With the volume of discussion around the tightening of Division 7A loans over the past year with particular regard to unpaid trust distributions, you'd be forgiven for getting that glazed over look after a while, and the potential consequences for not giving it due attention can be pretty steep.
This year sees trustees and companies having to deal with transitional and ongoing measures
that will require some important planning and decisions to be made. With the ATO improving its integrity measures, now is the time to get your affairs in order.
When a company, or trust on its behalf, pays cash to the benefit of a person or another trust, it must make a clear determination about whether it is in the form of a dividend or a loan.
In addition, if a company is entitled to a trust distribution and that distribution has not been paid then these provisions may apply to cause a deemed dividend.
Division 7A is necessary in our tax system to true up the tax obligation when money moves from a company to an individual as the company has a lower tax rate than what may apply to individuals. Companies pay tax at 30% and marginal tax rates of up to 46.5% apply to individuals.
The trust must make a documented decision about whether funds taken from the trust are a loan or a dividend of the company otherwise Division 7A will make that decision for you.
Where the income has been captured in a lower tax profile such as a company and this is separately dispersed to an individual who is on a higher tax rate, the ATO expects to pocket the difference in tax. This is what happens when a normal dividend is paid.
If the trust makes a loan to a beneficiary or another trust, it must assess and make the decision as to whether it is a loan or a dividend.
If it is a loan, then more decisions must be made:
- Can it be repaid prior to 30 June?
- Does a loan agreement need to be entered into?
If it is a loan then special terms and conditions need to be included and documented. Failing to make a complying loan means that the ATO will treat it as a deemed dividend rather than a loan.
If a normal dividend isn't declared at the correct time, the penalties can be stiff. An individual may be considered to be in receipt of an unfranked deemed dividend, which can attract tax of up to 46.5%. The company will also be penalised through various mechanisms that will cost the company no less than 30c in the dollar.
Clearly failing to make a determination can have expensive consequences.
If you're not sure of where you stand or you don't have your paperwork in order, contact us on 02 9957 4033 to talk to our team.
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Last updated June 2012. This article is provided for information purposes only and should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.
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.