Top 5 Division 7A watch-outs

The top 5 Division 7A watch-outs are as follows.📷

1/ Transaction caught by Division 7A

Division 7A will arise if transactions fall into the following three categories, for a shareholder or shareholder’s associate:

certain loans from a private company,certain payments from a private company, andforgiveness of a debt owed to a private company.

Some exceptions and exclusions exist however. These include:

payments of loans to other companies,payments or loans that are otherwise assessable,loans made in the ordinary course of business on normal commercial terms,if a loan is repaid in full before the lodgment date, andDivision 7A loan agreement is in place in writing before the lodgment date (for example, minimum interest rate, maximum term).

If being caught, a private company is deemed to have paid an assessable unfranked dividend.

2/ Interposed entities

The tax law deems a private company to have made a payment or loan to an entity (target entity) for Division 7A purposes if:

the private company makes a payment or loan to another entity (interposed entity) that is interposed between the private company and the target entity, anda reasonable person would conclude that the private company made the payment or loan solely, or mainly, as part of an arrangement involving a payment or loan to the target entity, andeitherthe interposed entity makes a payment or loan to the target entity, oranother entity interposed between the private company and the target entity makes a payment or loan to the target entity.

3/ Unpaid present entitlement (UPE)

If a private company (corporate beneficiaries) has an UPE from an associated trust but the trust uses the money for its own purposes, Division 7A will apply. Further, a private company that releases all or part of its UPE is making a payment for Division 7A purposes to the extent that the release represents a financial benefit to an entity.

This issue can be avoided if:

the trust fully pays the UPE to the private company before the lodgment day for the trust’s income tax return,the parties put a Division 7A loan agreement in place, ora sub-trust arrangement is in place for the sole benefit of the private company.

4/ Distributable surplus

The amount taken to be a dividend is limited to the company’s distributable surplus calculated at the end of the year of income. The formula is:

Net assets + Division 7A amounts – Non-commercial loans – Paid up share value – Repayment of non-commercial loans

The distributable surplus does not necessarily equal to retained earnings.

5/ Government’s proposed changes to Division 7A

In the May 2016 Budget, the government announced it is proposing to amend Division 7A with effect from July 1, 2018 to include:

a self-correction mechanism providing taxpayers whose arrangements have inadvertently trigger Division 7A with the opportunity to voluntarily correct their arrangements without penalty,new safe harbour rules, such as for use of assets, to provide certainty and simplify compliance for taxpayers, andamended rules, with appropriate transitional arrangements, regarding complying Division 7A loans, including having a single compliant loan duration of 10 years and better aligning calculation of the minimum interest rate with commercial transactions.

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