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Sladen Legal’s Neil Brydges, Patricia Martins and Sam Campbell discuss Treasury’s proposed amendments to Division 7A, which, they argue, could come at a significant cost. Submissions in response to the Consultation Paper close 21 November.
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On 22 October 2018, The Treasury released a Consultation Paper (Consultation Paper) seeking stakeholder views on proposed amendments to Division 7A of Part III of the Income Tax Assessment Act 1936 (Division 7A).
The proposed amendments in the Consultation Paper draw on, but include significant departures from, earlier recommendations in the 2014 Board of Taxation’s report on the ‘Post Implementation Review of Division 7A’ (Earlier Report).
In the 2017 Federal Budget the Government announced that amendments to Division 7A would incorporate the recommendations in the Earlier Report however the Consultation Paper proposes a different regime. If amendments in the Consultation Paper become law, the new regime will apply from 1 July 2019.
Key elements of the new Division 7A regime
Some key elements of the proposed new regime outlined in the Consultation Paper include:
1. “Simplified” single 10-year loans with interest charged at the Reserve Bank of Australia overdraft rate for small business, currently at 8.3% (RBA Rate), which is higher than the current Division 7A rate for the 2019 income year at 5.20% (Division 7A Rate).
2. Not adopting the amortisation model with principal repayments at the 3, 5, 8 and 10-years recommended in the Earlier Report. Instead the proposed new regime requires annual payments of both interest and principal.
3. Regardless of when a repayment occurs during the income year, interest will be for the full year.
4. The transitioning of both 7 and 25-year loans under Division 7A into the new regime. The Earlier Report had recommended grandfathering (preserving) 25-year loans under the existing arrangements.
5. Both existing 7 and 25-year loans will be subject to the new higher interest rate from 1 July 2019.
6. Existing 7-year loans will keep their current outstanding term when transitioned into the new regime, but existing 25-year loans must be either repaid or put on new 10-year complying loan arrangements prior to the lodgement day of the company tax return for the 2021 income year.
7. Both pre-4 December 1997 loans (with the benefit of a 2-year grace period until 30 June 2021) and unpaid present entitlements (UPEs) arising on or after 16 December 2009 must be put on new complying 10-year loans. The Consultation Paper does not address pre-16 December 2009 UPEs (which appear quarantined under the proposed new regime).
8. The removal of the concept of distributable surplus such that there is no limit to the amount that may trigger a deemed dividend under Division 7A.
9. The extension of the review period for Division 7A to 14 years after the end of the income year in which the loan, payment, or debt forgiveness triggered, or would have triggered, a deemed dividend.
10. The Earlier Report’s recommendation for a once-and-for-all election to exclude loans from companies (including UPEs owing to companies) from the operation of Division 7A (the ‘business income election’) is not included in the proposed regime, despite the Earlier Report noting that the election to be excluded from Division 7A should accompany the new loan model.
The Consultation Paper takes a “pick and choose” approach from the Earlier Report, removing the ability to choose to be excluded from the Division 7A regime, while introducing many of the penal aspects.
There are also several further proposed amendments relating to:
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- non-resident private companies;
- new safe harbour measures for the use of assets by a corporate taxpayer;
- amendments to the timing rules in section 109CA(2);
- amendments to the interaction between debt forgiveness and loans;
- amendments to section 109M that addresses loans made in the ordinary course of business;
- removing some of the restrictions around the interposition of entities in 109T to extend the operation of this provision; and
- the integration of Division 7A and fringe benefits tax and deductibility of payments.
Transitioning of existing 7 and 25-year loans under the proposed Division 7A amendments
One of the key elements of the new Division 7A regime proposed under the Consultation Paper consists of transitioning existing 7 and 25-year loans under Division 7A into 10-year loans.
What does the single 10-year loan model mean to those who have an existing 25-year loan?
The Consultation Paper states that all existing 25-year Division 7A loans as at 30 June 2019 will be exempt from most of the proposed changes for two-years until 30 June 2021 (Transitional Period). However, the interest rate payable on loans during the Transitional Period must equal or exceed the RBA Rate rather than stay at the Division 7A Rate.
After the Transitional Period, the outstanding principal will give rise to a deemed dividend of that amount unless a 10-year compliant loan is put in place prior to the lodgment day for the 2021 income year.
In practice, this means that those who have existing 25-year loans in place have approximately 3 years after the start date of 1 July 2019 until they are forced to decide whether they pay the outstanding loan amount or convert such amount into a 10-year compliant loan.
The impact of this decision will depend on when the 25-year loan began.
For example, if the 25-year loan began in 2001, by 2021 the loan will have been in place for 20 years. It appears that the remaining principal (if not repaid) could be put on a 10-year compliant loan giving a combined loan period of 30 years. Conversely, if the loan began in 2016, the combined term of the original 25-year loan that is replaced by a 10-year loan in 2021 will be 15 years. That is, a reduction of 10 years.
What does the single 10-year loan model mean to those who have an existing 7-year loan?
The Consultation Paper states that all existing 7-year Division 7A loans as at 30 June 2019 will retain their existing outstanding term, but the interest rate during the Transitional Period must equal or exceed the RBA Rate rather than stay at the Division 7A Rate.
What does the single 10-year loan model mean to pre-1997 loans?
For outstanding pre-1997 loans as at 30 June 2019 (those that have not been forgiven in an earlier period due, for example, by being statute barred), the proposed regime will provide borrowers with a grace period of 2 years before the first repayment is due with repayment due over the following 10 years.
Conclusion
The Consultation Paper outlines substantial changes to Division 7A that may affect taxpayers significantly, increase compliance costs, and potentially result in double taxation.
In many significant respects, the proposed new Division 7A regime outlined in the Consultation Paper departs from those recommendations outlined in the Earlier Report.
While further consultation on potential reform of Division 7A is welcomed, the starting date of 1 July 2019 may not be realistic, particularly when such reform is found to be financially and administratively onerous to taxpayers.
Submissions in response to the Consultation Paper are due by 21 November 2018.
Neil Brydges, Accredited Specialist in Tax Law, is a Special Counsel in the business law area, with a particular focus on taxation advice and disputes. Taxation law is a complex area. Neil’s aim is to provide technical expertise to clients, commercially applied and in a friendly and approachable manner. Neil’s practice involves advice, audits, disputes, and transactions. The client mix includes both family groups and business enterprises. Neil also regularly assists professional advisors, including tax agents, accountants and financial advisors, to understand complex legal issues and help them to better assist their own clients. Neil is a Chartered Tax Advisor with The Tax Institute and accredited as a specialist in taxation law with the Law Institute of Victoria. Neil is also a Member of the Law Institute of Victoria’s Taxation and Revenue Law Committee and a Member of The Tax Institute’s SME & Tax Practitioner, GST, and Large Business and International Tax Committees. Contact Neil at nbrydges@sladen.com.au You can also connect with Sladen Legal via Twitter and LinkedIn
Patricia Martins is an associate in the business law department at Sladen Legal where she works primarily in the areas of taxation, trust law, business structuring and asset protection. Patricia holds a Master of Laws (LLM) in Corporate and Taxation Law from University of New South Wales and has previously worked in the tax disputes division of a leading tax law firm outside of Australia. Having experience across civil law and common law jurisdictions, Patricia brings strong knowledge to assist domestic and international clients and is dedicated in ensuring that the best outcome is delivered with exceptional commitment. Patricia’s principal areas of practice include: Federal and State tax law advice; Trust law advice; Business structuring; Taxation issues associated with restructures and domestic and cross-border transactions; Taxation issues associated with asset protection and estate planning. Professional associations and awards: Member of the Tax Institute, Member of the Brazilian Bar Association, Proficient in Portuguese, Italian and Spanish. Contact Patricia at pmartins@sladen.com.au or connect via LinkedIn
Sam Campbell is an associate in the business law area of Sladen Legal, where he provides advice and assists clients on a wide range of tax and related commercial law matters. Sam deals with both private clients and those working in small to medium enterprises. He regularly assists professional advisors, including registered tax agents, accountants and financial advisors, to understand complex legal issues and empower them to better assist their own clients. Sam’s broad experience, ranging from private practice and professional services’ firms to the Australian Taxation Office, enables him to consider and apply practical and commercial outcomes for his clients, whilst navigating relevant legal, policy and commercial considerations. Sam’s experience working both for and against government, and for professional services’ firms, provides him a unique perspective and insight when seeking the most beneficial outcome for his clients, especially when engaging with government bodies. Sam’s principal areas of practice include: Federal and State taxation advice; Tax dispute resolution; Business and family succession consulting; Tax advice in relation to business and commercial transactions. Professional associations: Member of The Tax Institute. Contact Sam at scampbell@sladen.com.au
You can also connect with Sladen Legal via Twitter and LinkedIn
