Remember this is just a discussion paper, but I am confident these all will occur.
Change 1 – Simplified Loans
The biggest change is that the current 7 year and 25 year loan models will be replaced by a single loan model which has the following features:
- A 10 year loan begins at the end of the income year in which the advance is made.
- The taxpayer is still given until the lodgment day of the private company’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 private company’s income tax return.
- The minimum yearly repayment amount consists of both principal and interest, BUT 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.
- 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.
Here is the Government’s example of how this will work…
Example: Calculation of the deemed dividend
Bert is the sole director and shareholder of Sesame Pty Ltd.
On 1 August 2019, Bert withdraws $100,000 from Sesame Pty Ltd to pay for the renovation of his house. Bert does not have the funds to pay back Sesame Pty Ltd by the lodgment day of Sesame Pty Ltd’s income tax return, 15 May 2021. To avoid the $100,000 being treated as if it were a dividend paid from Sesame Pty Ltd, Bert decides to put in place a complying Division 7A loan agreement.
The repayments that Bert would be required to make according to the new loan model would be as follows:
Year Interest Rate* Opening Balance
2020-21 8.50% 100,000 8,500 10,000 18,500 90,000 2021-22 7.00% 90,000 6,300 10,000 16,300 80,000 2022-23 6.50% 80,000 5,200 10,000 15,200 70,000 2023-24 8.00% 70,000 5,600 10,000 15,600 60,000 2024-25 9.00% 60,000 5,400 10,000 15,400 50,000 2025-26 8.25% 50,000 4,125 10,000 14,125 40,000 2026-27 7.90% 40,000 3,160 10,000 13,160 30,000 2027-28 8.00% 30,000 2,400 10,000 12,400 20,000 2028-29 9.20% 20,000 1,840 10,000 11,840 10,000 2029-30 7.50% 10,000 750 10,000 10,750 0
*Interest rates shown are for illustrative purposes only
The interest paid by Bert each year will be taxed as income to Sesame Pty Ltd at its corporate tax rate.
- If the repayment actually made in the income year is less than the required minimum yearly repayment, a deemed dividend will arise for the amount of the shortfall between the minimum yearly repayment and the actual repayment made for that income year.
For example, the minimum yearly repayment in the above loan model example for the 2022-23 income year would be $15,200. If the actual repayment made in the 2022-23 income year was $12,200, the deemed dividend would be $3,000. Bert will include this $3,000 as income for the year, and pay tax at his marginal tax rate.
Change 2 – Self-correct without telling the Commissioner
Under the proposed changes, qualifying taxpayers will also be permitted to self-assess their eligibility for relief from the consequences of Division 7A. 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:
- The breach of Division 7A was an inadvertent breach;
- Appropriate steps have been taken as soon as practicable; 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 the private company’s income tax return for the income year in which the catch-up payment is made.
So now when you get the new client with heaps of Div7A issues you can clearly tell them how to fix it up.
Change 3 – Distributable surplus
The third major change is to the concept of distributable surplus – actually it is the total removal of the concept of distributable surplus.
This will align the treatment of dividends with section 254T of the Corporations Act 2001 which allows dividends to be paid out of both profits and capital.
And let’s be honest, if a certain amount is ‘distributed’ to the shareholder, then tax should be paid on the entire amount, and it should not be arbitrarily limited.
Change 4 – UPE argument over
After eight years of arguing with the Commissioner on whether UPE’s fall within Div 7A the argument is over as the law will be changed to say they are.
Under the proposed chnages, where a UPE remains unpaid at the lodgment day of the private company’s income tax return, the UPE will be a deemed dividend from the company to the trust or the UPE can be put on ‘complying loan terms’ under which principal and interest payments are required to be made.
All UPEs arising on, or after 16 December 2009 and on, or before, 30 June 2019, that have not already been put on complying loan terms or deemed to be a dividend, will need to be put on complying terms by 30 June 2020. The first repayment for such loans would be due in the 2019-20 income year. Any amounts outstanding that have not been put on complying loan terms by the end of the 2019-20 income year will result in a deemed dividend for the outstanding amount of the UPE.
All UPEs that arise on, or after, 1 July 2019 will need to be either paid to the private company or put on complying loan terms under the new 10 year loan model prior to the private company’s lodgment day, otherwise they will be a deemed a dividend.
Effectively, from 1 July 2019 there will be no argument… a UPE is the same as a loan.
There are lots of other proposed changes that will not be as relevant as these four changes and we can consider these later. But from these four main changes…
From 1 July 2019:
- If you find a Div 7A problem, you just fix it by paying what you missed;
- I don’t need written loan agreements;
- You don’t need to do distributable surplus calculations;
- UPEs to corporate beneficiaries are just treated like loans from the company to the trust;
- I pay the same principal off each year, 1/10thof the initial loan;
- The interest is just 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; and
- I pay off the loan over 10 years in every case.
Not as massive a change as we hoped, but a good start.