Division 7A – as any client with a private company would know – is a key compliance area of the tax law. Complex rules and concepts overshadow the simple policy objective behind the operation of this Division – which, broadly, is to prevent the indefinite use of company profits by shareholders without incurring marginal tax rates.
Even the Government recognises that the complexity of Division 7A extends well beyond the mischief sought to be addressed; three years ago, the Board of Taxation was commissioned with the task of reviewing the rules and recommending simpler concepts that could achieve the policy objective.
Changes to simplify the rules, however, still seem to be some way off – despite the release in June 2015 by the Government of the Board’s report of November 2014, we appear to be no closer to a final decision as to how the provisions should be shaped. So, we must continue to monitor and apply them as they stand.
You may ask yourself, why are we so careful to ensure that your private company is compliant with Division 7A particularly when it comes to making written loan agreements and ensuring loan repayments are made back to the company. Our answer comes partly from recent experiences with comprehensive risk reviews conducted by the Taxation Office into taxpayers’ affairs – whenever the Taxation Office approaches a taxpayer for such a review, Division 7A questions and documentation requests are invariably included.
One of the Division 7A questions that we sometimes face is whether a loan by a private company to a partnership, even where one of the partners may be another private company, can be subject to the rules. Such an arrangement is a common structure used, for example, in relation to property developments carried out in the name of the partnership. Our comment has always been that Division 7A could very well apply and care should be taken to comply with its requirements.
Two recent Administrative Appeals Tribunal (“AAT”) decisions would appear to support our position, and they represent a timely reminder of just how complex, and perhaps unjust, Division 7A can be. Each case involved a loan by a private company to a “tax law” partnership – that is, a partnership that was not carrying on a business but nevertheless was an arrangement where the partners were in receipt of income jointly – and the AAT held that Division 7A did apply. Consequently, the partners (which in one case included a private company) were to be assessed on a share of the loan provided by the private company as though it were a deemed unfranked dividend.
So, the lesson from these decisions is that if a private company makes a loan to a partnership but does not execute a written loan agreement with the partnership or the partnership does not make minimum annual repayments of the loan, the provisions of Division 7A are likely to apply – with adverse tax consequences.
Until such time as the Government, as promised, redesigns the Division 7A rules to accord more practical business sense, any loans or payments made by private companies to shareholders or to non-corporate borrowers should be carefully reviewed.
