New Div. 7A. Proposals
Treasury has released a Consultation Paper which proposes sweeping changes to how Taxpayers deal with Division 7A, the tax law which prevents shareholder tax-free use of company money. Herein we highlight those measures that have the most profound effect on Div. 7A. compliance.
The below items can be divided into two parts. Items 1, 2 and 3 are operational adjustments to the current regime, while items 4 and 5 mark more significant departures from the current Div 7A rules.
- Maximum 10-year loan term
Under the current law private companies can lend amounts to shareholders without triggering Div. 7A. penalty provisions if they enter into an 7-year unsecured loan or a 25 years loan secured by a registered mortgage over real estate, and make minimum repayments over the respective period.
Treasury has recommended for all loans, current and future, to be converted to a maximum term of 10 years.
- Annual interest
Currently Div 7A compliant loans must carry interest at a minimum “benchmark interest rate”, a variable figure which is set each year and publicised by the ATO in a Tax Determination issued annually. This is currently based on the ‘Indicator Lending Rates – Bank Variable housing loans’ rate published by the Reserve Bank of Australia.
Treasury’s recommendation is that the interest rate would now be set using the Reserve Bank’s, “Small business; Variable; Other; Overdraft – Indicator Lending rate” published prior to the start of each new fiscal year. Based on historical comparison between the two values, this will result in an average increase to the applied interest rate by between 3% to 4%.
Treasury recommends that the “minimum yearly repayment” consisting of both principal and interest be maintained. However, the yearly repayment will require the borrower to repay a fixed and equal portion of the principal sum each year, which differs from the current formula based amortised approach. This will simplify calculations required but also result in higher minimum repayments in earlier income years.
- The role of distributable surplus
Under current law, the amount that can be a deemed as a dividend as a result of Division 7A is capped at the “distributable surplus” of the company, which approximates the retained earnings of the company with some adjustments. The logic is clear: there should not be a dividend if the company doesn’t have any profits. The Consultation Paper takes the position that this “is considered contrary to the efficient operation of the Division 7A integrity rule.”
While the discussion of this proposal occurs within the context of loan arrangements, it seems the Treasury is proposing to remove the concept of “distributable surplus” entirely. Therefore, “dividends can be deemed for the entire value of the benefit that was extracted from the private company” and Div 7A will extract its full price. This would mean, for example, that if a company was established with an amount of capital and the same amount was immediately lent back to the shareholder, the entire amount would be subject to tax.
The Board of Taxation however was very clear in its original recommendation that, “the rules regarding the calculation of distributable surplus [should remain] as part of any rewrite of the Division 7A rules.” In fact, the Board had considered that the Government should provide relief from Division 7A in some situations where the distributable surplus consisted only of unrealised profits. That the treasury has directly opposed this recommendation may provide an indication of their objectives of the review overall.
- Companies who are entitled to trust income
The ATO has taken the view that where a trust makes a company presently entitled to a share of the income of the trust but does not pay the amount to the company, then the company has made a loan of that amount to the trustee. Where the trustee is an associate of the shareholder, a deemed dividend would arise.
The Paper says, “UPEs will be treated consistently with other payments made by private companies to taxpayers, by either requiring the UPE to be repaid to the private company as a complying loan or subject to tax as a dividend.” This is consistent with the Board’s recommendation.
The consultation period concludes 21 November 2018, after which feedback will be reviewed before draft legislation is proposed.
For more information on the proposed changes and what they may mean for you please do not hesitate to contact our office.
Date of Issue: 16 November 2018
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