Date posted: 8/05/2018 5 min read

Time to ask the question: is Division 7A too hard to fix?

Another Budget, another vague Division 7A announcement.

In brief

  • The government “will ensure unpaid present entitlements come within the scope of Division 7A”
  • What does this mean exactly?
  • How does it fit with recent ATO guidance?

Division 7A is the ticking time bomb for many private companies

The tortuous history of Division 7A, discretionary trusts and private company beneficiaries continues with the rather cryptic 2018-19 Federal Budget announcement that “the Government will ensure that unpaid present entitlements come within the scope of Division 7A of the Income Tax Assessment Act 1936 from 1 July 2019”.

The saga starts in 2009, when the ATO stated in Taxation Ruling 2010/3 that UPEs owed by a trust to a private company beneficiary within the same closely held family group were financial accommodations and therefore ‘loans’ made by the corporate beneficiary to the trust for Division 7A purposes. This meant that, where the trust was a shareholder or an associate of a shareholder of the company, then UPEs owed by the trust to the private company could be taxed as unfranked dividends. 

The ATO then indicated that it would not seek to apply Division 7A to the UPE if the funds representing the UPE were held on sub-trust for the sole benefit of the private company beneficiary using one of three investment options set out in PS LA 2010/4. 

Option 1 in PS LA 2010/4 was particularly attractive to clients because of the ATO view that UPE funds in the sub-trust were held for the sole benefit of the private company beneficiary if they were lent to the main trust under a seven-year interest only loan with the principal of the loan repayable at the end of this term (subject to appropriate documentation etc). 

For some clients, the seven year clock has struck, or will soon.

Then along came PCG 2017/13, setting out requirements to enable the seven year loan to be “refreshed”, but the new loan had to be on a principal and interest basis over the additional seven-year term (not interest only). The new arrangements had to be in place before lodgement of the company’s tax return.

All this was seen as a stop-gap solution. After all, the Board of Taxation was on the job, reviewing Division 7A and the 2016-17 Federal Budget papers included the following announcement in relation to Division 7A:

“Subject to the outcomes of consultation, amendments that will include: A self-correction, no-penalty mechanism for taxpayers who have inadvertently triggered Division 7A; Amended rules, with appropriate transitional arrangements, regarding complying Division 7A loans, including having a single compliant loan duration of 10 years and better aligning calculation of the minimum interest rate with commercial transactions. (Emphasis added)

Then, silence.

The 2018-19 Budget Papers say this latest announcement “will ensure the unpaid present entitlement is either required to be repaid to the private company over time as a complying loan or subject to tax as a dividend”.

But the Budget documents also then go onto say that the start date of the 2016 17 Budget measures (see above) will be deferred from 1 July 2018 to 1 July 2019. “This will enable all Division 7A amendments to be progressed as part of a consolidated package”.

We can only hope that we see some tangible progress soon.

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