any leaving entity will be entitled to make choices effective from the
time of leaving and at this time the head companies choices will be disregarded.
The head company must be a company that is a resident of Australia, that pays tax at the general
company tax rate. The head company cannot be a wholly owned subsidiary of another company.

To be a subsidiary member of a consolidated group an entity must be a company, trust or partnership
that is an Australian resident and is a wholly owned subsidiary of the head company. A subsidiary
member cannot be a non-profit company.
Section 703-20 sets out circumstances where entities are precluded from being members of a
consolidatable group, that is, they cannot be head companies or subsidiary members.
Dividends
Definition
Dividends are defined in s. 6(1) to include:
 distributions in money or property made by a company to its shareholders
 any amount credited by a company to its shareholders.
Amounts not included as dividends will be distributions from a share capital
account, repayments on cancellation or redemption of shares, and reversionary
bonuses on a policy of life assurance.
Legislation
ITAA 36
ss. 6(1), 44(1)
Textbook
Master Tax Guide
[4–100]–[4–120]
Assessability
Section 44(1) provides that dividends, and non–share dividends received by a shareholder will be
included in assessable income. For this section to be applicable to dividends the distribution must be a
dividend within the s. 6(1) definition, it must be paid to a shareholder, and it must be paid out of
profits.
Section 44(1A) ITAA36 specifically addresses changes made to the Corporations Act 2001 in 2010
by deeming that where an amount is paid out of an amount that is other than profits, it will be taken to
be a dividend paid out of profits.
To be classed as a shareholder, a person must be either the registered holder of the shares on the share
register, or be beneficially entitled to the shares. Patcorp Investments Ltd v FCT confirmed the
general principle that entry on the share register is necessary to constitute membership of the
company. Shareholders will also include persons entitled to be registered, and those beneficially
entitled to shares.
To be paid, the distribution does not need to be actually given to the shareholder, but may be credited
for the benefit of the shareholder, as provided in the definition of ‘paid’ in relation to dividends in s.
6(1) e.g. dividend reinvestment plan.
The interpretation applied to the term ‘out of profits’ has been very wide, the court considering that
any gain made by a business during an income year would be profit. In FCT v Slater Holdings Ltd the
court applied the approach from Re Spanish Prospecting Co Pty Ltd [1911] 1 Ch. 92 that profit was
measured as the difference between the net assets at two specific dates.
Deemed dividends
Liquidators distributions
At common law, the distribution to shareholders on liquidation of a
company is characterised as a distribution of capital, being payment in full
for the shares held.
However, s. 47 ITAA 36 operates to treat as a dividend the distribution
made by a liquidator on winding up a company, to the extent that the
distribution represents income amounts other than income applied to
replace a loss of paid–up share capital. By deeming the income amounts
distributed to be dividends paid to the shareholders by the company out of
profits, s. 47 brings the distribution squarely within the assessability
provision of s. 44.
Legislation
s. 47 ITAA 36
S47 (1), s 47(1A) ITAA 36
Div 7A ITAA 97
s. 109 ITAA 36
Textbook
Master Tax Guide
[4 200]–[4 320]
Section 47(1A) operates to define what is referred to by the term ‘income’ in s. 47. In applying s.
47(1A) income will include:
those amounts which are income at ordinary concepts, and other amounts included in
assessable income, excluding capital gains; and
 the amount of any capital gain calculated without indexation and without offsetting any
capital losses.
This means that shareholders are assessable on the full amount of any capital gain without the benefits
of indexation and offsetting capital losses.

The concept of income in s. 47(1A) is somewhat artificial since it includes capital gains on assets
acquired post 19 September 1985, but not gains on assets acquired before that time. There may be an
advantage for shareholders if gains from these periods were kept in separate funds, with the liquidator
being able to nominate from which fund a distribution was being made.
Deemed dividends that arise under s. 47(1) will constitute frankable dividends therefore they must be
appropriately franked according to the operation of the imputation system.
Loans to associates
Division 7A
Deemed dividends arise under Div 7A ITAA36 when loans and payments are made by private
companies to associated entities as described below.
When a private company:
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pays an amount to an associated entity
makes a loan to an associated entity which is not repaid by the end of the income year; or
forgives a debt owed by an associated entity,
then the company is taken to have paid a dividend out of company profits to the person in
their capacity as shareholder, thus making the dividend assessable.
This will be the case even if the associated person is not a shareholder.
The actions above of payment, a loan, or forgiveness of a debt are all widely construed. The concept
of a payment under these provisions has been extended by the operation of s. 109CA(1) ITAA36 from
1 July 2009 to also include the provision of an asset that is held by the entity and available for use by
an associate on other than an arm’s length basis. There are some minor exceptions to this extension
arising under s. 109CA(4) – (8) such as minor benefits and otherwise deductible exclusions.
These changes have a significant effect on practices that have been engaged in by many private
company shareholders as it means that shareholders and associates are no longer able to make use of
private company assets for private purposes without the Div 7A provisions applying to include such
use as a dividend paid.
The effect of the provisions in Div 7A is that the amount is automatically deemed a dividend, and thus
assessable, rather than the Commissioner having to determine that it is a dividend, this being more in
keeping with self–assessment.
To avoid being deemed to be a dividend, the transaction between the private company and the
associated person must be:
a) payment of a genuine debt owed by the company to the person
b) payment or loan by the private company to another company
c) payment or loan already assessable to the associated person
d) a loan by the private company in the ordinary course of business and on commercial terms
e) a loan meeting requirements as to a minimum interest rate and maximum term; or
f) a debt forgiven because of bankruptcy, or because payment would cause undue hardship.
Under these provisions the onus is on the taxpayer to establish that the payment, loan, or debt
forgiveness should not be treated as a deemed dividend, rather than on the Commissioner to decide to
treat it as a deemed dividend.
Under amendments to the provisions made on 1 April 2005, a private company has until lodgement
day to have the amount repaid or put the loan on a commercial footing to avoid the application of
these deeming provisions. Lodgement day is the date the company’s return is actually lodged or the
date that the return is due to be lodged, whichever is earliest, for the year of income in which the loan
is made.
Where a deemed dividend arises under Div 7A this will not give rise to a debit in the company’s
franking account as it generally constitutes an unfrankable dividend.
Excessive payments to associates
Section 109 deals with situations where a private company makes payments to an associated person
that constitute remuneration for services, or compensation on retirement.
The section provides that so much of the payment as the Commissioner considers exceeds a
reasonable amount will be deemed a dividend paid from profits to the associated person as a
shareholder, thus being received and assessable as an unfranked dividend.
Further, the section disallows the company a deduction for the excessive component of the payment.
Conclusion
You need to have an awareness of the effects of consolidation on companies within the group. It is
also important to have an understanding of the effects of the deemed dividend provisions to ensure
that the operation of private companies takes places without an unintended breach of these provisions.