We anticipate the Federal Government will soon release details confirming its final amendments to the Div 7A legislation which regulates certain payments and loans from private companies to its shareholders and associates.
What does Div 7A do?
Division 7A of the Income Tax Assessment Act 1936 was introduced in 1997 as an integrity measure to prevent shareholders in private companies and their associates from accessing funds in those companies without paying income tax at their marginal rates. It achieves this in three ways by treating the following amounts as unfranked dividends:
- Payments or transfers of property from the company
- Loans from the company
- Debts due to the company that are forgiven
Most tax payers operating private companies are familiar with the principles of the current Div 7A rules for loans so we will not restate them here.
However, the rules are complicated and have been the subject of much analysis and dispute since their introduction. Following a review by the Board of Taxation the Federal Government announced in the 2016-17 Budget it would make targeted amendments to improve the operation of Div 7A. A Treasury consultation paper was issued in October 2018 in which the Government proposed a number of changes to the Div 7A rules.
What changes has the Government proposed for private company loans?
The Board of Taxation’s review of the Div 7A rules concluded they ‘are complex, inflexible and impose significant compliance costs on taxpayers, including many small businesses’. The Government’s response was to acknowledge this and propose some enhancements, but also to take the opportunity to make changes which appear to be focused on raising revenue. These changes were scheduled to come into effect from 1 July 2019, but were deferred in the 2019-20 Federal Budget to 1 July 2020.
Subject to any amendments arising from the consultation process, a summary of the main changes that may impact your private company loan arrangements are:
- the interest rate applied to Div 7A loans will change benchmarks with the result it will significantly increase. The current benchmark interest rate is 5.37% (2019-20). Under the changes it will be linked to the RBA Small business; Variable; Other; Overdraft benchmark which is currently 7.74%
- interest will be applied to the loan balance on 1 July for the full year regardless of any repayments made in the period
- the maximum loan period will be 10 years with principal repayments being equal payments over the period of the loan
- existing 7 year loans will transition to the new rules immediately without a change to the loan term. The effect of this is the new benchmark interest rate will apply to the loan balance at 1 July 2020, and this balance will be paid off in equal instalments over the remaining life of the loan
- existing 25 year loans will transition to the new repayment rules from 1 July 2022, to be repaid in equal instalments over a maximum of 10 years, but with the new benchmark interest rate applying from 1 July 2020
- Pre-1997 loans will transition to the new rules from 1 July 2022, to be repaid in equal instalments over a maximum of 10 years and with the new benchmark interest rate applying from 1 July 2022
There are a number of other technical amendments proposed but these are not covered here.
What do you need to do?
Whilst we cannot confirm that these changes will be brought in as proposed, you should consider how they could impact your loan and your cashflow arrangements from 1 July 2020 onwards.
There are three areas where there could be an immediate or short term impact on your cashflow:
- all current Div 7A loans will be more expensive to operate going forward as a higher benchmark interest rate will apply and principal repayments in the year will not be effective until the following financial year
- existing 25 year loans with a term in excess of 10 years on 1 July 2022 will require additional funding for earlier repayment of the principal than under current Div 7A arrangements
- pre-1997 loans will require new funding from 1 July 2022 to pay the benchmark interest rate and repayments of principal over 10 years
The impact on pre-1997 loans will be the most dramatic. These loans were made over 20 years ago, and it is extremely unlikely that the money has not been spent or invested in illiquid assets since that time.
Given the potential for significant impact on your personal cashflow arrangements, we recommend you consider how these changes could affect you as soon as possible.
To discuss how the changes to Div 7A could affect your private company funding arrangements please contact your usual Bentleys adviser.
Disclaimer – this is a simplified summary of the current draft consultation proposals and cannot be relied as advice for a reader’s existing circumstances or the basis on which to make decisions about any future actions.