October 30, 2018
Treasury has issued a Consultation Paper proposing major changes to the Division 7A regime.
The Paper is the Government’s response to an earlier Board of Taxation review, however the proposed changes go much further than the Board’s recommendations. The proposals are subject to further consultation, therefore may be altered before being legislated. The proposed start date for many of the measures is 1 July 2019.
Broadly, Division 7A is an integrity rule that is intended to limit access by individuals and trusts to company funds that have not been taxed at applicable marginal rates. The Division 7A rules deem a payment, loan or forgiven debt to be an unfranked dividend in the hands of the recipient. However a benefit is not currently treated as a deemed dividend if it is converted to a 7 year loan (or a 25 year loan secured over property) with mandated interest and principal repayments.Under existing rules, loans made prior to 4 December 1997 (“pre-1997 loans”) are quarantined and not subject to Division 7A rules.
The Paper proposes the following key changes:
- The 7 and 25 year loan models will be replaced by a single 10 year loan model.
- From 1 July 2019 the applicable interest rate will increase as it will be based on the small business overdraft rate. Based on current year rates, this is an increase from 5.2% to 8.3%.
- The relevant start and transitional dates for the 10 year loan model are as follows:
- All new loans made on or after 1 July 2019 will be subject to the 10 year term.
- Existing 7 year loans at 30 June 2019 must comply with the new interest rate from that date, but retain their existing term.
- Existing 25 year loans at 30 June 2019 must apply the new interest rate from 1 July 2019, and must convert to a 10 year loan from 30 June 2021.
- Pre-1997 loans will be taken to be financial accommodation from 30 June 2021, and must be put on a 10 year complying term from that date.
- Currently, deemed dividends are capped to the amount of a company’s “distributable surplus” (broadly equal to the company’s undistributed profits). The proposals abolish the concept of distributable surplus, meaning dividends will be deemed for the entire value of the benefit extracted.
- Where a trust makes a company entitled to a share of its income for a year, and does not actually pay that amount to the company, this gives rise to an unpaid present entitlement (UPE) for that income. The Paper proposes:
- All UPEs arising between 16 December 2009 and 30 June 2019 must be put on complying 10 year loan terms by 30 June 2020.
- All UPEs arising after 1 July 2019 will be treated as loans arising during the year and must be put on complying 10 year loan terms by the tax return due date for that year (not the following year as per current rules).
- UPEs arising before 16 December 2009 remain quarantined.
- A self-correction mechanism to be introduced under which inadvertent breaches of Division 7A can be rectified by qualifying taxpayers, provided the taxpayer converts the benefit into a complying 10 year loan and makes immediate catch up payments.
- The amendment period for Division 7A transactions will be extended from 4 years to 14 years from 1 July 2019.
- Other proposed changes include a safe harbour for the provision of assets for use, extension of the interposed entity rules and clarification of the interaction between Division 7A and fringe benefits tax.
These proposals are far-reaching and will likely impact all client groups that include companies. Whilst the proposals help to clarify certain aspects of the rules that were uncertain, the Paper proposes changes that greatly surpass the Board’s recommendations.
In particular, pre-1997 loans that are currently quarantined, as well as current 25 year secured loans, will need to be repaid over 10 years from 2021. This may result in cash flow impacts to client groups.
We will be discussing these changes with all of our affected clients over the coming months and DAA intends to make a submission to Treasury on our client’s behalf. If you have any questions please contact our office.