Do you have a loan from your company? Change may be coming.
Division 7A of the Tax Assessment Act 1936 aims to prevent companies from avoiding tax by distributing tax-free profits to shareholders and associates through payments, loans and forgiven debts.
A division 7A loan can include an advance of money, a provision of credit, a payment made by a company for a person, on their behalf or at their request, with a repayment obligation and any other transaction that is substantially similar to a loan. Division 7A loans can be deemed to be dividends, therefore making them part of the shareholder or associate’s taxable income.
The Federal government has announced changes to Division 7A loans in its 2018/19 Federal Budget.
What changes are being made?
If we do not have a change of Federal government before then, as of 1 July 2019, the following changes will be made to Division 7A loans:
- unpaid present entitlements will come within the scope of Division 7A; and
- the start date for the changes announced in 2016/17 to be deferred.
The 2016/17 amendments included:
- a self-correction mechanism to assist taxpayers to rectify breaches of Division 7A;
- simplified rules in relation to Division 7A loans;
- rules that will increase certainty around Division 7A for taxpayers.
What will the new Division 7A model look like?
The new loan model will include a number of improved features. One such feature is the maximum 10 year term, which will replace the current model that allows 7 year terms for unsecured loans and 25 year terms for secured loans.
Secondly, the annual benchmark interest rate will be the most recent Lending Rate published by the Reserve Bank of Australia prior to the beginning of each financial year.
Thirdly, although no formal written agreement is required, the new model requires some evidence (either written or electronic) that shows the loan was entered into. This evidence must exist by the lodgement day of the company’s tax return. The evidence can come in many forms, including letters, emails and accounting records. We would still recommend a property documented loan agreement is best practice.
Under the new model, the yearly minimum repayment will consist of both principal and interest, with the principal amount being a series of equal annual payments and the interest being the appropriate benchmark rate. If the yearly minimum repayment has not been made in full before the company’s lodgement date, the shortfall will be deemed a dividend for that year.
What are the self-corrective measures?
Under the new model, some taxpayers will qualify to self-assess their eligibility for relief after having breached Division 7A. The eligibility criteria is as follows:
- the breach was inadvertent;
- appropriate steps have been taken as soon as to ensure that affected parties are placed in the position they would have been in had they complied with their obligations; and
- the taxpayer has taken, or is taking, reasonable steps to identify and address any other breaches of Division 7A.
If a taxpayer is successful in applying for self-assessment, it could have the result of reversing the effect of a prior deemed dividend under the law.
Unpaid present entitlements
An unpaid present entitlement arises when a trust makes a private company entitled to a share of its income but does not pay that amount to the company. Any unpaid present entitlements arising from 16 December 2009 until 30 June 2019 will be required to be put onto complying terms or deemed to be a dividend, according to the new model. This means both principal and interest payments will be required by 30 June 2020.
As of 1 July 2019, all unpaid present entitlements will need to be paid to the company or put on complying loan terms in accordance with the 10 year loan model. This will need to occur before the company’s lodgement day to prevent it being deemed to be a dividend.
The new model seeks to simplify the operation of Division 7A. If you have any questions or concerns about Division 7A loans, please contact Lynn & Brown Lawyers for expert legal advice.
About the authors:
James Tadros completed a Bachelor of Laws/Bachelor of Commerce degree in August 2015 from Murdoch University, WA. He was admitted as solicitor of the Supreme Court of Western Australia in 2016. Steven is a Perth lawyer and director, and has over 20 years’ experience in legal practice and practices in commercial law, dispute resolution and estate planning.