News & Insights

By now you would think we should all know how Division 7A of the Income Tax Assessment Act 1936 (Cth) (ITAA36) operates. Dividends and wages are ok, payments, loans and forgiveness of debts not so much.

Aside from major legislative reform in 2009 to tighten it up, there has been no real movement or review outside of proposed changes to the regime that are yet to (and will hopefully never) see the light of day.

Despite being in place for 25 years (and largely unchanged for 15), Division 7A continues to wreak havoc. And for most the part, it is the basics that continue to catch everyone out. Mistakes are a part of life. This inevitability is no different in Division-7A land – where mistakes can and do happen, either by reason of doing something or by doing nothing at all.

In accepting this, the Commissioner is able – under section 109RB ITAA36 – to exercise discretion to disregard the self-executing Division 7A outcomes that arise as a result of an honest mistake or inadvertent omission.

For a long time, the Commissioner chose to exercise that discretion very kindly and sometimes in circumstances where – if we’re being honest – the deemed dividend arose out of anything but an honest mistake or inadvertent omission. It is implicit in the concept of an honest mistake or inadvertent omission, that there is an understanding of the fundamentals of the broader framework, i.e. please when taking money from a private company, do so as a dividend or wage.

That’s pretty much it.

How the Commissioner views the concept is set out in the ATO’s Practical Statement Law Administration PSLA 2011 /29. That guidance tells us that an honest mistake or inadvertent omission may be a mistake of law (other than as a result of ignorance), a mistake of fact, or a mixture of mistakes, and may have been made by the company, the recipient, or any other entity whose conduct contributed to the error.

You can have a read for yourselves of the ATO examples of honest mistakes in that guidance.

Practically, in making an application under section 109RB, you are required to demonstrate how and why the mistake was made and put forward a sensible time period for corrective action. For a long time, it was enough to simply say – this is a new client, we’ve identified an issue (including that the previous adviser appeared to be oblivious to Division 7A) and we want to fix it.

That is very unlikely to work anymore.

Given the absence of recent change (outside of the views relating to UPEs which remains a TBD), it is astounding, that a working knowledge of Division 7A – it’s basic operation and consequences – continues to be abysmal. After 25 years, how exactly is this possible?

This is essentially the reasoning behind the ATO’s now apparent reluctance to exercise discretion under 109RB – that there is ample guidance afforded to taxpayers, and to the tax-advisor community, such that honest mistakes and inadvertent omissions should seldom arise.

Premised on the basis that far too many continue to ignore fundamental concepts or are being “too cute” in attempts to circumvent the provisions – the ATO has begun a year-long educational series on Division 7A. The message is clear. As far as the Commissioner is concerned, enough is enough. The ATO has been explicit in 109RB not being applied carte blanche, and taxpayers and advisors are formally on notice.

There is no denying that Division 7A can be a particularly difficult concept to navigate with some technical breaches clearly resulting from experienced advisors, and sophisticated taxpayers, being honestly mistaken.

That said – we continue to see the following, and it is often received with surprise by those we are talking to:

• Repaying a loan before year’s end and re-borrowing that amount shortly thereafter is not ok;
• Choosing an interest rate outside the ATO benchmark interest rate (currently 8.27% p.a.) is not ok;
• A private company making a loan to a trust ‘for investment purposes’ on non-complying terms is not ok;
• Reliance on a saving clause in the company constitution that has Div 7A terms that require an acknowledgement by the borrower (…. and there is no acknowledgement) is not ok;
• 30 June ‘repayments’ done by way of journal entry only are not ok;
• Loans by foreign private companies to Australian tax resident individuals or trusts are not ok;

In many cases, a mistake is only identified by a fresh set of eyes.

So, what do we do?

As a start, appreciating that inheriting a new client with historic Division 7A issues won’t necessarily mean automatic exercise by the Commissioner of his discretion particularly where non-compliance is simply not knowing the basics as opposed to being seen as trying to comply but falling down on a particular aspect. The latter, when identified and acknowledged in a timely manner, is far more likely to have the Commissioner exercise his discretion to remedy the honest mistakes.

For a lot of the other ‘not ok’ scenarios, appreciating that 109RB may not be fit-for-purpose for each and every unwelcome Division 7A breach.

There are alternatives such as considering time limitations, refinancing and a few others that clients should consider when wanting to tidy up their affairs.

As always, we’re here to help

Macpherson Kelley can assist when it comes to getting Division 7A right. Please feel free to reach out to anyone on the Taxation Team to discuss Division 7A and those alternatives.

Until next time.