Division 7A of the Income Tax Assessment Act 1936 (Div 7A) aims to make sure shareholders pay income tax on amounts they receive from their companies. It achieves that aim by deeming each of the following payments to be a dividend (on which income tax must be paid):
As a tax integrity measure, Div 7A is generally effective in preventing shareholders from failing to pay tax on receipts from their companies. However:
One legal way to avoid a payment being deemed a dividend and assessed for income tax is for the company/trustee and the recipient to enter into a Div 7A Loan Agreement.
Some attempts to circumvent Div 7A are less than subtle, are easily spotted, and are ineffective — as is shown by 4 recent cases , involving identical tax avoidance schemes, which were heard before the Commonwealth Administrative Appeals tribunal.
Each of the cases involved an elaborate scheme in which:
Effectively the shareholder purported to pay the company with a valueless piece of paper which the company had itself issued. The company accepted repayment of the debt in this form.
In each case, the taxpayer argued that the so called "promissory note" the company issued in relation to a forgiven loan:
The AAT held:
As part of the 2009 Federal Budget announcements in May, the Federal Government announced that it would tighten the non-commercial loan rules in Div 7A. The proposed amendments are in a Treasury Discussion Paper issued on 5 June 2009. A copy of the Discussion Paper can be downloaded here.
The amendments are very technical so we cannot describe them in detail here. The reforms have two primary objectives:
Closing down a number of schemes to circumvent the effects of Div 7A, such as through strategically interposed companies or trusts, or carefully timed cross loans.
For example: Any payment by a trust to a shareholder of a company that is a beneficiary of the trust and that has an unpaid present entitlement to money from the trust is deemed to be a dividend (and so is assessable for income tax). However, the Government is concerned that the relevant rule could be circumvented by the company making the payment as a loan to an unrelated company which then on-loans the money to a beneficiary. The Government proposes amendments to cover this situation.
Making Div 7A fairer, including by eliminating double taxation in some circumstances and making sure the rules for loans by trusts are treated the same as private company loans.
For example: Double taxation can occur if a trustee makes a loan to a shareholder of a beneficiary company and that loan is later forgiven. First the loan is deemed to be a dividend, and so is assessed for income tax. Later, the forgiving of repayment of the loan is also deemed to be a dividend, and is taxed again. So the shareholder is taxed twice on the one loan. In contrast, if a company makes a loan to a shareholder, then the forgiving of the loan is not treated as a dividend as long as the loan was originally treated as a dividend. The Government would like to make the rules for companies and trusts consistent.
The closing date for submissions in relation to the Discussion Paper was 3 July 2009. To date there has been no response to submissions made, nor is draft legislation available. However, ClearLaw will continue to monitor the progress of the suggested changes.
The cases and the proposed reforms show that the Government and the Tax Office are vigilant in terms of tax schemes to avoid Div 7A.
It is important for companies, trusts (and their advisers) to make sure they properly document shareholder (and associate) loan arrangements. If a payment is deemed to be a dividend, then it will be assessable for income tax — any later attempt to treat a payment as a loan will fail if there are no supporting documents.
For more information, please contact Maddocks (03 9288 0555) and ask for a member of the Cleardocs Help Desk. They will put you in contact with the relevant Tax & Revenue lawyer in Melbourne or Sydney.
Read about the Cleardocs Division 7A Loan Agreement
Download a checklist of the information you need to order Cleardocs Division 7A Loan Agreement
Paul is a Special Counsel in the Maddocks Commercial team with particular expertise in commercial agreements for the supply of goods and/or services, the Personal Property Securities Act 2009, the National Consumer Credit Protection Act 2009 and the National Credit Code and the Australian Consumer Law.
Paul's key areas of practice include:
Before joining Maddocks, Paul was employed for 13 years with the Victorian Department of Justice, principally as a Deputy Registrar in the Victorian Magistrate's Court, but also as a legislation, policy and project officer for the Department.
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