On 22 October 2018m, the Assistant Treasurer, the Hon Stuart Robert MP, released a consultation paper seeking views on the proposed implementation of the amendments to Division 7A of the Income Tax Assessment Act 1936 (ITAA36).
He said the proposed amendments drew on recommendations from the Board of Taxation and will provide clearer rules for taxpayers and assist them in meeting their compliance obligations, while maintaining the overall integrity and policy intent of Division 7A.
The 2018 Federal Budget also announced measures for Division 7A. It said:
- The Government will ensure that unpaid present entitlements come within the scope of Division 7A of the Income Tax Assessment Act 1936 from 1 July 2019. The Assistant Treasurer said, in his Media Release, this is an area where Treasury is particularly interested in submissions.
- The Government will also defer the start date of the Ten Year Enterprise Tax Plan — targeted amendments to Division 7A measure that was announced in the 2016-17 Budget, from 1 July 2018, to 1 July 2019. This will enable all Division 7A amendments to be progressed as part of a consolidated package.
The Board of Tax investigated Division 7A, concluding in its 2014 final report that the Division 7A rules are complex, inflexible, and impose significant compliance costs on taxpayers, including many small businesses that find the rules difficult to comply with. The Board also found that many taxpayers may not be aware of the impact or operation of the rules.
The Government’s response, to the Board’s Report, makes a number of enhancements to Division 7A, drawing on some of the Board’s observations and recommendations to improve the operation of Division 7A and address stakeholder concerns.
The amendments will comprise:
- simplified Division 7A loan rules to make it easier for taxpayers to comply;
- a self-correction mechanism to assist taxpayers to promptly rectify breaches of Division 7A;
- safe harbour rules for the use of assets to provide certainty and simplify compliance for taxpayers;
- technical amendments to improve the integrity and operation of Division 7A while providing increased certainty for taxpayers; and
- clarification that unpaid present entitlements (UPEs) come within the scope of Division 7A.
The start date for these amendments will be 1 July 2019.
Two of the proposals are worth dealing with in further detail.
1. Simplified Division 7A loan rules to make it easier for taxpayers to comply
The current 7 year and 25 year loan models will be replaced by a single loan model which has the following features:
- A maximum term of 10 years. Consistent with current practices, the loan effectively begins at the end of the income year in which the advance is made. This is because the taxpayer is given until the lodgment day (the earlier of the actual date of lodgment or lodgment due date) of the privatecompany’s income tax return to repay the loan or put it on complying loan terms.
- The annual benchmark interest rate will be the Small business; Variable; Other;
Overdraft – Indicator Lending rate most recently published by the Reserve Bank of Australia prior to the start of each income year.
- There will be no requirement for a formal written loan agreement, however written or electronic evidence showing that the loan was entered into must exist by the lodgment day of the privatecompany’s income tax return. This evidence must show:
- the parties to the loan;
- the agreement that the loan be made, including details of the date and evidence of its
execution and binding nature on the parties to the agreement; and
- the loan terms (the amount of the loan, the date the loan was drawn, the requirement to repay the loan amount, the term of the loan and the interest rate payable).
Consistent with current ATO practice, as set out in Taxation Determination 2008/8, this evidence may be included in an exchange of letters, emails, fax, accounting records, etc.
- The minimum yearly repayment amount consists of both principal and interest:
- The principal component is a series of equal annual payments over the term of the loan.
- The interest component is the interest calculated on the opening balance of the loan each year using the benchmark interest rate.
- The minimum yearly repayment amount reduces the balance of the loan each income year. Where the minimum yearly repayment has not been made in full any shortfall will give rise to a deemed dividend for the year.
- Interest is calculated for the full income year, regardless of when the repayment is made during the year (except Year 1). If the loan is paid out early, that is before Year 10, interest will not be charged for the remaining years of the loan.
- Repayments of the loan made after the end of the income year but before the lodgment day for the first income year are counted as a reduction of the amount owing even if they are made prior to the loan agreement being finalised. Interest for Year 1 is calculated for the full income year on the balance of the loan outstanding at lodgment day.
2. Self-correction mechanism to assist taxpayers to promptly rectify breaches of Division 7A
Consistent with the Board’s recommendation, qualifying taxpayers will be permitted to self-assess their eligibility for relief from the consequences of Division 7A, which will operate to reverse the effect of a prior deemed dividend arising under the law.
To qualify for self-correction, the taxpayer will need to meet eligibility criteria in relation to the benefit that gave rise to the breach. The eligibility criteria will require that:
- on the basis of objective factors, the breach of Division 7A was an inadvertent breach;
- appropriate steps have been taken as soon as practicable (and no later than six months after identifying the error unless the Commissioner allows more time) 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.
Under this approach, in order to self-correct an eligible taxpayer must:
- convert the benefit into a complying loan agreement, on the same terms that would have applied had the loan agreement been entered into when it should have been; and
- make catch-up payments of the principal and interest that would have been payable as prior minimum yearly repayments had the taxpayer complied with Division 7A when it should have. The interest component of the catch-up payment will be compounded to reflect prior year non-repayments. This compounded interest should be declared as assessable income in theprivate company’s income tax return for the income year in which the catch-up payment is made.
In certain cases, the concept of self-correction may include other appropriate action, considered reasonable, by the Commissioner, based on the taxpayer’s circumstances. Reasonable circumstances would be set out by the ATO in its public advice and guidance products.
The current Commissioner’s discretion will be removed in its current form, and remain available only in circumstances where the taxpayer seeks the Commissioner’s discretion to have the dividend franked.
COMMENTS are due by 21 November 2018.
CPD questions (answers available)
- Is Treasury seeking submissions on the changes the Government proposes to make to the ‘deemed dividend’ provisions in Division 7A (of Part III of the ITAA36)?
- Are these the first announcements the Government has made, about changes to Div 7A, after the 2014 Board of Tax Report?
- Are UPE’s going to be brought within Div 7A?
- When are these changes due to start?
- Are the Div 7A complying loan rules going to change?
- Will the loan period’s still be 7 and 25 years?
- Will the loans still be ‘principal and interest’ over the term of the loan?
- Will the principal be reduced on a rule of 78 basis, so that repayments are the same each year?
- Will the amount of interest payable depend on how early in the year the payment is made?
- Will there be a self-correction mechanism for inadvertent breaches of Div 7A?
- Will taxpayers be able to ‘self-assess’ this?
- What will be the main step in self-correcting?
- Would the taxpayer have to make catchup payments on the backdated loan?