Issue #1
Cleaning up the mess – can Division 7A problems be fixed now?
The new discretion offered by the Commissioner for loans, payments and debt forgiveness that should have been disclosed by taxpayers over the past six years offers taxpayers a real opportunity to clean out their Division 7A tax risks. It essentially applies where a taxpayer converts payments and forgiven debts into complying loan and then they catch up on the payment that should have been made. This has to happen by 30 June 2008 when the blanket discretion ceases to be available.
As with all initiatives there are some interesting consequences and also some issues as yet unresolved.
The practice statement requires that a taxpayer ‘catch up’ with the minimum repayments that they should have made over the years from when the loan was made and then complete the loan repayment arrangement.
This catchup can occur in the 2008 income tax returns (or in an earlier year should the taxpayer wish). The interest will presumably be assessable to the company in the year of receipt. The advantage for the company is that it does not need to amend prior year returns to update for unreceived interest income, whilst the recipient of the deemed dividend is not liable for past year income taxes paid late (with the possible interest becoming payable on the late payments). What interest to pay?
Contrast the two statements below:
11. If the deemed dividend arose in respect of a loan under section 109D then ‘corrective action’ means:· now having in place a loan agreement that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose, and · the taxpayer has made a payment, or payments, equal to the total of minimum yearly repayments that would have been payable had the loan existed from the start of the period that began with the year in which the deemed dividend arose. 15. If a taxpayer has taken ‘corrective action’ in the form of a payment or payments that in total equal the total amount of the minimum yearly repayments that would have been payable had the taxpayer made minimum yearly repayments throughout the period that began with the year in which the deemed dividend arose, then that payment, or the total of those payments, has two components: · Capital component - an amount equalling the difference between the original amount of the loan and the carried forward loan balance on 1 July 2008 if all complying minimum yearly repayments had been made (less any actual capital repayments made prior to 1 July 2008), and · Interest component - an amount equalling the sum of the annual interest that would have accrued on the loan from the date the loan should have commenced with interest compounding (less any interest actually paid prior to 1 July 2008).
How can an amount “equal to the minimum yearly repayments that would have been repayable” actually equal an amount calculated “with interest compounding”? In the normal course of events there is no compounding of interest under a complying loan agreement, so a taxpayer will not be able to meet both definitions of ‘corrective action’.
Should you read the practice statement in full you will see that the payment amount is defined six separate times – five of the definitions match paragraph 11 above (one for payments, one for loans, one for forgiven debts etc), whilst paragraph 15 clearly has a different definition. Even the first part of paragraph 15 does not match the sum of the bullet point amounts.
We note that the ATO have released a fact sheet that uses the ‘paragraph 15’ definition of corrective action (http://www.ato.gov.au/businesses/content.asp?doc=/content/00104288.htm).
It will be interesting to see what action the ATO take if a taxpayer meets the former definition but not the latter!
Can I redraw my payment?
Interestingly, paragraph 17 of the practice statement indicates that repayments made as part of the corrective action that the practice statement allows will not be taken to be payments to which section 109R applies.
This means that the catch up payments can be immediately redrawn as a new loan without jeopardising the legitimacy of the payments themselves. This allows a taxpayer to freshen up a loan for a new seven year term when they are not in a position in the current year to make the payments from their own resources and where they do not wish to liquidate assets or to have a sizable dividend paid to them by the company to fund the repayment.
Other matters to consider
The practice statement is silent in relation to what taxpayers should do in relation to payments, loans and forgiven debts arising before 1 July 2001. Can we take this that the Commissioner accepts that he is out of time to tax these? We still don’t know. There will also be taxpayers who have deemed dividends that arose later than 1 July 2001 that the Commissioner is also out of time to amend, so advisers need to keep the ATO’s amendment powers in mind when advising their clients whether to take up the offer contained in the practice statement.
Finally, the ATO has undertaken to consider objections against amended assessments raised by it arising from Division 7A reviews and audits of taxpayers undertaken by it in recent years. Taxpayers need to be able to show that an honest mistake occurred and that they have already taken the recommended corrective action in order for these objections to have any chance of success.
In amongst all of this is the need to keep grounded in the basics of Division 7A. For example, check for a distributable surplus as the amount of any deemed dividend is capped by this. There is no need to ‘over declare’ a deemed dividend in the rush to meet the 30 June 2008 deadline.
Don’t wait until the fy08 returns are being prepared to consider whether your clients should take this up, but be careful that they don’t give themselves a tax bill that the ATO could not have!
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