ATO’s warning on common Division 7A mistakes
The ATO is warning that a series of common mistakes are being made in relation to Division 7A, which can apply when shareholders or their associates access money and assets from a private company.
Division 7A is a focus area of the ATO. If taxpayers fail to identify and deal with Division 7A issues appropriately, this can lead to harsh tax outcomes resulting in a deemed unfranked dividend in the hands of the shareholder or their associate.
While Division 7A contains some complex and highly technical provisions, the ATO has indicated that often the mistakes that are being identified relate to fundamental aspects of the rules.
One of the common ways of preventing a loan from a private company to a shareholder or their associate being treated as a deemed unfranked dividend in the year the loan is made is to ensure the loan is placed under complying loan terms by the relevant deadline. However, the ATO has been identifying situations where loan arrangements don’t meet the strict requirements contained in Division 7A.
In order for a loan to be subject to complying Division 7A terms there needs to be a written agreement which meets the following requirements:
- A minimum interest rate at least equal to the Division 7A benchmark rate; and
- A maximum term of 7 years (or in some cases 25 years if the loan is secured by a mortgage over real property).
Placing a loan under a complying Division 7A loan agreement will normally prevent the full loan balance from being treated as a deemed dividend. However, if the borrower doesn’t make the minimum annual loan repayments in a subsequent income year then this can trigger a deemed dividend for the shortfall in the repayments for that year. The ATO has identified that it is relatively common for errors to be made when making minimum repayments.
It is also important to remember that the use of private company assets by a shareholder or their associate can sometimes be treated as a payment for Division 7A purposes, which can trigger a deemed dividend if the shareholder or associate doesn’t pay market rates for the use of the asset. The ATO is finding that taxpayers often don’t realise that the use of private company assets can trigger Division 7A or they aren’t taking appropriate steps to prevent a deemed dividend from arising.
The low level of compliance with Division 7A has prompted the ATO to launch a series of webinars and articles to help educate practitioners and taxpayers on key aspects of the rules. However, this doesn’t mean that the ATO won’t continue to undertake reviews and audits looking for situations where Division 7A has been triggered. This is clearly an ATO focus area at the moment and practitioners should ensure that appropriate steps are being taken to identify potential Division 7A problems and that these are managed carefully.
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