Ms B carries on a business through her company, C Ltd. In each of the 2012–2017 tax years she provides management services to C Ltd and, in return, C Ltd pays her a salary of between $150,000 and $200,000.
In the 2018 tax year, C Ltd’s revenue reduces due to adverse market conditions. C Ltd also requires funds to meet capital expenditure. Ms B decides to forego her salary so C Ltd can pay for the capital expenditure and meet its ongoing operating costs.
By the start of the 2020 tax year, market conditions have improved, and C Ltd has met its capital expenditure needs and is trading near the levels it was trading at before the 2018 tax year. Despite this, C Ltd does not resume paying Ms B a salary. This creates a shortfall in the funds Ms B needs to meet her private expenditure. Ms B funds the shortfall using periodic borrowings obtained from C Ltd, and C Ltd funds the borrowings out of retained earnings. The borrowings are repayable on demand and interest is charged at the fringe benefit tax rate. All interest is capitalised at year end. The advances are recorded in a loan account Ms B maintains with C Ltd. At the end of the 2025 tax year, the account balance is $950,000.
The Commissioner considers s BG 1 of the ITA 2007 applies to the loan advances in the 2020–2025 tax years and proposes to treat the advances as income under s GA 1 of the ITA 2007. Ms B disputes this. In support of her position, she contends:
- the amounts she received cannot be taxed as income because they are loan advances
- the terms on which the advances were made are not objectionable because they are typical of the terms used in related-party transactions
- her initial decision to stop being paid a salary had a commercial purpose of leaving funds in C Ltd to be used for business purposes
- a person is entitled to live off capital, and under the loan she received advances of capital that she intends to repay.