Last month the Federal Treasury released for public consultation a paper on the “Targeted amendments to the Division 7A integrity rules”. If the proposed changes go ahead, any existing Div 7A loans, unpaid present entitlements (UPE’s) that have been placed on sub-trust arrangements, or any loans that predate the introduction of Div 7A (December 1997) will need to be reviewed before 30 June 2019.
We have made a submission to Treasury setting out our key concerns and comments. A copy of our submission can be downloaded below.
The major proposed changes, most which will commence on 1 July 2019, are:
The benchmark interest rate will be based on the overdraft rate (no longer the variable housing rate), resulting in an increased interest cost of approximately 3% pa;
Div 7A complying loans will be 10 years with principal and interest, and existing 7 year or 25 year loans will be subject to transitional arrangements;
Pre 97 loans will be converted to 10 year complying loans;
Sub-trust arrangements for UPE’s with interest only payments will cease.
A deemed deemed dividend will no longer be limited to the distributable surplus; and
There will be a 14 year amendment period for Div 7A transactions.
Our key concerns on these proposed changes are:
The proposed 14 year amendment period
It is unclear whether the 14 year amendment period only applies from 1 July 2019 for payments, loans or debt forgiveness that arise after that date, or whether it is intended to operate retrospectively.
This proposal is intended to capture those taxpayers that manipulate their Division 7A position by claiming the Commissioner is out of time to amend assessments and include a deemed dividend. It is considered that this proposed amendment is unnecessary, as the legislation already provides that If there has been fraud or evasion, the Commissioner has an unlimited time to go back and amend.
Higher Interest Rate
Although there are a number of transitional rules available for pre-existing Division 7A arrangements, there is no grandfathering available for the existing lower benchmark interest rate to continue to apply.
Regardless of whether you have an existing 7 year or 25 year loan, as at 1 July 2019 the interest payable will be based on the significantly higher benchmark interest rate of the applicable overdraft rate (currently the difference is approximately 3.2% extra interest payable).
For those clients that have already entered into arrangements, in particular where there is a secured 25 year loan in place, the higher interest rate can significantly impact on cash flow. It may be worthwhile considering alternative external financing arrangements prior to 30 June 2019.
Pre 97 loans
The proposal is for outstanding pre 97 loans to be subject to Div 7A as at 30 June 2021. To avoid the loan amount as at this date being a deemed dividend, the outstanding amount will need to be placed on a 10 year complying loan agreement.
It may be the case that many pre 97 loans have become statute barred (many years ago) and a review should be undertaken of all pre 97 loans to determine the correct position.
The Commissioner released a practice statement (PSLA 2006/2) which provided that he would not take “active compliance action” for pre Division 7A loans that have become statute barred.
If you do have pre 97 loans, a review should be undertaken to determine the impact of the proposed changes, to take effect from 1 July 2019.
Currently, if there is a deemed dividend under Division 7A, the amount of the assessable dividend is limited to the distributable surplus of the company. The distributable surplus is calculated according to a formula in the legislation, but essentially ensures the dividend will only be from profits of the company.
The proposed amendments will remove the concept of distributable surplus, with the intention that this will align the treatment of deemed dividends under Division 7A with section 254T of the Corporations Act 2001 (Cth) which allows dividends to be paid out of both profits and capital.
This proposed measure will broaden the potential application of Division 7A.
Unpaid Present Entitlements (UPE’s)
Where there is a company beneficiary of a trust with a UPE, from 16 December 2009 this UPE, if it remains unpaid by the trust, will be a deemed dividend.
The Commissioner allowed such UPE’s, if placed on a sub-trust arrangement, to be lent to the trust for 7 or 10 years on concessional arrangements compared to ordinary Div 7A loans, as the terms were for interest only repayments. The guidance for such sub-trust arrangements was set out in Practice Statement (PSLA 2010/4).
From 1 July 2019, this “concessional” arrangement will cease, and all UPE’s will need to be put on 10 year complying loan terms. The transitional arrangements will give those with existing UPE’s until 30 June 2020 to place the existing UPE on a new 10 year loan term.
For UPE’s that were in existence before 19 December 2009, although these UPE’s have historically been quarantined and not subject to Division 7A, the consultation paper raises the question of whether or not from 30 June 2019 they may become subject to Division 7A.
The release of the consultation paper follows on from 2 years of Budget announcements that there would be changes to Div 7A, and is largely in response to a number of Board of Taxation recommendations made several years ago.
If you do have existing Div 7A loans, or corporate beneficiaries with UPEs, or any loans that were made before December 1997, please contact us to discuss the potential impact of these proposed changes.