The draft ruling released by the ATO on 16 December 2009 in relation to whether undrawn entitlements from trusts to companies are loans has generated a lot of interest and also significant uncertainty. Many accountants are concerned whether the change of interpretation will really impact only for the current and later financial years, whether the ATO intends to raise a lot of past year assessments and whether there will be any consideration given to providing guidelines and a period of time to adjust to the new reality that this draft ruling will bring if it is finalised in its current form.
Division 7A has really changed the way that corporate beneficiaries are used in closely held groups. Before Division 7A was enacted distributions went to the company and the cash went on personal assets and lifestyle. Now these companies are really used as financing vehicles. Profits that are needed to be reinvested in a business are distributed to a corporate beneficiary and the money remains in the trust to help fund the relevant business or investment, essentially becoming a source of long-term finance. Tax is seen to be capped at ‘only’ 30%. Reliance upon external finance is reduced and hopefully businesses grow stronger (and more profitable) as a result. When money is drawn for private purposes then either trust distributions reflect this usage or a dividend is declared to cover the payment.
The result is that monies drawn out of groups with company members for private use are tax-paid monies, which was the policy intent all along.
I’m looking for a tax mischief here that needs fixing by these new draft rules. Nope, none here!
This draft ruling essentially will require the undrawn entitlements that fund a business to come from individuals not drawing down on their entitlements because companies will no longer be able to be used, or can only be used for a few years as the minimum repayment rules forcibly reduce the loan with no regard to business conditions or what loan terms are available in the real world. In some cases the after-tax monies available to individuals to act as financiers will be higher (if the tax rate is lower for that individual), but in the main the tax cost will increase and so the cash flow pressures experienced by the business will increase.
If the ATO offer a ‘concession’ to treat all undrawn entitlements as loans from the current financial year onwards then the burden on businesses to repay these ‘new yet old’ loans over seven years could be too much for many. If the concession requires a ‘new yet old’ loan to be brought up to where it would have been if it had been a loan from the beginning (similar to what was provided under PS LA 2007/20) then the 2010 year could be a very difficult one for small businesses to survive.
This edition of ‘The Assessment’ was prepared by Graeme Prowse If you would like assistance in relation to The ATO Redefines the Rules of the Game please feel free contact Graeme by phone on 03 8662 3200 or by graemep@webbmartinconsulting.com.au
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