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Significant Changes Coming to Division 7A

November 2018

A newly-released Treasury consultation paper explains how changes to Division 7A are likely to apply and while still to be legislated, the changes are potentially significant.

The Federal Budget of 2017-18 and 2018-19 announced proposed changes to Division 7A, signaling substantial changes to the rules and obligations.

A recent consultation paper from the Australian Treasury has outlined how these changes may apply and while the proposed rule changes could look very different after the consultation process, it's important to understand how these changes could affect you.

So what is changing and how should you prepare? Some of the key proposals which are due to commence from 1 July 2019 are summarised below.

Maximum 10-year loan agreement

The current rules for Division 7A allow for loans to be placed under 7-year or 25-year loan agreement, however, the consultation paper says that new rules would only allow for a maximum 10-year loan agreement. Annual repayments of principal and interest would be required to prevent a deemed dividend from arising. Transitional rules would be introduced to ensure existing Division 7A rules are brought into the 10-year loan model as follows:

  • 7-year loans would retain their existing outstanding term.
  • Existing 25-year loans would be largely exempt from the new rules until 30 June 2021.

Pre-1997 loans

Loans made before 4 December 1997 that have not been forgiven (or deemed to have been forgiven) will be refreshed and brought within the scope of Division 7A on the following terms:

  • They will be treated as financial accommodation as at 30 June 2021
  • Will need to be repaid or placed under a complying loan agreement by the company's lodgement day for the 2021 tax return to avoid a deemed dividend.

Distributable surplus will be removed

The concept of distributable surplus will be completely removed, which means that the entire value of the loan, payment or forgiven debt will be an assessable deemed dividend regardless of the financial position of the company.

Unpaid present entitlements may trigger a deemed dividend

Unpaid present entitlements (UPEs) are the balances of trust distributions that have been distributed on paper but the cash is yet to follow the distribution. UPEs will trigger a deemed dividend unless they are paid out or placed under a complying loan agreement by the lodgement day of the company's tax return. Existing UPEs that arose between 16 December 2009 and 30 June 2019 will be brought within the scope of these new rules as well. Treasury is still considering whether UPEs that arose before 16 December 2009 should be brought within the scope of Division 7A.

Existing UPEs that arose between 16 December 2009 and 30 June 2019 will be brought within the scope of these new rules as well. Treasury is still considering whether UPEs that arose before 16 December 2009 should be brought within the scope of Division 7A.

Self-correction mechanism to fix Division 7A problems

A self-correction mechanism will be introduced which will enable taxpayers to fix Division 7A problems without having to ask for the Commissioner's discretion to disregard a deemed dividend.

A number of conditions would need to be met in order to be able to take advantage of this, for example, appropriate steps must be taken to fix the problem within 6 months of identifying the error.

The amendment period rules for Division 7A issues will be extended to cover 14 years after the end of the income year in which the loan, payment or debt forgiveness occurred.

Safe harbour mechanisms will be introduced in relation to the use of company assets where the parties are trying to show that the shareholder has paid an arm's length amount for the use of the asset.

A number of other changes are being proposed with the aim of clarifying issues which currently cause confusion as well as addressing some integrity concerns that have been identified.

Watch this space – but speak to your accountant anyway

While the final legislation may evolve over coming months it is quite clear that there are some significant changes to Division 7A arrangements on the way. The proposed start date is 1 July 2019, which won't leave much time for you to work with your accountant to understand how the new rules will impact your current arrangements.

We recommend that you speak to your accountant now to ensure that your Division 7A arrangements are properly documented and to ensure that any outstanding matters are addressed to enable your accountant and your business or trust to adapt to the legislation when it does land.

For more information, please contact us on 02 9957 4033.

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Disclaimer

This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.

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