• Corrective action

    Certain amounts paid, lent or forgiven by a private company to shareholders or their associates may be treated as being a deemed dividend for tax purposes under Division 7A of the Income Tax Assessment Act 1936 subject to some exclusions. However, we have discretion to disregard this outcome if the deemed dividend arises as a result of an honest mistake or inadvertent omission.

    When deciding whether or not to exercise discretion, one of the factors we consider is the extent to which corrective action has been taken and, if so, how quickly that action was taken. Alternatively, if corrective action has not been fully undertaken prior to the ATO's discretion being sought, we may exercise our discretion subject to the condition that corrective action is taken within a specified time period.

    What is corrective action?

    Corrective action involves the taxpayer taking specific steps to put themselves in the position that they would have been in had they complied with the exclusions in Division 7A to avoid the amount being treated as a deemed dividend.

    Corrective action usually involves entering into a complying loan agreement and making catch-up payments of interest and capital. The interest amount is compounded, as it represents the capitalisation of missed interest payments in the earlier years.

    Example

    Example

    In the 2013 income year, ABC Pty Ltd loaned $700,000 to an associated trust, the XYZ Trust.

    The Commissioner exercised his discretion subject to the following corrective action being taken in the 2016 income year:

    • A loan agreement must be entered into commencing in the year in which corrective action is taken and conclude in the year in which it would have concluded had it been entered into at the time the original loan was made. In this case, that would be 2020.
    • Under the loan agreement, the interest rate applicable must equal or exceed the benchmark interest rate for the year (these rates are published by the Reserve Bank of Australia).
    • XYZ Trust must make catch up repayments of principal and interest in respect of the 2014, 2015, 2016 and 2017 income years.
    End of example

    Calculations

    The formula for calculating the minimum yearly repayments that XYZ Trust must make is as follows:

     Minimum yearly repayments

    Table 1 below illustrates the minimum yearly repayments that would have been payable had a complying loan agreement been entered into at the time the original loan was made.

    Year

    Interest Rate

    Opening Balance

    Interest Amount

    MYR

    Ending Balance

     

    %

    $

    $

    $

    $

    2014

    6.20

    700,000

    43,400

    126,287

    617,113

    2015

    5.95

    617,113

    36,718

    125,300

    528,531

    2016

    5.45

    528,531

    28,804

    123,600

    433,735

    2017

    5.40

    433,735

    23,422

    123,457

    333,700

    TOTAL INTEREST

    132,344

     

    Table 2 illustrates the amount of catch-up payment that XYZ Trust must make as part of their corrective action (assuming no repayments have been made in any prior year).

    Year

    Interest Rate

    Opening Balance

    Interest Amount

    MYR

    Ending Balance

     

    %

    $

    $

    $

    $

    2014

    6.20

    700,000

    43,400

    -

    743,400

    2015

    5.95

    743,400

    44,232

    -

    787,632

    2016

    5.45

    787,632

    42,926

    -

    830,558

    2017

    5.40

    830,558

    44,850

    -

    875,408

    Catch up Payment Due by 30 June 2017

    541,708

    333,700

    TOTAL INTEREST

    175,408

     

    In both Table 1 and Table 2, the “interest amount” payable in each year is calculated using the benchmark interest rate for each of the relevant years. However, because no repayments have been made in any year, the total “interest amount” payable is compounded in Table 2.

    After the catch up payment of $541,708 is made in the 2017 year (which includes the 2017 minimum yearly repayment), the outstanding balance is what it would have been had a complying loan agreement been put in place at the commencement of the loan. The interest component of the catch up payment would be included in the assessable income of ABC Pty Ltd in the 2017 year.

      Last modified: 21 Sep 2016QC 43028