Tax Bites: Inheriting Division 7A problems

All accountants would most likely experience the situation of taking over a new client that has pre-existing Division 7A exposures.

When the above occurs, it is worth considering the following relevant points / strategies:

  • Provided prior year loans have been quarantined, the Division 7A exposure arising under section 109D of the Income Tax Assessment Act 1936 will arise in the particular year the loan was provided.

    Therefore, the ATO will only be able to treat the amount of the loan as a deemed unfranked dividend in the year the loan was provided.  If the resulting deemed dividend under Division 7A was crystallised in a year outside of the amendment period of the shareholder / associate, the ATO will not be able to include the amount in a tax return of the shareholder / associate.
  • In calculating the Net Distributable Surplus for the company, section 109Y reduces the Net Distributable Surplus calculation by any loan amount on the balance sheet of the company that has previously been treated as a deemed dividend under Division 7A. Thus, even if the shareholder has not actually been assessed on the deemed dividend (i.e. due to the loan being provided outside of the amendment period or due to the company not having a Net Distributable Surplus in the year the loan was provided), the current year Net Distributable Surplus of company will not include the value of these loans.
  • Section 109F of the Income Tax Assessment Act 1936 results in the forgiveness of a loan by a private company in favour of a shareholder / associate triggering a deemed dividend under Division 7A. However, section 109G(3) of the Income Tax Assessment Act 1936 excludes the application of section 109F where the debt being forgiven has already been treated as a deemed unfranked dividend.

    Thus, in circumstances where a prior year loan provided from a private company to a shareholder / associate was not established on complying loan terms thus triggering a deemed dividend exposure in a prior year, the subsequent forgiveness of the loan by the private company should not result in an adverse Division 7A implication.  Further, the application of section 109G(3) will not be impacted by (i) any deemed dividend not being assessed to the shareholder / associated as a result of the deemed dividend arising in a year which falls outside of the amendment period; or (ii) any deemed dividend on the provision of the loan not being assessable to the shareholder / associate as a result of the private company not having a Net Distributable Surplus in the particular year.

If you have any further questions, please do not hesitate to contact Tim Olynyk on (03) 9810 0700 or at t.olynyk@banksgroup.com.au.

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