02 Jul 2020 This week in tax
Division 7A … too little too late?
As we cross over into a new financial year, it seems inappropriate to wish you all a ‘happy new financial year’ in this downcast economic climate, where any hopes of an early emergence from the COVID-19 crisis have been dashed by the recent surge of the virus in Victoria and the messages of continual vigilance, despite the lighter restrictions in other states and territories.
Instead, The Tax Institute once again acknowledges the remarkable efforts of our members.
Under relentless pressure from the Government’s economic stimulus package, many of you are still attending to outstanding 2018–19 compliance work, while undertaking year end planning for 2019–20 and now turning your minds to the start of the 2020–21 compliance season. Kudos to you all.
This week, it is fitting to discuss two significant recent developments on a perennial topic for private companies, namely Division 7A:
- the ATO’s recent advice, issued on 26 June 2020, on the extension of time for borrowers who are unable to make minimum yearly repayments on complying Div 7A loans due to the COVID-19 crisis; and
- the Assistant Treasurer’s announcement shortly before close of business on 30 June 2020 that the start date of the long-awaited reforms has been deferred.
Request for more time to make minimum yearly repayments on Div 7A loans
As anyone who is familiar with managing a loan made by a private company to a shareholder (or associate of a shareholder) knows, the borrower must make a minimum yearly repayment (MYR) on a complying 7- or 25-year loan by the end of the private company’s income year (generally 30 June, and assumed as such for the purposes of this article) each year to ensure that a deemed dividend does not arise equal to the amount of the MYR shortfall.
This year, due to the COVID-19 crisis, the capacity of some borrowers to make the required MYR is diminished or non-existent. On 26 June 2020, the ATO set out its position on allowing borrowers who are unable to make the MYR by 30 June 2020 to apply to the ATO for relief under s 109RD of the ITAA 1936.
Section 109RD allows the Commissioner to disregard a deemed dividend that otherwise arises due to a failure to make the MYR where, in the Commissioner’s opinion, the inability to make the MYR is due to circumstances beyond the borrower’s control. The provision requires the Commissioner to determine the specified time within which the borrower must pay the MYR to the company.
Borrowers can apply in the approved form to the ATO for an extension of time if they are unable to make the 2019–20 MYR by 30 June 2020 due to the COVID-19 situation. If the ATO approves the application, a deemed dividend will not arise for the shortfall provided the 2019–20 MYR is paid by 30 June 2021. This relief is available only for 12 months and only for applications made by affected borrowers in respect of 2019–20 MYRs under s 109RD.
It should be noted that, under s 109RD, the Commissioner may determine any later time for the borrower to pay the shortfall. In this case, the Commissioner has specified 30 June 2021 as the latest time by which the shortfall for 2019–20 must be paid. Also, the relief offered by the ATO does not constitute a change to the law. The discretion available to the Commissioner under s 109RD is nothing new and taxpayers are still required to meet the requirements of the law.
A borrower may still apply for the Commissioner’s discretion under s 109RB where there has been an honest mistake or inadvertent omission or under s 109Q where there is undue hardship (it should be noted that the Commissioner is required to take in account the capacity of the borrower to repay the loan at the end of the year in which the loan was made when exercising his discretion under s 109Q).
The following should be noted when seeking more time to make the 2019–20 MYR due to COVID-19:
- The application for more time to make the 2019–20 MYR must be made using the approved form.
- The ATO will respond to a request within five business days.
- Even if you applied before 30 June 2020, the ATO cannot make a decision until after 30 June 2020 (because s 109RD can only operate once a deemed dividend has arisen under s 109E for failure to make the MYR).
- If an extension is allowed, the 2019–20 MYR can be made by 30 June 2021 instead of 30 June 2020. This is in addition to the 2020–21 MYR which must also be paid by 30 June 2021.
- The 2019–20 interest is not capitalised but must still be paid by 30 June 2021.
- An extension of time to make the 2019–20 MYR does not recalibrate future MYRs. The loan repayment schedule reverts to normal for the remainder of the loan term from 2021–22.
- If the discretion is not exercised, the shortfall is assessed as a deemed dividend in 2019–20. Amendments to the 2019–20 assessment may be necessary depending on when the 2019–20 tax return is lodged and when the Commissioner makes a decision on a s 109RD application.
- If the discretion is not exercised, there is no ability to go back and ‘backdate’ an MYR or declare a dividend to make the MYR, and great caution should be exercised by any practitioner whose client may contemplate such action.
- Discretion can be sought at any time in the next 12 months. But the longer a borrower takes to apply for the discretion, the longer the uncertainty is prolonged.
- The discretion is available for 7- and 25-year complying Div 7A loans only. It is not available for the annual return (i.e. interest) on unpaid present entitlement sub-trust arrangements as set out in PS LA 2010/4.
- To the extent that the borrowed funds were used for a taxable purpose, the interest component of the MYR would still be deductible in 2019–20 as the interest has nonetheless been incurred in 2019–20 for the purposes of s 8-1 even if the amount is not paid until 2020–21.
- Whether a borrower is ‘unable to pay’ the MYR is a question of fact, and the availability of cash resources is unquestionably a factor here. A borrower is considered able to pay an amount if they can readily sell their assets or use them as security to obtain finance with the exception of assets that were necessary to maintain an adequate living standard. A borrower who has access to a redraw facility on their home loan is likely to be considered ‘able to pay’. An ability to realise an asset but a choice not to will be a factor against the ATO exercising the discretion.
- How will the ATO view a company with profits as at 30 June 2020 that chose not to pay a dividend to the shareholder who was required to make the MYR? Will this also be a factor against the ATO exercising the discretion?
- Assuming an extension is allowed by the ATO, deferring the 2019–20 MYR will only compound demand on cash flow as it simply postpones the problem into 2020–21.
Too little, too late?
The Tax Institute made a joint submission on 7 April 2020 in which a request was made to the Treasurer and the ATO for relief for taxpayers who cannot make their MYRs due to the COVID-19 crisis. The Tax Institute made a further request in a joint submission on 26 May 2020.
While it is pleasing that the ATO is allowing taxpayers to apply for the relief outlined above, it would have been preferable for this to have been announced some months ago. The certainty taxpayers now have on the nature of relief that is available came only 4 days out from year end. Had taxpayers known earlier they could apply for the Commissioner’s discretion under s 109RD, they could have done so and been certain on their tax position before 30 June 2020. As it stands, informed decisions could not be made by affected taxpayers by 30 June 2020 because they have no certainty until the ATO responds to a request after the end of the income year. There is no recourse if it is unfavourable for the taxpayer; a deemed dividend for 2019–20 will arise.
We asked for a result. We got the result we asked for. But did it come soon enough? And what of those taxpayers who do not receive an extension of time from the Commissioner because they failed to sell a realisable asset not considered necessary to maintain an adequate living standard? How could they have promptly sold a property in this current market to provide the cash to make the MYR even if the ATO position had been known in April or May?
Time will tell how many taxpayers apply for the discretion, and how many of those are granted extensions.
Deferral of start date of Div 7A proposed reforms
Onto a crucial issue … the proposed start date of the long-awaited Div 7A reforms. The Government announced in the 2016–17 Federal Budget that, following a Board of Taxation review which recommended changes be made to improve the integrity and operation of Div 7A, the reforms would commence on 1 July 2018. In the 2018–19 Federal Budget, the Government announced the reforms would be deferred until 1 July 2019. On 22 October 2018, The Treasury released a consultation paper that contained an outline of the proposed changes which continue to be of great concern to the profession and The Tax Institute. In the 2019–20 Federal Budget, the Government announced the reforms would be further deferred until 1 July 2020.
Just before close of business on 30 June 2020, the Assistant Treasurer, Michael Sukkar, announced that five tax and superannuation measures due to commence on 1 July 2020 have been deferred, including the Div 7A reforms.
The Tax Institute had repeatedly requested the measures be deferred from 1 July 2020 to 1 July 2022 (in the same submissions referred to above). The Government has sensibly deferred the reforms to income years commencing on or after the date of Royal Assent of the enabling legislation. This will be of enormous relief to our members.
While the Government’s announcement seconds before the twelfth hour of the 2019–20 income year marks the third deferral of the proposed measures, the deferral is very welcome. It will allow a sensible period for design and implementation of the new rules, whatever form they take. The Tax Institute will be actively engaged in the months ahead advocating for workable amendments to the provisions of Div 7A.
Keep abreast of latest developments
To minimise the number of emails we send our members, we are using LinkedIn as our primary platform for broadcasting breaking news such as significant announcements, introduction of major bills and important ATO guidance. We also broadcast through Twitter and Facebook. Both of the major Div 7A developments covered in this Preamble were promptly broadcast through LinkedIn: the extension for MYRs and the deferral of the Div 7A reforms.For those of you who are not avid social media users, we will of course follow up these messages in the weekly TaxVine. We encourage you to follow us on LinkedIn so that you can be kept informed as things happen.
Reshaping TaxVine member feedback
We encourage member engagement and value the views and insights of our members. Your contributions assist us in identifying issues for escalation to the regulators and other external stakeholders and allow us to support you. To that end, we are reshaping the way in which you provide your TaxVine feedback to ensure it is better targeted and better directed to our advocacy efforts.
When you provide feedback, we ask that you select one of the following four categories:
- Tax Time issue
- Policy, interpretation and tax administration
- Other advocacy issue.
You can now provide your feedback using this form.
Contributions to the discussion on the topics covered in preambles will be published in TaxVine. Other contributions will be used to identify issues for escalation, and published when the content is of value to members. As foreshadowed last week, we will encourage members to continue conversations about both preambles and advocacy matters via our new community platform, which is coming soon.
Robyn Jacobson, CTA