The top Division 7A issues have been hunted down.
By Michael Parker
Business to business
The number one problem we see is the continually held, mistaken belief that there is some form of exemption from Division 7A for payments, loans and forgiveness of debts between businesses or between entities. For instance, many still believe that a loan from a private company to a trust is OK as long as it is used for business or other income-producing purposes. In some respects it’s understandable – people have assumed the “otherwise deductible rule” for FBT applies in a similar fashion to Division 7A. They don’t perceive that there is any mischief.
The old landscape was that an Unpaid Present Entitlement (UPE) owed by a trust to a company was OK as long as the trust did not makes certain payments, loans or forgive debts while the UPE was in existence. However, once the trust made such payments, loans or forgave debts, Division 7A was triggered. This in itself was problematic and widely missed by practitioners. Importantly, these rules still apply. From December 2009 the ATO’s position is that UPEs, of themselves, can be a loan for Division 7A purposes. As such, their mere existence can trigger Division 7A regardless of what the trust has done with the cash.
3 Sub-trust arrangements
A method of ensuring a UPE, of itself, does not trigger Division 7A is to invest it under a sub-trust arrangement using ATO approved criteria. The ATO will then accept the UPE is not a loan for Division 7A purposes. However, while this will be effective in ensuring the UPE, of itself, does not trigger Division 7A, the fact remains it’s still a UPE. If the trust then makes certain payments, loans or forgives debts, while the UPE exists, Division 7A is triggered (see problem 2, above).
Division 7A – A complete guide: this comprehensive course illustrates the application of all the substantive provisions of Division 7A set out in Subdivisions A to F. The complex issues relating to Division 7A of the Income Tax Assessment Act (1936) (the ITAA) are explained via case studies, and include invaluable tips, tax traps and warnings throughout.
Interposed entity rules
Complex rules can operate to deem a company to make payments or loans to a taxpayer (thereby triggering Division 7A provisions) where the company has, in fact, made payments or loans to another entity which has, in turn, made payments or loans to the taxpayer. Other rules operate to deem a trust to owe UPEs to a company in situations where the trust owes UPEs to other trusts, who in turn owe UPEs to a company. If the first trust then makes certain payments, loans or forgives debts, Division 7A is triggered as if that trust had UPEs owed to the company. When looking at individual entities’ balance sheets it may appear at first glance that there are no Division 7A breaches to contend with. However, when looking at them in the context of a larger group, the cracks begin to emerge.
We often see Division 7A breaches occurring as the result of the recommendations and actions of other, well-intentioned advisers. By the time the accountant is brought in the damage has been done. For instance, take the case of the family lawyer who prepares property settlement orders requiring a company to transfer cash or other assets to one of the spouses. They may have turned their mind to the availability of a CGT roll-over but are unaware of the Division 7A (or possibly ordinary dividend) ramifications. Similarly, the estate executor who arranges for the loans owed by the deceased to be forgiven without realising it may create a deemed dividend for the estate; or the financial planner who recommends their client borrow from the bank to make investments, using their private company as a guarantor. n
Michael Parker is a partner at Hall and Wilcox.