Division 7A of the ITAA36 has been operational since 1997. However, the provisions are complex and their application extends beyond the boundaries of what many accountants think.
Below are some common misconceptions around the application of Division 7A that I still seem to see:
1. Loans provided by a private company to another entity (say a trust) for income producing purposes are outside of the realm of Division 7A.
This is incorrect. Section 109D will apply to any loan provided by a private company to a shareholder or an associate of a shareholder even where the loan is to another entity (say a trust) and irrespective of whether the loan will be used by the other entity for private purposes or for income-producing purposes.
2. Pre-2009 UPE’s can be quarantined and have no further issues arising under Division 7A.
Paragraph 28 of TR 2010/3 states that the Commissioner of Taxation will not seek to treat a UPE arising prior to 16 December 2009 as a loan for Division 7A purposes.
However, even where pre-16 December 2009 UPE’s held by a trust in favour of a corporate beneficiary are correctly quarantined, Division 7A still applies where the trust then provides a loan, payment or debt forgiveness to a shareholder or associate of a shareholder of the corporate beneficiary.
3. A private company that does not have retained earnings will not have any Division 7A issues.
The amount of Division 7A exposure is determined having regard to the Net Distributable Surplus of the private company. This is calculated pursuant to section 109Y of the ITAA36. Importantly, in calculating the amount of the Net Distributable Surplus, the Commissioner is empowered to revalue assets. This could mean that a company with carry forward losses but with significant unbooked goodwill could still have Division 7A obligations.
4. Division 7A will not apply where a private company is required to transfer assets as part of a matrimonial settlement.
In releasing TR 2014/5, the ATO has changed their opinion on this issue. The ATO now conclude that any transfer of property from a private company to a shareholder of the private company can represent an ordinary section 44 dividend while any transfer of property from a private company to an associate of a shareholder can be subject to Division 7A.
In TR 2014/5, the ATO specifically note that section 109J within Division 7A (which excludes payments made by a private company which discharge pecuniary obligations) will not exclude Division 7A applying where a private company makes a payment to a spouse pursuant to a matrimonial settlement.
5. Even where a company does not have a Net Distributable Surplus in the year the loan is first made, the loan will subsequently need to be put on commercial Division 7A terms if the company returns to a Net Distributable Surplus.
Finally, I can give some good news! Where the private company does not have a Net Distributable Surplus in the year the loan is first provided, the loan should never become subject to the application of Division 7A going forward provided the loan continues to be correctly quarantined from other loans provided thereafter.