You will need to comply with Division 7A obligations before 30 June 2020.
Division 7A is an anti-avoidance measure in the Income Tax Assessment Act 1937 (Cth) (ITAA) and contains integrity provisions designed to prevent private companies from making tax-free distributions of profits to shareholders (or to their associates) in the form of payments, loans or debts that are forgiven. The Division 7A integrity measures start date has been postponed until 1 July 2020.
Division 7A of the ITAA sets out the minimum terms for financial accommodation or loans provided by private companies to shareholders (or their associates). The minimum loan terms include (amongst other things):
1. Term – the financial accommodation or loan can operate for either a 7 year or 25 year term;
2. Security – if the term is 25 years, it must be secured by a real property mortgage (and the unencumbered value of the property must be at least 110% of the amount of the loan or financial accommodation). A 7 year loan does not require any security; and
3. Interest – interest must accrue at the benchmark interest rate (which is the Indicator Lending Rates (Bank variable house loan) interest rate published by the Reserve Bank of Australia), being 5.37% for the 2019/2020 income year.
In addition to the above, one of the key requirements for Division 7A loans is the requirement for the borrower (being the shareholder or its associate) to make a minimum yearly repayment of principal and interest before the end of each financial year (excluding the financial year in which the loan was made).
WHY SHAREHOLDERS SHOULD ACT URGENTLY TO CONVERT 7 YEAR LOANS
There are 2 reasons for this:
Firstly, the end of the 2019/2020 income year, and the requirement to make a minimum yearly repayment, is fast approaching.
Secondly, the Federal Government is proposing to replace the existing 7 year and 25 year loan structures with a single 10 year loan model (10 Year Loan Model) with effect from 1 July 2020. The 10 Year Model will increase the interest rate on Division 7A loans to 8.3% (creating further cash flow issues for many shareholders).
All existing 7 year and 25 year loans will be required to transition to the new 10 Year Loan Model.
If a shareholder (or its associate) has an existing 7 year loan agreement in place and they are unable to make the required minimum yearly repayment before 30 June 2020, the shareholder and company lender should consider whether a conversion of the 7 year loan to a 25 year loan is possible. By converting the loan now, the term of the loan is extended and consequently the minimum yearly repayments of the borrower will be reduced. Keeping in mind that we are yet to see any draft legislation, as to whether the 10 Year Loan Model will actually take effect on 1 July 2020, now is the opportunity to arrange for a 7 year loan conversion to be actioned so the relevant shareholder gets the benefit of the proposed grandfathering (i.e. exemptions) arrangements. These grandfathering arrangements will allow 25 year loans to continue for a certain period of time after any legislation takes effect.
You should also be aware that where it is a company loan to a shareholder or an associate, the superannuation fund is typically an associate or where you've got a family trust that distributes net income to a company and doesn't physically transfer the money, there's this unpaid present entitlement, which can give rise to division 7A deemed dividend. Speak to your accountant to ensure that you are compliant.
The new rules will also impact pre-1997 loans. Many taxpayers will have pre-1997 loans sitting on their balance sheet. However, under the new rules taxpayers will need to put these under a complying loan agreement by the end of the 2020–21 income year.
Unpaid Present Entitlements (UPEs) will come within the scope of Division 7A, that will ensure the UPE is either required to be repaid to the private company over time as a complying loan or subject to tax as a dividend. UPEs arising on or after 16 December 2009 will need to be paid to the company, or put on complying 10-year loan terms by 30 June 2020.
If you require any further information on any of the above, please contact Rostom Manookian, 0416 716 960 or email rostom@manookiansolicitors.com to put in place the necessary Division 7A loan agreement to ensure compliance.
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