The constitution deemed every drawing a complying loan. It was not. The fix was worse than the problem.
Your client draws $1.3 million from his company. The constitution deems every loan to be made under a pro-forma agreement in Schedule 1. His advisers interpose a holdco, frank a dividend, and use a promissory note to offset the old drawings. Lazanas DP held the loans still fail s 109N, and the restructure is dividend stripping.
Botella and Commissioner of Taxation [2026] ARTA 604.
The constitution is not the agreement
Clause 19 of the PPD constitution deemed every loan to a member to be made under a pro-forma Loan Agreement in Schedule 1 setting the rate and term. Drawdowns ran through FY18 as book entries in Mr Botella’s loan account [78].
Section 109N(1)(a) requires “the agreement that the loan was made under is in writing” before the lodgment day. Lazanas DP held the deeming clause could not turn advances made by conduct into loans “made under” a written agreement [82]. A constitution regulates relations among members as members, not a separate contract with the shareholder personally: Bailey (1995) 184 CLR 339, applied at [83]. A contract by conduct is not wholly “in writing” [84]. $1,315,257.54 of unrepaid loans failed s 109N.
The fix was a strip
In September 2018 Mr Botella interposed PPH, took a Subdivision 122-A rollover, and PPD declared a fully franked $1,008,918 dividend to PPH. PPD issued a promissory note to PPH; PPH endorsed it to Mr Botella; he presented it back to PPD as “repayment” of his prior loan [47], [49].
Each of the six CPH characteristics was satisfied: dividend stripping under s 177E and a dividend stripping operation under s 207-155 [91]-[101]. A wholly owned stripper did not save it: Hayes (Full Court) [2024] FCAFC 80 at [48] confirms the stripper can be related [109]. A franked dividend to a corporate shareholder is still an “escape” in the net sense [112]. CGT rollover does not prevent the new shares being a “capital sum” [116].
$1,008,918 into Mr Botella’s assessable income under s 177F. $382,693 franking credits denied to PPH. Scheme penalty affirmed.
The practitioner lesson
First, a pro-forma loan agreement embedded in a constitution does not typically satisfy s 109N(1)(a). Draft a separate agreement between company and shareholder before the lodgment day, specifying amount, rate and term.
Second, restructuring out of a Division 7A problem carries s 177E risk. Where retained profits backing the drawdowns are paid as a franked dividend to a holdco owned by the same shareholder, the arrangement may be dividend stripping. CGT rollover does not insulate it.
Third, Part IVA is not displaced by Division 7A: Lawrence (Full Court) (2009) 175 FCR 277 [122].
General information only. This note was accurate when written. The law may have changed since and the note is not updated. It is not legal or tax advice, does not take account of your circumstances and must not be relied upon as a substitute for advice on your own matter. If the issue is live for you or your client, email arda@nortonquaytaxlaw.com.au for advice on the current position.