Tax Insight: Treasury proposes significant changes to how the tax law applies to payments, loans and forgiven debts from a company to its shareholders
On 22 October, the Australian Treasury released a consultation paper seeking feedback about proposed amendments to Division 7A of the Income Tax Assessment Act 1936 (Division 7A). Overall, these changes are designed to simplify compliance with Division 7A and reduce the adverse tax consequences that can arise.
We have outlined the key proposals in this article. Treasury proposes that most of these measures commence from 1 July 2019. We note that some of these proposals may change as a result of any feedback which Treasury receives.
We recommend you carefully review current arrangements that are subject to Division 7A to determine your compliance obligations from 1 July 2019 and ensure no unintended adverse tax consequences arise.
Why does Division 7A exist in the tax law?
In certain circumstances, Division 7A deems payments, loans and forgiven debts from a private company (Company) to a shareholder or an associate of the shareholder (Shareholder) to be income in the form of an unfranked dividend. It is often described as an integrity measure because it is designed to prevent tax-free or tax-preferred access to undistributed profits of a Company.
What are the amendments that have been proposed?
- Simplified loan rules: The current options of 7 and 25 year terms for loans will be replaced with a single 10 year term loan. The current ‘benchmark’ interest rate which applies to these types of loans will also change to the Reserve Bank of Australia indicator lending rate for small business variable overdraft most recently published prior to the start of the relevant income year (eg for FY2019, the June 2018 published rate of 7.30% would be the relevant rate);
- Loan documentation: The current requirement of formal loan agreements will be replaced with a simpler requirement to show evidence that the loan exists. This reflects the ATO’s administrative practice in Taxation Determination TD 2008/8 and that emails, accounting entries or meeting minutes may now be sufficient evidence that a loan exists;
- Minimum yearly repayments: The current requirement that a minimum amount of principal and interest is paid on a yearly basis will be replaced. It is proposed that interest will be calculated on the balance of the loan at the beginning of the financial year irrespective of when repayments of principal are made, and, repayments of principal will occur in equal instalments throughout the loan term;
- Pre-1997 loans: Currently, loans that were entered into prior to 4 December 1997 are not subject to Division 7A. However, it appears that these loans will become subject to Division 7A from 30 June 2021;
- Distributable surplus: The current requirement that the amount of any deemed dividend must be reduced to the extent of the Company’s distributable surplus will be abolished. Generally speaking, distributable surplus is a tax law calculation of a Company’s retained earnings;
- Unpaid present entitlements (UPE): The current ad-hoc approach to UPEs will be replaced by treating UPEs as loans from 1 July 2019;
- Self-correction of mistakes that may arise: The current option of applying to the ATO for relief from the adverse tax consequences arising under Division 7A will be complemented with a self-correction mechanism. In certain circumstances, Shareholders will be able to self-correct mistakes that could otherwise lead to an amount of tax becoming payable on an unfranked dividend;
- Period of review for the ATO to revise assessments: The limited period of review for the ATO to revise assessments where Division 7A has been triggered will be replaced with a review period of 14 years; and
- Safe-harbour and technical amendments: There are a number of safe-harbour and technical amendments which are also being proposed. For example, the interaction between Division 7A and the Fringe Benefits Tax, interposed entity rules and the deductibility of deemed dividends.
What should you do now?
If you are a Shareholder that has received a payment, loan or had a debt forgiven by a Company, now is the time to review what your obligations will be under proposed amendments to Division 7A. Relevantly, under the proposed transitional rules:
- Any 7 year complying loans in existence at 30 June 2019 would be required to comply with the new model to remain complying loans, but will retain their existing term;
- Any 25 year complying loans in existence at 30 June 2018 would be exempt from the majority of the changes until 30 June 2021; and
- Any pre-1997 loans will be taken to be financial accommodation as at 30 June 2021. Therefore, borrowers will have a two-year grace period to either repay these loans or put in place a complying loan agreement, otherwise they will be treated as a deemed divided in the 2020-21 income year.
The full consultation paper is available here.
The HWL Ebsworth National Taxation Group will keep you updated on major developments in these areas as they occur. Please contact a member of our tax team to discuss any aspect of the above further.
This article was written by Nima Sedaghat, Partner, Vincent Licciardi, Senior Associate and Ellis Rigby, Solicitor.
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Important Disclaimer: The material contained in this publication is of a general nature only and is based on the law as of the date of publication. It is not, nor is intended to be legal advice. If you wish to take any action based on the content of this publication we recommend that you seek professional advice.