The Treasury has recently released an important Consultation Paper proposing significant tax changes to the Shareholder Loan rules in Division 7A. The proposed changes will impact small to medium businesses all across Australia.
Broadly, these rules were introduced to ensure loans made to shareholders out of private companies and related trusts are taxed as if they were dividends. This applies where the loans are funded by profits which have been taxed at the company tax rate. There is a key exclusion for loans that are subject to a complying written loan agreement, interest charges and principal repayments typically over a short seven-year period (or 25 years in the case of securitised loans). The rules were first introduced in December 1997.
Currently, loans entered into prior to December 1997 are exempt from complying with these rules. Treasury is now proposing that such loans be subject to Division 7A, requiring repayments over a 10 year period. This represents a retrospective change going back more than 20 years, placing onerous compliance and cashflow obligations on Australian business taxpayers.
Treasury has also proposed that loans should be treated as dividends even where they are not funded out of company profits. This could mean that benefits received by shareholders are taxed, even if they represent a return of the capital contributed by shareholders. This would be a clear departure from the policy intention of these rules historically and would certainly introduce some presumably unintended outcomes.
In addition, Treasury has suggested that the current four-year ATO tax review period be extended to 14 years going forward for Division 7A loan arrangements, to allow ATO review throughout the 10-year life of the loan, plus the normal four year amendment period.
KPMG Enterprise’s view is that any errors or omissions under Division 7A should be treated in the same way as any other taxpayer error or omission, and on that basis, the normal four year ATO review period should remain. Proposing a 14 year ATO tax review period places unnecessary recordkeeping and compliance obligations on Australian business and goes against the ATO’s aim to “simplify” compliance.
Lastly, Treasury has proposed to eliminate the 25-year securitised loan option going forward on the basis of simplicity, proposing only one loan option going forward of 10 years. We view this as an unfavourable and unnecessary change. In particular, Australian banks will offer 30-year loans on interest-only basis in some cases. In this situation, there is no reason why private company loans should be so restrictive.
The changes proposed by Treasury also include some useful simplification measures such as moving to standardised repayment arrangements and introducing self-correction mechanisms for inadvertent breaches. However, we would hope that some of these more onerous changes are reconsidered throughout the consultation process.