Recent changes introduced by the Government to the “Division 7A integrity rules” on private company loans do not remove all the uncertainties surrounding the rules, nor the compliance burden they create.
Most of the changes will start from 1 July 2019 and include:
- All new loans will be for a maximum 10-year term with yearly principal and interest payments
- The annual benchmark interest rate will be the official “Small Business: Variable: Other; Overdraft” indicator lending rate, published by the Reserve Bank, which is currently around 8.65 percent (approximately three percent higher than the bank variable housing rate)
- There will be no requirement for a formal loan agreement but evidence of the loan must exist prior to lodgement of the company income tax return
- The minimum yearly repayment will now consist of principal and interest. The principal will be made up of equal annual payments over the loan term, with any shortfall in the minimum repayment to be a deemed dividend in that year.
There are also a number of transitional rules including:
- Existing seven year loans will retain their current term from 1 July 2019, however the interest rate will be reset in line with the new annual benchmark interest rate
- Existing 25 year loans will not be subject to the new rules until 30 June 2021 but the interest rate will be the new rate. On 30 June 2021, the outstanding balance of the loan will give rise to a deemed dividend unless a loan agreement complying with the new rules is put in place by the lodgement day of the company’s 2021-22 tax return
- Currently, pre-1997 are generally outside the current Division 7A rules. It is proposed to make these loans subject to Division 7A from 1 July 2021 (which represents a complete reversal of treatment that has applied for over 20 years).
The current mechanism to calculate the amount of the deemed dividend under Division 7A is the “distributable surplus”. It is proposed that this concept will be removed, meaning that a deemed dividend will arise where there are no profits in the company. The consultation paper notes this is justified on the basis that the Corporations Act 2001 no longer requires dividends to be paid out of profits.
Unpaid Present Entitlement (UPE)
The proposed amendments will deem a UPE to be a loan whether or not it is put in a sub-trust, thus treating UPEs consistently with private company loans. Following the 30 June 2019 deadline, UPEs would have to be paid to the private company or put under a complying loan. UPEs arising between 16 December 2009 and 30 June 2019 that are not under complying loans or deemed to be a dividend will have to be put on complying loan terms by 30 June 2020.
It will be interesting to see where these changes will fit in the legislative priority of the Government, whoever that may be, after this year’s election.