Division 7A Changes – Consultation Paper

Treasury has released a consultation paper setting out its proposed implementation of previously announced amendments to Division 7A. Although these are stated as being based on recommendations made in a Report by the Board of Tax, they include significant departures from those recommendations which may have serious financial consequences for many small businesses.

The amendments are to apply from 1 July 2019. As this is only a consultation paper, and there are already many criticisms of the proposals, it is possible there will be some changes prior to the legislation being introduced. However, due the limited time frame until commencement we would strongly recommend advisors start to consider the potential impact on their clients now and any planning steps that may be required.

Simplified loan rules – single 10 year loan model

The current 7 year and 25 year loans will be replaced by a single 10-year loan. The Government has decided not to adopt the Board’s recommended model and has proposed the model will operate as follows:

– Principal – payable in equal annual instalments over the loan term. This will result in higher upfront loan repayments and varies from the Board’s proposal to allow deferred repayment terms.

– Interest – charged at the Small business; Variable; Other; Overdraft Lending rate. To illustrate this change, this would increase the current Division 7A benchmark rate from 5.20% to 8.30% .

Interest is also to be calculated for the full income year based on the opening balance, regardless of whether any repayments are made during the year.  Again, this was not a recommendation of the Board, and does not reflect a commercial arrangement.

There will no longer be a requirement for a written loan agreement. However, there must still be  evidence of the loan being executed and binding on the parties, as well as specific terms and details. We would therefore question whether the intended simplification will be achieved by this change.

Transitional rules  – current 7 & 25 year loans

All 7 year loans will need to comply with the new loan model and benchmark interest rate from 1 July 2019, but will retain their existing term. The remaining principal will therefore be paid equally over the rest of the term.

Although Treasury claims that current loan agreements which refer to the legislation should not need to be rewritten, this is unlikely to be the case if interest is to be charged in full based on the opening balance.

25 year loans will be exempt from the majority of changes until 30 June 2021. However, the new benchmark interest rate must be charged. A new 10 year loan agreement will need to put in place by the lodgement day of the 2021 company tax return.

Pre–1997 loans

Pre-1997 loans, which have been excluded from Division 7A to date, will no longer be grandfathered. A loan agreement will need to be put in place by the lodgement day of the 2021 company tax return, with the first
repayment due in the 2022 income year.

Distributable surplus

Treasury has proposed the concept of ‘distributable surplus’ be removed. This means that a deemed dividend can arise for the entire value of a benefit provided by a company, regardless of whether or not this was sourced from profits.

This was not a recommendation by the Board of Taxation and, in our view, goes beyond the original policy intention of Division 7A.

Unpaid Present Entitlements (UPEs)

All corporate UPEs arising between 16 December 2009 and 30 June 2019 will also need to be put on complying loan terms. The first repayment of these amounts will be due in the 2020 income year.

All UPEs that arise from 1 July 2019 will need to be either paid to the company or put on 10-year loan terms.

In one welcome development, Treasury’s current approach appears to leave UPEs arising prior to 16 December 2009 quarantined and not subject to Division 7A. However, Treasury has asked for submissions on this aspect.

Self-correction mechanism

Taxpayers will be able to self-assess their eligibility for relief from the consequences of breaching Division 7A. Taxpayers will need to take appropriate self-correction action with in a reasonable period. At present, a taxpayer has to apply to the Commissioner for this relief.

Period of review

It is proposed that the review period for Division 7A transactions be extended to cover 14 years from  the income year in which the loan, payment or debt forgiveness would have given rise to a deemed dividend.

This extends the period recommended by the Board and is well beyond the amendment period allowed in any other area of the tax law other than for fraud or evasion.

Use of assets — Safe Harbour

A safe harbour rule will be legislated to calculate the value of a company providing assets for private use (other than motor vehicles ). The formula will be based on the value of the asset multiplied by the benchmark interest rate uplifted by 5%.

The cost of the asset will initially be able to be used as its value). However, once an asset has been held for more than five years, its value will instead be the greater of the cost or market value (no allowance will be made for depreciation. A  formal market valuation will therefore be required every five years.

Contact Us

For further information on any of these updates, or for general assistance, please contact Our Directors, Jacci Mandersloot or Natalie Claughton.

The information contained in this bulletin is intended to  provide  general information only and is not intended to serve as tax advice. Specific advice should always be sought regarding a taxpayers’ particular circumstances. Please contact MC Tax Advisors if you would like assistance with the issues identified in this bulletin.