In the 2010 Federal Budget, the Government announced that it would introduce some changes to the application of Division 7A. Amongst the changes foreshadowed was a vague reference to the introduction of new integrity measures. The Government has now released a discussion paper in relation to the proposed changes which sheds some light on these integrity measures.
The integrity measures are substantially more extensive than expected and a brief summary of the key proposals are set out below.
The proposed amendments are to apply from 1 July 2009.
Interposed (or "funnel") trusts to be caught under Division 7A
Under the existing provisions in Division 7A, the deemed dividend rules only applies to payments made in relation to unrealised gains, loans or debts forgiven made by trusts that have an unpaid present entitlement owing to a private company beneficiary. Hence, Division 7A does not currently apply to the following structure whereby a trust is interposed between the trust making the payment, loan or debt forgiveness and the company beneficiary.
The Government has announced that Subdivision EA of Division 7A will be tightened to make such arrangements ineffective. It will be interesting to see how the provisions are drafted with respect to multiple layer arrangements, but in the above circumstances, the clear intention of the change is that payments, loans and debt forgivenesses provided in favour of the shareholder by Trust 1 would be caught. No comment is made in the paper as to any transitional rules (presumably this will be one of the matters on which consultation will take place), but it is worth bearing in mind that, with the broadening of the definition of payment to cover the use of assets (see later), existing assets held by Trust 1 that are provided for use by the shareholder may also be subject to Division 7A going forward.
Another similar technique which has been flagged for attention is the use of a company interposed between a Trust and the shareholder, which under the current provisions of Division 7A, can be used to ensure that loans made by a trust are not subject to the deemed dividend rules. The Government proposes to introduce amendments which will ensure that such arrangements will be subject to Division 7A from 1 July 2009.
Payments to be included in the calculation of distributable surplus
One of the key concepts involved in the deemed dividend rules is that of a distributable surplus. This is broadly a measure of the surplus that a company has for distribution from which, in effect, a dividend is deemed. The distributable surplus of the private company effectively caps the amount that can be deemed under Division 7A to be a dividend.
Under the current law, the distributable surplus of a private company is to be determined at the end of the relevant year. In effect, this created something of an opportunity for taxpayers to undertake transactions during the year that would have the effect of reducing the distributable surplus, with the result that a reduced (or no) deemed dividend would arise.
The Government proposes to remove any opportunities in relation to this rule by amending the definition of distributable surplus to include certain payments made to shareholders/associates during the year.
Other integrity measures There are other integrity measures also proposed to be introduced to tighten the application of Division 7A, the more important of which are:
- amendments to deal specifically with revaluation arrangements that are not adequately dealt with by the existing rules in Subdivision EA;
- amendments to tighten the repayment rules to ensure that taxpayers are unable to defeat the purpose of Division 7A by taking out a new borrowing from the relevant private company to repay an existing borrowing; and
- as announced in the Federal Budget:
- extending the definition of 'payment' in Division 7A to include benefits provided by way of a license or right to use real property and chattels. This change was announced in the Federal Budget and the paper provides further detail as to what is envisaged in respect of this measure; and
- amending Division 7A to bring corporate limited partnerships within its realm and to confirm that non-resident private companies fall within Division 7A. The former of these measures was also announced in the Federal Budget and the paper provides further detail as to what is proposed.
Technical amendments that favour the taxpayer
There are also some technical amendments proposed that will benefit the taxpayer. Most of these amendments are in relation to improving the integration of Subdivision EA with the rest of Division 7A and to remove existing anomalies that are detrimental to the taxpayer. For example, under the current rules, where a loan from a trust to a shareholder is treated as a deemed dividend due to the application of Subdivision EA, if the loan is later forgiven the debt forgiveness will also be a deemed dividend. This would results in a double application of Division 7A, which is clearly not appropriate. The Government proposes to amend the legislation to ensure that the subsequent debt forgiveness would not be subject to Division 7A in the same way that this outcome is achieved in the existing legislation where the lender is a private company.
Persons wishing to provide feedback on the discussion paper have until 3 July 2009. However, regardless of stakeholder feedback, it is considered likely that the Government will proceed with these integrity measures. Hence, taxpayers are encouraged to revisit their current arrangements and ensure that they consider what might be appropriate to mitigate any downside arising from the proposed amendments. Again, we reiterate that the start date for the proposed amendments is 1 July 2009, so it is the existing provisions that are expected to apply for the 2009 year, which may afford some opportunity for alert clients to review their existing structures and consider whether any changes would be beneficial.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.