RSM Australia

Division 7A or Doomsday

Treasury Releases Consultation Paper

On 22 October 2018 Treasury released consultation paper “Targeted amendments to the Division 7A integrity rule”. The consultation paper has long been anticipated by both taxpayers and advisers waiting for certainty surrounding proposed changes to Division 7A and the resulting tax and financial impact. Division 7A Consultation Paper

Division 7A is an integrity measure intended to ensure taxpayers can’t access funds that have not been taxed at their marginal tax rates (i.e. the funds have been taxed at the corporate tax rate).  In its current format, Division 7A has been in operation since December 1997 and has application to shareholders of private companies and their associates, which can include other individuals and trusts.

All talk no action

Talk of changes to Division 7A has been circulating since 2012, when the Government commissioned the Board of Taxation to undertake a post implementation Review of Division 7A. The Board first issued a discussion paper in December 2012, with their final report to Government provided in November 2014.  Proposed changes to Division 7A were announced by the Government in the 2016-17 Federal Budget with an implementation date of 1 July 2018.  That legislation, however, wasn’t forthcoming and in the 2017-18 Federal Budget the Government announced the implementation date would be extended further to 1 July 2019.  As the consultation paper has only just been released, and there is no draft legislation, the question of whether legislation will pass before the next Federal election hangs heavy.

All good things must come to an end?

After the long wait to see the Government’s proposed changes to Division 7A legislation, what can taxpayers expect?  

Significant proposed changes include:

  • A new single loan model with a maximum term of 10 years.
  • The proposed new loan model with have a variable interest rate and payments of both interest and principal each year.
  • There will be no requirement for a formal written loan agreement, however written or electronic evidence must exist by the lodgement date of the private company tax return.
  • Interest will be calculated for the full year, regardless of when the repayment is made.
  • Post 16 December 2009 Unpaid Present Entitlements (UPEs) owing from associated Trusts will be required to be converted to complying 10-year Division 7A loans.
  • Pre 16 December 2009 UPEs owing from associated Trusts are not currently included in the proposed changes, however they have not been ruled out.
  • Transitional rules will apply to existing complying 7-year and 25-year loans and also to the previously excluded pre-4 December 1997 loans.  It is proposed these loans will transition to the new 10-year model.
  • Deemed dividends will arise where complying 25-year loans and pre-4 December 1997 loans are not repaid or placed under new complying 10-year loan agreements before the lodgement date of the 2020-21 company tax return.
  • It is proposed the period of review for Division 7A transactions will be extended to 14 years from 1 July 2019.  The consultation period is unclear on whether the 14-year amendment period will apply retrospectively or prospectively from 1 July 2019.
  • A proposed new self-correction mechanism making it easier for taxpayers to correct mistakes.

Transitional Rules Transitional rules

Transitional rules will be introduced to assist taxpayers with existing 7-year, 25-year and pre-4 December 1997 loans transition to the new single 10-year loan mode.

7 Year Loans

Complying 7-year loans in existence at 1 July 2019 will convert to the new proposed loan model and new benchmark interest rate. The loans, however, will retain their existing remaining loan term.

25 Year Loans

Complying 25-year loans in existence at 1 July 2019 will be exempt from most of the changes until 30 June 2021, however, interest charged on these loans must be equal to or exceed the new benchmark interest.

At 30 June 2021 a deemed dividend will arise if the 25-year loan is not repaid in full or placed under a new complying 10-year loan agreement by the lodgement date of the 2020-21 company tax return.

Under the proposed changes the first repayment will be due in the 2021-22 income year.

Pre 4 December 1997-loans Division 7A Consultation Paper

For outstanding pre-4 December 1997 loans (i.e. those loans which have not already been forgiven and are still reported in tax returns), the proposed transitional rule will provide an affected taxpayer with a two-y ear grace period before the first repayment is due, with the loan to be repaid over the subsequent 10 years. 

Under the transitional rules, pre-4 December 1997 loans will be taken to be financial accommodation as at 30 June 2021. Taxpayers with pre-4 December 1997 loans will have until the lodgement day of the 2020-21 company tax return to either pay out the amount of the loan or put in place a complying 10-year loan agreement, otherwise the loan will be treated as a dividend in the 2020-21 income year. 

Under the proposed changes, the first repayment will be due in the 2021-22 income year.  

What does this mean for taxpayers?

The proposed changes to current complying 25-year loans and loans that pre-date 4 December 1997 may result in a situation where taxpayers either won’t have the financial capacity to repay loans or they may have to realise assets to make the repayment. The financial impact for some taxpayers could be significant, particularly where the repayment of these loans was part of a succession plan, where fully franked dividends could be applied in low income years to make use of the franking credits to offset tax payable.

The consultation period for the proposed changes is open until 21 November 2018.

We strongly recommend taxpayers who may be impacted by the proposed changes seek advice from their tax advisers.  We also recommend tax agents with clients impacted by the proposed changes take a proactive approach and work with clients to identify planning opportunities.