The ATO has released long-awaited guidance on Division 7A minimum yearly loan repayments and COVID-19.
However, given the late release of the guidance and the onerous requirements to be satisfied in the application form it is arguably too little, too late.
In general terms, Division 7A ITAA 1936 (Div 7A) has an application where a private company makes a payment or loan to a shareholder or associate of the company.
Where amounts advanced by a private company to a shareholder or associate are placed under a complying Div 7A loan agreement, the borrower (subject to conditions) is required to pay the minimum yearly repayment (MYR) by 30 June of the repayment year.
Div 7A can also have applications where trustees of discretionary trusts make distributions to corporate beneficiaries and the distribution remains unpaid.
With COVID-19 having a significant impact on the economy, many Division 7A borrowers (‘borrowers’) may find they are unable to meet their Division 7A MYR due to job losses, the financial impact on business, or general financial hardship.
Under the ATO guidance released on 26 June 2020, a borrower who is unable to make their Div 7A MYR due to the impact of COVID-19 may be able to request an extension to the time to make the MYR provided they meet certain conditions.
If the request is approved, the borrower may be provided with an extension to pay the MYR by up to 12 months. We note, the MYR is merely deferred and if an extension is granted by the ATO, the shortfall must be paid by 30 June 2021.
How do I access the extension?
In order to access the extension to the due date to pay the MYR, the borrower must make an application to the ATO via an online form and (among other things) must provide the following information:
- Information about the loan and the amount of the shortfall (this is the amount of the MYR the borrower is unable to pay by 30 June 2020); and
- Details of the circumstances in which the shortfall has arisen (that is, the reasons why the borrower is unable to make the MYR).
We note, in order to demonstrate the borrower was unable to pay due to the impact of COVID-19, it may not be sufficient that the individual or entity is merely experiencing cash flow difficulties, the borrower must be able to demonstrate they did not have the funds to pay or assets that they could realise to make the payment.
We are of the view that where a borrower has access to assets that can be realised, and knowing they had an obligation to make a Division 7A MYR have not made attempts to realise assets or seek external finance in order to satisfy the obligation, the ATO is not likely to approve a request to extend the payment date under section 109RD ITAA 1936.
Where the borrower does have the funds to repay the MYR, the ATO may still consider an application to extend the payment date where the borrower requires the funds to;
- Operate their business or;
- To meet personal needs or;
- The needs of people (such as family members) that the borrower is responsible for.
We are of the view, personal needs are likely to be limited to very basic costs of living, such as providing necessary food and accommodation and are unlikely to include costs associated with maintaining the borrower’s usual lifestyle.
For many taxpayers struggling to meet Div 7A MYRs, the ATO guidance is too little, too late.
The onerous requirements to demonstrate how the borrower was adversely impacted by COVID-19 (for example, the borrower had COVID-19) combined with the fact that capacity to make the MYR is not tied to cash flow, borrowers who have assets or borrowing capacity who have not taken steps throughout the year to obtain the funds required to make the MYR, are unlikely to be provided with additional time to pay under section 109RD ITAA 1936.
What if I'm experiencing financial difficulty?
Borrowers who are experiencing financial difficulty may also be able to make an application to defer the Division 7A MYR under section 109Q ITAA 1936, however, demonstrating financial difficulty is not a simple process.
Case law indicates that where the taxpayer has assets that are capable of realisation (including the family home), the Commissioner is unlikely to take the view that the taxpayer is genuinely experiencing financial hardship.
How can RSM help?
Borrowers impacted by COVID-19 who have an obligation to make Division 7A MYRs by 30 June 2020, are advised to make urgent contact with their tax adviser to obtain advice on the options available. Non-compliance with Division 7A MYRs by 30 June 2020 may result in the assessment of a deemed unfranked dividend to the borrower, which in turn could result in a significant and unexpected tax liability. If you require assistance with any COVID-19 related queries, please contact your local RSM office.