Changes to tax laws make Division 7A loans a poisoned apple for many

The Government has provided long-awaited guidance (as a consultation paper for feedback) on the detail for proposed changes to Division 7A loans from companies. The changes are not proposed to take effect until 1 July 2019 and others deferred to 1 July 2021.

However, given the potential impact on tax liabilities and cash flow consequences that result from the changes, it is recommended that those with Division 7A loans consult with a tax professional immediately to seek strategies to plan ahead of the proposed changes. While not the final provisions, they do indicate the direction the government is taking and the basis of how the revised laws will be drafted.

The proposed changes will have the biggest impact for those with loans that were previously quarantined at 4 December 1997 as being outside the scope of Division 7A. Such loans have been often left on the balance sheet to be dealt with in the never-never. Under the proposals, such loans will come into Division 7A from 1 July 2021 and will require repayments and have interest charged on them over a 10-year period from that date and will likely result in a significant tax gap on loans.

There will also only be the option for 10-year loans rather than the current seven or 25-year loans. While this is good news for seven-year loans as the repayment term has been increased, the removal of the 25-year option is significant where loans were used to acquire property and were secured by mortgages over the acquired property.

The Most Significant Changes Are:

1. A higher interest rate to be introduced on all loans
2. A straight-line principal repayment requirement (annual principal repayments are the loan amount divided by the 10-year period and interest is the opening balance multiplied by the deemed interest rate)
3. Repayment terms of 10 years for all loans, but current seven-year loans are not extended and will just expire on their current repayment period
4. Confirmation that unpaid present entitlements (UPEs) are loans for Division 7 purposes and that while current pre-December 2009 UPEs are not included, the consultation raises the possibility they should be
5. An extension to the period of review for Division 7A matters to 14 years (currently four years)
6. The removal of the concept of distributable surplus so that regardless of the company’s position, the taxpayer receives a deemed dividend.

Who Is Affected?

The clock is ticking to get your house in order and minimise the impact of these changes on your financial position. Those likely to be affected include:

• Those with pre-4 December 1997 loans still outstanding
• Those that have been distributing trust income to company beneficiaries but not passing on the amount as cash or assets
• Those that have 25-year loans.

What Is A Division 7A Loan?

Division 7A is an integrity rule that is designed to prevent shareholders from using private company profits without paying tax at their marginal tax rates. PKF estimates that many private companies have such loans and have Division 7A compliance requirements and that the impacts of the changes need to be considered for every business that operates through a company.

Who to Contact?

Darren Shone is PKF’s resident tax guru. He has the skills and knowledge to help you navigate this complex area and put a strategy in place to ensure that your finances are protected.