Finally, after 6 years of reviews and discussion papers the Government released a Consultation Paper in October 2018 which proposes a number of significant amendments to Division 7A loans.
In general terms, if a private company makes a payment (excluding dividends, wages, or similar forms of remuneration), provides assets for private use or loans money to a shareholder (or their associate), then Division 7A may apply to treat these amounts as unfranked dividends (deemed dividends) in the hands of the recipient at their marginal rates of tax, unless the amount has been converted into a complying loan.
The proposed amendments will apply from 1 July 2019, and could have the following practical implications:
- Increase in loan repayments
- Pre-December 1997 loans being caught by Division 7A
- Loans to corporate beneficiaries (UPE’s) subject to principal repayments
- Cash flow problems due to additional tax liabilities
- Extension of the ATO amendment period to 14 years
Based on our experience in matrimonial property settlements, Division 7A loans can often complicate the division of the property pool, as a result of the sometimes unexpected, but very real, taxation liabilities. Any current negotiations involving Division 7A loans should consider the potential implications that could arise as early as 30 June 2019.
Summary of the main amendments are explained below:
Current 7 and 25 year loan models will be replaced with a single loan model comprising:
- Maximum 10 years
- Benchmark interest rate will be increased to the small business variable overdraft rate
- Written or electronic evidence that the loan exists
- Minimum yearly repayment consists of principal (equal over the term) and interest (based on opening balance each year)
- 7 year loans in existence as at 30 June 2019 must comply with the new benchmark interest rate, although they will retain the existing outstanding term.
- 25 year loans in existence as at 30 June 2019 will be exempt from most of the changes until 30 June 2021, and then will be required to place any outstanding loan on a repayment term not exceeding 10 years.
- Loans made before 4 December 1997, that have not been subject to Division 7A, will need to be placed on a loan under the new proposed model (ie., max of 10 years) if outstanding as at 30 June 2021.
Unpaid Present Entitlements (UPE’s)
- UPE’s arising between a trust and a company as from 16 December 2009, are generally subject to Division 7A
- Any post 16 December 2009 UPE’s that exist at 30 June 2019 that have not already been put on complying loan terms (principal and interest), will need to do so by 30 June 2020, otherwise any amount outstanding will result in a deemed dividend.
- UPE’s already placed on complying loan terms will be subject to the transitional rules.
- The removal of the concept of a “distributable surplus” makes the determination of a deemed dividend simpler, although widens the application.
- This amendment aligns the definition to the Corporation Act which allows dividends to be paid out of both profits and capital
- Under the current law, some taxpayers argued that the Commissioner was unable to amend a prior year’s return to account for a deemed dividend since the relevant period had expired.
- It is now proposed to extend the review period to cover 14 years after the end of the income year in which the deemed dividend would have arisen under Division 7A.
- Eligible taxpayers may be able to self-assess and rectify Division 7A breaches covering a 14 year period
- The review period in which the Commissioner can amend a tax return to account for a deemed dividend covers 14 years