New financial year resolution: clean up the Div 7A loans mess
A new practice statement gives private companies the chance to fix up certain outstanding non-compliant debit loans, write Michael Parker and Andrew OBryan.
In a piece of good news for private companies and their shareholders, the Australian Taxation Office has released a practice statement giving it the opportunity to fix up certain outstanding, non-compliant debit loans.
The practice statement, PS LA 2007/20, follows the recent passage of amendments to Division 7A (Div 7A) giving the commissioner of taxation discretion to disregard the effects of Div 7A on a loan or payment made by a private company to a shareholder or shareholder's associate, or on the forgiveness of a debt owed by such a person to a private company.
Conditions for the opportunity to be available
In response to this new discretion, the Tax Office is providing a one-off opportunity for taxpayers to take 'corrective action' to fix up non-compliant loans, payments and forgiveness of debts if the following conditions are met:
the failure to comply with Div 7A was the result of an honest mistake or inadvertent omission by the taxpayer (the shareholder or associate), the private company or another relevant party, which can include the tax agent
'corrective action' is taken by the taxpayer on or before 30 June 2008
the transaction giving rise to the operation of Div 7A (and hence a deemed dividend) occurred between 1 July 2001 and the end of the 200607 income year (generally 30 June 2007)
the taxpayer has lodged all required income tax returns for the 200102 to 200607 income years
This will be a self-assessing opportunity. That is, taxpayers do not need to request the commissioner to exercise the discretion when the conditions are all met. So, taxpayers can correct their Div 7A problems and have a clean slate without needing to run it past the Tax Office first.
In addition, if a taxpayer has already been assessed on a deemed dividend under Div 7A for any of the relevant years, they can seek an amendment of that assessment provided the conditions are met and that they are within the time limits for amending.
Honest mistake or inadvertent omission
The need for there to be an honest mistake or inadvertent omission stems from the amendments to Div 7A. The amendments provide the commissioner with the discretion to disregard breaches of Div 7A in cases where there is an honest mistake or inadvertent omission.
The explanatory memorandum accompanying the amendments and the practice statement itself provide some guidance and examples of when there will be an honest mistake or omission. Importantly, the mistake or omission can be that of the tax agent.
A common example is where taxpayers and their tax agents mistakenly believe that a loan from a private company to a business trust or investment trust associated with the shareholders is not caught by Div 7A.
This mistake generally arises because taxpayers and agents believe that a loan from a company to a trust does not involve the use of company funds for private purposes and so is not the sort of thing Div 7A is targeting. However, such a loan would still be caught by Div 7A and treated as a deemed dividend. This would seem to be an honest mistake. It is an example the Tax Office uses in the practice statement.
Similarly, loans from trusts to individuals or other trusts, in circumstances where the lending trust owes an unpaid present entitlement to a company, may be incorrectly viewed by some taxpayers and their agents as being acceptable. But it is another example of a loan that Div 7A will treat as a deemed dividend. Such a mistaken belief or omission would also appear to fit within the concept of honest mistake or inadvertent omission.
Another example is where a taxpayer does not use a tax agent and is unaware of the existence of Div 7A. This would also appear to be an honest mistake.
By contrast, writing off loans made by companies to their shareholders in order to get them off the balance sheet so as to avoid detection would clearly not fall within the honest mistake/inadvertent omission category.
Corrective action
One of the conditions for the opportunity to be available is that the taxpayer must take corrective action on or before 20 June 2008.
Essentially, the corrective action is designed to place the taxpayer in the same position they would have been had they entered a Div 7A compliant loan with the company at the time the original transaction took place.
In the case of loans made by a company to a shareholder or associate, the corrective action consists of putting in place a loan agreement that complies with section 109N by requiring annual repayments of principal and interest at rates equal to those published annually by the Tax Office with a seven-year term or 25 years if secured by real property.
The corrective action also consists of making sufficient repayments of interest and principal on that loan to equate to the minimum yearly repayments that would have been made had a complying loan agreement been in place from the year in which the dividend arose.
In the case of a payment made by a company to a shareholder or associate, corrective action means converting the full amount of the payment into a loan that complies with section 109N, and making sufficient repayments of interest and principal to equal the minimum amounts that would have been repaid had a complying loan been in place from the year the deemed dividend arose.
Corrective action for forgiven debts means treating the forgiven debt as the principal of a loan, entering into a loan agreement that complies with section 109N, and making sufficient payments of interest and principal to equal the minimum repayments that would have been made had a complying loan been in place from the year the deemed dividend arose.
Similar rules apply as to what constitutes corrective action for loans, payments or forgiven debts under section 109XA where the original transaction was between a trustee and the shareholder/associate while the trustee owed an unpaid present entitlement to a corporate beneficiary.
The simple approach
The Tax Office has also released a guide to calculating payments forming part of the corrective action. In the guide, the Tax Office outlines factors that can be used to determine the amount of interest and principal repayments required for seven- and 25-year loans to bring them up to date.
For seven-year loans the message is: fix it up as this is your last chance to go quietly. Even if you think your circumstances don't fit the criteria perfectly, the best position you can be in at 1 July 2008 is to at least look compliant. Looking compliant probably means making sure the loan has been repaid in full and all applicable interest has been paid.
The practice statement doesn't say anything about there being an amnesty. However, deputy commissioner Mark Konza has confirmed the Tax Office's approach will be to 'give people the opportunity not to worry about the tax they will have to pay' and that for the next 12 months, the Tax Office will be taking 'a general attitude to the application of the discretion'.
Konza then warns that there are two reasons for companies to take advantage of the Tax Office's 'amnesty'.
First, taxpayers can fix up their mistakes before they're audited.
Secondly, they can do it without having to wave a red flag in front of the commissioner.
From 1 July 2008, you can expect the Tax Office to be less than generous if it finds your clients in a non-compliant situation.
