On October 2 2018, the Government released a Consultation Paper regarding proposed amendments to Division 7A of the Income Tax Assessment Act 1936. Division 7A contains integrity rules designed to prevent shareholders from inappropriately obtaining the benefit of private company profits without paying tax at their applicable marginal tax rates.
The amendments draw on some of the recommendations from the Board of Taxation in its 2014 report ‘Post Implementation Review of Division 7A of Part III of the Income Tax Assessment Act 1936’. The proposed legislative amendments include various measures applying from 1 July 2019 with key changes summarised below:
- Simplified single loan model for complying Division 7A loans including a maximum 10-year loan term with minimum yearly repayments comprising an annual principal and interest component.
- The interest component will be charged at the new (higher) annual benchmark interest rate prescribed by the Reserve Bank of Australia reflecting the small business variable overdraft rate.
- Existing 7 and 25-year Division 7A loans will be transitioned into the new regime, rather than being grandfathered, and will both be subject to the new benchmark interest rate from 1 July 2019.
- Existing 7-year unsecured loans will keep their current outstanding term upon transition.
- Existing 25-year secured loans will need to have in place a complying 10-year loan agreement prior to the private company’s lodgment day for the 2021-22 income year.
- An unpaid present entitlement (UPE) will be treated consistently with other payments made by private companies to taxpayers, by requiring the UPE to be repaid over time as a complying loan, with existing arrangements to be on complying terms by 30 June 2020.
- The concept of a ‘distributable surplus’ will be scrapped. The consequence of this will be that a private company’s deemed dividends assessed in an income year will reflect the entire value of the benefit extracted, rather than being capped at an amount equal to the distributable surplus.
- The ATO’s review and amendment period for Division 7A arrangements will be extended to 14 years. As the burden of proof lies with a taxpayer to disprove the Commissioner’s assessments, we anticipate that the proposed review period of this length could cause significant issues for taxpayers.
- A self-correction mechanism to assist taxpayers to promptly rectify breaches of Division 7A rather than having to apply for the discretion of the Commissioner under the current rules.
- The introduction of a safe harbour mechanism for the provision of certain assets by a private company to reduce the compliance burden when applying the arm’s length methodology.
- Other minor technical amendments to improve the integrity of the Division 7A regime.
The outcomes of this consultation will inform the development of legislation required to implement these measures. Submissions in response to the Consultation Paper are due by 21 November 2018.