• Division 7A - answers to frequently asked questions

    The questions and answers set out below are a guide only and are not a substitute for the law. All references to legislation are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise specified.

    General

    1. What is the aim of Division 7A and why is it needed?

    Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) is an integrity measure to ensure that private companies can no longer make tax free distributions of profits to shareholders or shareholders' associates in the form of payments, loans and debts forgiven.

    Prior to the introduction of Division 7A, section 108 of the ITAA 1936 was the integrity provision intended to prevent private companies from distributing profits tax free to shareholders and shareholders' associates. In practice, section 108 was found to be ineffective in several ways.

    Section 108 has been repealed and its residual operation is limited to assessments for income years proceeding the income year in which 1 July 2006 occurred.

    2. How does Division 7A work?

    Division 7A applies to certain amounts provided to entities that are connected with a private company, including a non-resident private company.

    From 1 July 2009, Division 7A applies to closely held corporate limited partnerships in the same way it applies to private companies.

    Division 7A treats three kinds of amounts as dividends paid by a private company:

    • amounts paid by the company to a shareholder or shareholder's associate (section 109C)
    • amounts lent by the company to a shareholder or shareholder's associate (sections 109D and 109E), and
    • amounts of debts owed by a shareholder or shareholder's associate to the company that the company forgives (section 109F).

    An amount may be treated as a dividend even if it is paid or lent by the company to the shareholder or shareholder's associate through one or more interposed entities (Subdivision E). Division 7A also applies to non-share equity interests, equity holders and non-share dividends in the same way it applies to shares, shareholders and dividends respectively (section 109BA).

    Some payments, loans and forgiven debts are not treated as dividends (Subdivisions C and D).

    Where a payment is made to a shareholder or their associate in their capacity as an employee or an associate of an employee, Division 7A does not apply. Instead fringe benefits tax (FBT) may apply.

    Treatment of the amounts as dividends makes the amounts assessable income of the shareholder or shareholder's associate (section 44).

    Amounts treated as dividends under Division 7A are generally not frankable, even though they are taken to be paid out of the private company's profits. However, there are some exceptions.

    If the total of the dividends is more than the company's distributable surplus, the dividend amounts are proportionately reduced so that the total equals the distributable surplus (section 109Y).

    To prevent double taxation there are some special rules for actual dividends distributed if some or all of the later dividend is set off against some or all of an amount that has been taken to be a dividend by Division 7A.

    Division 7A also contains provisions (Subdivision EA) which are designed to ensure that a trustee cannot shelter trust income at the prevailing company tax rate by creating a present entitlement to a private company without paying it and then distributing the underlying cash to a shareholder (or their associate) of the company. These provisions apply to certain trustee payments, loans and debt forgiveness made in favour of a shareholder (or shareholders associate) of a private company with an unpaid present entitlement from the trust.

    Subdivision EB, which applies from 1 July 2009, introduces interposed entity provisions to prevent Subdivision EA being circumvented by interposing an entity between the trust making the payment or loan to a shareholder (or their associate) or between a trust and a private company that holds a present entitlement to an amount from the net income of the trust.

    However, Subdivision EA does not apply in all circumstances where there is an unpaid present entitlement. See question 86 (Certain payments, loans and debt forgiveness by trustees (section 109UB and Subdivision EA))

    The Commissioner has a number of discretions in Division 7A which enable him to disregard deemed dividends in certain circumstances.

    3. What is a closely held corporate limited partnership?

    A corporate limited partnership will be considered to be closely held where it has fewer than 50 members or an entity has, directly or indirectly, and for the entity's own benefit, an entitlement to a 75% or greater share of the income or capital of the partnership.

    (See subsection 109BB.)

    4. What amendments were made to Division 7A in respect of non-resident private companies?

    Legislative amendments applying from 1 July 2009 put beyond doubt that Division 7A applies to arrangements that involve a non-resident private company making a payment, loan or forgiveness of debt to a resident shareholder (or their associate).

    The amendments explain that for non-resident private companies, references in Division 7A to a:

    • year of income will be the non-resident's foreign tax accounting period
    • lodgment day for a year of income will be the non-resident's due date for lodging its income tax return in the foreign jurisdiction.

    (See section 109BC.)

    5. What is the commencement date of Division 7A?

    Generally, Division 7A applies to loans and payments made on or after 4 December 1997 (the day the legislation was introduced into Parliament). However, it also applies to loans, the terms of which have been varied on or after that date, and to debts forgiven on or after that date regardless of when the debts were created.

    In addition, any consequential amendments made to other parts of the Income Tax Assessment Acts or other legislation, such as the Fringe Benefits Tax Assessment Act1986 (FBTAA), apply from 4 December 1997.

    The following provisions only apply from 4.00pm Australian Eastern Daylight Saving Time on 27 March 1998:

    • section 109U, (which deals with payments and loans through interposed entities relying on guarantees)
    • section 109UA, (which treats certain liabilities under guarantees as payments), and
    • section 109UB, (which treats certain trust amounts as loans).

    Section 109BA, (which ensures that Division 7A applies to non-share dividends), applies from 1 July 2001.

    Section 109UB has since been repealed and replaced by Subdivision EA of Division 7A which applies to certain payments, loans and forgiven debts made on or after 12 December 2002. Subdivision EA:

    • extends the operation of the former section 109UB to cover distributions of the underlying cash that are in the form of a payment or forgiven debt in addition to loans, and
    • allows loans to be repaid or put under a qualifying written agreement within certain timeframes.

    Division 7A has been amended, effective from the 2004-05 income year, to allow a loan from a private company to be repaid or put on a commercial footing before the 'lodgment day' in order to avoid being treated as a deemed dividend. The 'lodgment day' is the earlier of the due date for lodgment and the date of lodgment of the private company's income tax return for the income year in which the loan is made. However Practice Statement Law Administration PS LA 2005/3 (GA) sets out an administrative concession for the 2003-04 income year.

    In June 2007 a number of significant amendments were made to Division 7A. They are summarised in question 6. The answer to the question includes the dates of effect. These amendments were made to reduce the extent to which taxpayers can trigger a deemed dividend inadvertently.

    Further amendments were made in June 2010 and they are summarised in question 7.

    6. What amendments were made to Division 7A in June 2007?

    In June 2007, amendments were made to Division 7A to reduce the extent to which taxpayers could trigger a deemed dividend inadvertently. Generally, the amendments apply to the 2006-07 income year (or for the income year in which 1 July 2006 occurred) and later income years except for:

    • the FBT amendment which applies to benefits in the year of tax that begins on or after 1 April 2007, and
    • the amendment relating to the Commissioner's discretion to disregard a deemed dividend or allow it to be franked, which applies to the 2001-02 income year and later income years.

    The 2007 amendments included:

    • removal of the automatic debiting of a private company's franking account when a deemed dividend arises under Division 7A
    • allowing payments to be converted to a loan before lodgment day
    • where the minimum yearly repayment was not satisfied the amount of the deemed dividend becomes the amount of the shortfall in the income year rather than the amount of the outstanding loan balance
    • the introduction of a discretion to disregard a deemed dividend if the recipient of a loan is unable to pay the minimum yearly repayment because of circumstances beyond the recipient's control
    • allowing for refinancing of loans in certain circumstances
    • allowing in certain circumstances a private company to frank a deemed dividend that arises because of a family law obligation
    • where a loan meets the requirements of an excluded loan it will be exempt from FBT
    • the introduction of a general discretion to disregard a deemed dividend or allow it to be franked if that dividend arises because of an honest mistake or inadvertent omission by the private company, the entity taken to have been paid the dividend or any other entity whose conduct contributed to the result.

    7. What amendments were made to Division 7A in June 2010?

    In June 2010 further legislative amendments were made to Division 7A. These amendments apply from 1 July 2009 and are summarised in the table below:

    New law

    Current law

    Division 7A applies to closely-held corporate limited partnerships in the same way as it applies to private companies.

    Corporate limited partnerships are excluded from the operation of Division 7A.

    The meaning of 'payment' is extended to include the provision of an asset for use by an entity (other than a transfer of property within the meaning of paragraph 109C(3)(c)).

    Not included in this extended definition of 'payment' are the minor use of company assets, certain payments that would otherwise be allowable as once only deductions and the use of certain residences.

    The meaning of 'payment' in subsection 109C(3) includes a transfer of property to an entity, which entails the ownership of an asset passing to a shareholder or their associate, and a lease of real property to an entity.

    A payment made by an entity in relation to a loan from a private company must not be taken into account in determining whether a loan has been repaid in whole or in part in the year in which it was made, or in determining whether a minimum yearly repayment has been made, if a reasonable person would conclude that:

    • when the payment was made the entity intended to obtain a loan or loans from the private company of an amount similar to or larger than the payment, or
    • in order to make the payment the entity obtained, before the payment was made, a loan or loans from the private company of a total amount similar to, or larger than, the payment.
     

    A payment made by an entity in relation to a loan from a private company must not be taken into account in determining whether a loan has been repaid in whole or in part in the year in which it was made, or in determining whether a minimum yearly repayment has been made, if a reasonable person would conclude that when the payment was made the entity intended to obtain a loan from the private company of an amount similar to, or larger than, the payment.

    The requirement that the payment made is a discharge of, or a reduction in, a present entitlement of a shareholder (or their associate) that is wholly or partly attributable to an unrealised gain is disregarded if certain conditions are satisfied.

    Any loan repayments made by the trustee to the shareholder (or their associate) in subsequent years may then give rise to a deemed dividend for the purposes of Division 7A, where there is an unpaid present entitlement.

    Subdivision EA allows an amount to be included in an entity's assessable income if a trustee makes a payment, and that payment is a discharge of, or a reduction in, a present entitlement of a shareholder (or their associate) that is wholly or partly attributable to an unrealised gain and a company has an unpaid present entitlement to the income of the trust.

    Subdivision EA may be ineffective in loan-back arrangements related to the distribution of an unrealised gain because the loan payments made by the trustee to the shareholder (or their associate) in subsequent years is not a payment that discharges or reduces an entitlement to an unrealised gain. The arrangements are designed to circumvent the operation of Division 7A.

    Work and income support related withholding payments and benefits payable by a private company or trust to an entity offset against a loan can be a repayment by an entity, in relation to a loan.

    Work and income support related withholding payments and benefits payable by a private company to an entity offset against a loan can be a repayment by an entity, in relation to a loan.

    Where a loan that has previously been included in the assessable income of a shareholder of a private company (or their associate) under Subdivision EA is forgiven by the trustee, the forgiven amount does not give rise to a deemed dividend.

    Where a loan that has previously been included in the assessable income of a shareholder of a private company (or their associate) under Subdivision EA is forgiven by the trustee, it may give rise to a deemed dividend.

    Where an entity is interposed between a trust and the shareholder of a private company (or their associate), the trust will be treated as having directly paid or loaned an amount to the shareholder of the private company (or their associate) for the purposes of Subdivision EA, where a reasonable person would conclude that the trustee made the payment or loan as part of an arrangement involving the target entity.

    An entity interposed between a trust and a target entity (that is, a shareholder of a private company or their associate) may circumvent the operation of Subdivision EA.

    If a reasonable person would conclude that a private company is entitled to an amount from a trust estate that is interposed between the private company and a trust (target trust) making a payment, loan or forgiveness of debt to a shareholder of the private company (or their associate) as part of an arrangement involving that target trust, the private company is taken to be entitled to an amount from the net income of the target trust.

    When a private company is presently entitled to an amount from the net income of a trust estate that is interposed between the company and a trust making a payment, loan or forgiveness of a debt to a shareholder of the private company (or their associate) Subdivision EA may not apply.

    Payments or forgiveness of debt amounts that have resulted in a private company being taken to have paid a dividend are recognised in the distributable surplus formula.

    Payments or forgiveness of debt amounts that have resulted in a private company being taken to have paid a dividend are not currently recognised in the distributable surplus formula.

    Amounts that are included in the assessable income of a shareholder of a private company (or their associate) under section 109XB, in an earlier year of income, are reflected in the non commercial loans component of the distributable surplus formula.

    Amounts included in the assessable income of a shareholder of a private company (or their associate) under section 109XB, in an earlier year of income, are not reflected in the distributable surplus formula.

    If a loan from a trustee to a shareholder of a private company (or their associate) is included in their assessable income under Subdivision EA, and a later dividend is received by the shareholder (or their associate) and offset against that loan, the offset amount is excluded from their assessable income to the extent that the dividend is unfranked.

    If a loan from a trustee to a shareholder of a private company (or their associate) is included in their assessable income under Subdivision EA and a later dividend is received by the shareholder (or their associate), that dividend cannot be offset against the loan from the trustee.

    The law will put beyond doubt that Division 7A applies to arrangements that involve a non-resident private company making a payment, loan or forgiveness of debt to a resident shareholder (or their associate).

    No equivalent.

    8. When does section 108 apply?

    Section 108 has been repealed and now only applies to assessments for income years preceding the income year in which 1 July 2006 occurred. For those income years section 108 continues to apply to:

    • loans and payments made before 4 December 1997, and
    • loans and payments made on or after 4 December 1997 to another company or made by the private company in the ordinary course of its business on its usual terms to parties at arm's length.

    Section 108 can also apply to the forgiveness of debts, whether the debt is forgiven before, on, or after 4 December 1997, as there is no provision specifically excluding the application of section 108 to such transactions. For the ATO view on the application of section 108 to debt forgiveness, see Taxation Ruling IT 2637.

    (See subsection 108(2AA).)

    9. What transactions may be considered as a dividend under Division 7A?

    The following types of transactions may be considered as a dividend under Division 7A:

    • payments made by a private company to a shareholder or shareholder's associate
    • loans by a private company to a shareholder or shareholder's associate, and
    • the forgiveness by a private company of debts owed by a shareholder or shareholder's associate to the company.

    Division 7A may also apply where:

    • a private company pays or loans an amount to an interposed entity on the understanding that the interposed entity or another interposed entity will pay or loan an amount to a shareholder or shareholder's associate of the private company
    • guarantees and securities are given by private companies
    • certain trustee payments, loans and debt forgiveness are made in favour of a shareholder or shareholder's associate of a private company with an unpaid present entitlement from the trust
    • from 1 July 2009, certain trustee payments or loans are made to an interposed entity on the understanding that the interposed entity or another interposed entity will pay or loan an amount to a shareholder or shareholders associate of the private company with an unpaid present entitlement from the trust. Where a trust is interposed between the private company and the trust from which the payment or loan is made (the target trust) the company can be taken to be entitled to amount from the net income of the target trust if certain conditions are satisfied.

    From 1 July 2009 Division 7A also applies to closely-held corporate limited partnerships.

    (See sections 109BB, 109C, 109D, 109E, 109F and Subdivisions E, EA and EB.)

    10. What conditions must be satisfied for a private company payment, loan or debt forgiveness to be treated as a dividend under Division 7A?

    Generally, Division 7A applies where a private company has made a payment or loan to, or forgiven the debt of, an entity in an income year and in that income year either:

    • the entity was a shareholder or shareholder's associate of the private company at the time the payment, loan or debt forgiveness was made, or
    • a reasonable person would conclude that the loan, payment or debt forgiveness was made because the entity had been a shareholder or shareholder's associate at some time.

    However, in the case of loans, the following additional requirements must be satisfied for Division 7A to apply:

    1. the loan must not be an excluded loan under Subdivision D, and
    2. the loan must not have been fully repaid (subject to section 109R):
      (a) by the end of the income year in which it was made for a loan made before the 2004-05 income year. However Practice Statement Law Administration PS LA 2005/3 (GA) sets out an administrative concession for the 2003-04 income year, or
      (b) before the 'lodgment day' for loans made in the 2004-05 or a later year of income.

    There are also certain exclusions relating to payments and debt forgiveness.

    The 'lodgment day' for a private company is the earlier of the due date for lodgment and the date of lodgment of the company's tax return for the year of income in which the loan is made. If the Commissioner has deferred the due date for lodgment of the private company's tax return then the due date for lodgment is the deferred due date.

    11. When is a private company taken to pay a dividend under Division 7A?

    The general rule is that a private company is taken to pay a dividend to an entity at the end of the income year in which the payment or loan is made or the debt is forgiven.

    However, where a loan is under a qualifying written agreement that satisfies certain minimum interest rate and maximum term criteria, the private company is not taken to have paid a dividend in the year the loan is made. If the entity then fails to make the minimum yearly repayment in a subsequent year, the private company is taken to have paid a dividend to the entity in the income year in which the minimum yearly repayment is not made.

    In addition, if the loan is made in the course of the winding-up of a private company by a liquidator and the loan is not fully repaid by the end of the following income year, the company is taken to pay a dividend at the end of that income year.

    (See subsections 109C(1), 109D(1), 109D(1A), and 109F(1), and section 109NA.)

    12. Does the Commissioner have any discretions to disregard deemed dividends?

    Yes. Division 7A contains four discretions or powers to disregard dividends, two of which were introduced as part of the June 2007 amendments with one back dated to the 2001-02 income year. For the first two discretions the private company is not taken to have paid a dividend and in the case of the others the deemed dividend is disregarded. The discretions are:

    • If the Commissioner is satisfied that a debt was forgiven because payment of the debt would have caused undue hardship, the recipient of the loan (that is, shareholder or associate) had the capacity to pay the debt when the debt was incurred and the inability to pay the debt in the foreseeable future resulted from circumstances beyond the recipient's control. Under these circumstances the private company is not taken under Division 7A to pay a dividend because of the forgiveness of the debt.
    • If a failure to make a minimum yearly repayment occurs because of circumstances beyond the control of the recipient of the private company loan and that person would suffer undue hardship if there was a deemed dividend the private company is not taken under Division 7A to pay a dividend because of the failure to make a minimum yearly repayment. See question 75 (Amalgamated loans).
    • From income years in which 1 July 2006 occurred, the Commissioner may disregard a deemed dividend where the recipient was unable to make the minimum yearly repayments because of circumstances beyond their control. The Commissioner can specify a later time by which the minimum yearly repayment must be made. See questions 70 to 72 (Amalgamated loans).
    • The Commissioner has a discretion to disregard a deemed dividend or allow it to be franked if that dividend arises because of an honest mistake or inadvertent omission. This discretion, although a June 2007 amendment, applies in relation to the 2001-02 and later income years for a decision to disregard a deemed dividend and from 1 July 2002 for a decision to allow a deemed dividend to be franked. The Commissioner may make the decision subject to specified conditions. See questions 17 to 22.

    (See subsection 109G(4) and sections 109Q, 109RB and 109RD.)

    13. What is an entity for Division 7A purposes?

    An entity includes: an individual, a body corporate, a body politic, a partnership, any other unincorporated association or body of persons, a trust, and a superannuation fund.

    (See definition of 'entity' in section 109ZD of the ITAA 1936 and section 960-100 of the ITAA 1997.)

    14. What is the amount of the dividend taken to be paid by the private company?

    Generally, the amount of the dividend is taken to equal the amount of:

    • the payment
    • the loan that has not been repaid by the required time, or
    • the debt forgiven.

    The 'required time' for loans made in the 2003-04 or earlier year of income is the end of the year of income in which the loan is made. However Practice Statement Law Administration PS LA 2005/3 (GA) sets out an administrative concession for the 2003-04 income year. For the 2004-05 year or a later year of income the required time is before the 'lodgment day'. The 'lodgment day' for a private company is the earlier of the due date for lodgment and the date of lodgment of the company's tax return for the year of income in which the loan is made.

    For amalgamated loans, the law was amended with effect for the year in which 1 July 2006 occurred and for later income years such that the amount of the dividend is the shortfall in the minimum yearly repayment for the income year.

    The dividend is limited to the amount of the company's distributable surplus.

    (See subsections 109C(2), 109D(2), 109F(2) and section 109Y.)

    15. How is a dividend amount that arises from a private company payment, loan or debt forgiveness treated under Division 7A?

    The amount taken to be a dividend is treated as having been paid at the end of the company's income year out of the company's profits to the entity in the capacity of a shareholder.

    For income years preceding the income year in which 1 July 2006 occurred (generally the 2005-06 and earlier income years) the deemed dividend is included in assessable income as an unfranked dividend and the private company's franking account is debited. The deemed dividend is not subject to dividend withholding tax or PAYG withholding tax and it is not a fringe benefit.

    For the income year in which 1 July 2006 occurred and later income years:

    • the automatic debiting of the private company's franking account is removed, and
    • certain deemed dividends may be frankable, for example, a dividend taken to be paid because of a family law obligation.

    (See sections 109Z, 109ZA and 109ZB of the ITAA 1936, and subparagraph 202-45(g)(i) and section 205-30 table item 8 of the ITAA 1997. Also, see paragraph(r) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA.)

    16. What is the effect on the private company's franking account if the company is taken to pay a dividend at the end of an income year?

    In general, amounts treated as dividends under Division 7A are not frankable, even though they are taken to be paid out of the private company's profits. Generally where amounts are treated as deemed dividends, a private company cannot allocate a franking credit to the dividend and you are not entitled to a tax offset in relation to the dividend.

    The implications for the franking account depend upon whether the amount is deemed as a dividend under Division 7A:

    • before 1 July 2002
    • on or after 1 July 2002 until 30 June 2006, or
    • on or after 1 July 2006.

    Before 1 July 2002

    Amounts treated as dividends (unfranked) may cause a franking debit to arise in the franking account on the last day of the company's income year, subject to the company having a franking account surplus. In general terms, the amount of the franking debit was equal to the 'required franking amount' of the deemed dividend. In the circumstances where a company did not have a franking account surplus at the end of the income year the deemed dividend did not result in a franking debit. This was because the 'required franking amount' would be calculated at nil.

    The 'required franking debit' represented the minimum extent to which a frankable dividend was required to be franked by using as much of the frankable surplus as possible at the date of payment of the dividend. This meant that:

    • if the franking account surplus was equal to or greater than the dividend, the dividend had to be fully franked
    • if the franking account surplus was less than the amount of the dividend, the dividend had to be partly franked to the extent of the surplus, and
    • if there was no franking account surplus, the dividend was not required to be franked.

    If the company had resolved to pay other frankable dividends on the same day or had committed to pay frankable dividends later in the income year, the company was required to pro rata its franking surplus over all of the frankable dividends to be paid in that year (unless the company's franking surplus was sufficient to fully frank all the relevant dividends to be paid).

    On or after 1 July 2002 until 30 June 2006

    Generally, an amount that is treated as a dividend under Division 7A causes a franking debit to arise in the private company's franking account on the last day of the company's income year. The amount of the franking debit is the amount of the debit that would have arisen if the dividend was a frankable distribution and the distribution was franked at the private company's 'benchmark franking percentage' for the income year. If the company does not have a benchmark franking percentage for the income year, the benchmark franking percentage is taken to be 100%.

    However, in certain circumstances, the Commissioner may exercise a discretion to disregard a deemed dividend or allow the deemed dividend to be franked if that dividend arises because of an honest mistake or inadvertent omission (see question 17). The Commissioner's discretion to allow deemed dividends to be franked would only apply where the deemed dividend is made to the shareholder.

    If a deemed dividend is disregarded because the Commissioner exercises his discretion and there has been a previous debit to the franking account because of the deemed dividend, the private company's franking account can be re-credited by the amount of the debit.

    The Commissioner will not be able to make a decision to permit the franking of a deemed dividend that arose before 1 July 2002. If the Commissioner exercises his discretion to allow the private company to choose to frank the deemed dividend (subject to conditions being complied with) the deemed dividend will be taken to be frankable. If the private company does frank the deemed dividend then the private company's franking account:

    • will be debited as if it had franked an ordinary distribution, and
    • it is not to be debited again as a result of the deemed dividend, and
    • can be re-credited by the amount of any previous debit because of the deemed dividend.

    On or after 1 July 2006

    Unless the Commissioner exercises his discretion to allow deemed dividends to be franked (see question 17) an amount that is treated as a dividend on or after 1 July 2006 will not cause a franking debit to arise in the private company's franking account on the last day of the company's income year.

    If the Commissioner exercises his discretion to allow the private company to choose to frank the deemed dividend (subject to conditions being complied with) the deemed dividend will be taken to be frankable. If the private company does frank the deemed dividend the private company's franking account will be debited as if it had franked an ordinary distribution.

    17. Does the Commissioner have a general discretion to disregard the operation of Division 7A?

    Yes. The law was amended in June 2007 but the discretion was back dated to the 2001-02 income year. Before the Commissioner can consider exercising the discretion the applicant needs to demonstrate to the Commissioner that the failure to comply with Division 7A was the result of an honest mistake or inadvertent omission. There is a two stage process.

    Stage 1

    The Commissioner can only act if the failure to satisfy the requirements of Division 7A is the result of an honest mistake or inadvertent omission by any of the following:

    • the shareholder or associate of the shareholder
    • the private company
    • any other entity whose conduct contributed to the deemed dividend arising under Division 7A.

    Stage 2

    Once it is established that there is an honest mistake or inadvertent omission the Commissioner is empowered to make a decision. In making a decision the Commissioner must have regard to:

    • the circumstances that led to the mistake or omission
    • the extent to which any of the entities have taken action to try and correct the mistake or omission, and if so how quickly that action was taken
    • whether Division 7A has operated previously in relation to any of the entities - private company, shareholder (or associate) and any other entity whose conduct contributed to the failure to comply
    • any other matters the Commissioner considers relevant.

    The Commissioner must consider all relevant factors in the context of the particular circumstances of the each individual taxpayer. The relative weighting of each factor depends upon the actual circumstances of the case.

    The Commissioner may then decide in writing that:

    1. the deemed dividend shall be disregarded, or
    2. the dividend may be franked (but the Commissioner cannot make a decision to permit the franking of a deemed dividend that arose before 1 July 2002).

    The decision made by the Commissioner may be subject to any of the following kinds of conditions:

    • a condition that the recipient or another entity must make specified payments to the private company or another entity within a specified time
    • a condition that a specified requirement in this Division must be met within a specified time.

    For example, the Commissioner could require that there be a written loan agreement that satisfied all the requirements of Division 7A and for the shareholder to make additional payments equal to the total of the minimum yearly repayments that should have been paid if Division 7A had been complied with.

    If the Commissioner makes a decision and the conditions are satisfied then the private company is not taken to have paid a dividend and an amount will not be included in the recipient's assessable income as if it were a dividend.

    (See section 109RB.)

    18. Does the private company or recipient (shareholder or their associate) need to apply to the Commissioner to exercise his discretion to disregard a deemed dividend?

    In most cases the private company or recipient will need to apply to the Commissioner to exercise his discretion to disregard a deemed dividend.

    Note:Practice Statement Law Administration PS LA 2007/20 sets out transitional arrangements for the 2001-02 to 2006-07 income years. If the conditions set out in the practice statement are satisfied, taxpayers do not need to apply to the Commissioner in writing to exercise his discretion to disregard each deemed dividend that has arisen from the application of Division 7A. See question 21.

    The Commissioner may make a decision without being requested by the company, shareholder or their associate. However, the Commissioner would need to know all the facts and circumstances relating to the failure to comply.

    There is no prescribed or standard application form. However, in the application the applicant will need to:

    • provide details of all the circumstances surrounding the failure to satisfy the requirements of Division 7A, and
    • detail when and how they tried to rectify the mistake or omission, and
    • detail previous applications (if any) of Division 7A.

    The Commissioner may request additional information prior to making a decision.

    19. If the shareholder or their associate has been assessed on a deemed dividend can the Commissioner exercise the discretion to disregard the deemed dividend?

    Yes, provided the necessary requirements are satisfied.

    A taxpayer can lodge an objection to the assessment requesting that the Commissioner should exercise his discretion to disregard the deemed dividend. If the period for lodging a taxation objection has expired, the objection should be accompanied by a request that it be treated as having been lodged within time. The Commissioner's discretion to extend the period within which an objection can be lodged is explained in Law Administration Practice Statement PS LA 2003/7 (particularly paragraphs 5 to 26).

    20. How significant is correcting the mistake or omission in the exercise of the discretion to disregard the operation of Division 7A?

    Corrective action is significant as the law requires the Commissioner to have regard to:

    • the extent to which the private company, shareholder or associate or any other entity whose conduct contributed to the failure to comply has taken action to try to correct the mistake or omission, and
    • if so, how quickly the action was taken.

    There are other factors that the Commissioner must consider. The respective weighting of each factor depends upon the actual circumstances of each case.

    (See subsections 109RB(2), 109RB(3) and 109RB(4).)

    21. For the general discretion that was back dated to the 2001-02 income year what transitional arrangements were in place?

    The discretion was inserted by Tax Laws Amendment (2007 Measures No.3) Act 2007 and applies in relation to the 2001-02 income year and later income years.

    In most cases the private company or shareholder (or their associate) will need to apply to the Commissioner to exercise his discretion to disregard a deemed dividend. However, as the discretion was backdated to the 2001-02 income year a transitional arrangement was implemented for the 2001-02 to 2006-07 income years. The transitional arrangement is set out in Practice Statement Law Administration PS LA 2007/20.

    It allowed the taxpayer to get on a compliant footing going forward by taking the necessary 'corrective action' rather than applying directly to the Commissioner in writing to exercise his discretion to disregard the deemed dividends. The practice statement states that in respect of 2001-02 to 2006-07 income years taxpayers do not need to apply to the Commissioner in writing to exercise his discretion if the following conditions are satisfied.

    • it is clear from all the circumstances currently within the Commissioner's knowledge that the failure to comply with one or more of the provisions of Division 7A was the result of an honest mistake or inadvertent omission by the taxpayer, private company, or other relevant party
    • 'corrective action' as defined in the practice statement was taken by the taxpayer on or before 30 June 2008
    • the deemed dividend under Division 7A arose in respect of a transaction or action that occurred after 30 June 2001 and by the end of the 2006-07 income year, and
    • the taxpayer had lodged all required income tax returns for the 2001-02 to 2006-07 income years if necessary.

    The purpose of the practice statement is to outline the Commissioner's approach during the initial transitional period where taxpayers take specific corrective action to put themselves in a position which complies with the present Division 7A requirements. Tax officers must consider the individual circumstances of each taxpayer and the factors set out in section 109RB. If the conditions set out above are satisfied then in most cases it would not be unreasonable for a taxation officer to conclude that the discretion should be exercised in the taxpayer's favour.

    However, if there are other factors which outweigh the 'corrective action' and which might cause the Commissioner to not exercise his discretion to disregard the deemed dividend then the matter must be referred to either the Division 7A Case Panel or an Assistant Commissioner for advice before any decision is made on the exercise of the Commissioner's discretion.

    22. What is 'corrective action' for the purposes of Practice Statement PS LA 2007/20?

    'Corrective action' has the meaning set out in paragraphs 10 to 14 of the practice statement and loans, payments and debt forgiveness are covered. Relevant paragraphs include:

    10

    If the deemed dividend arose in respect of a payment under section 109C then 'corrective action' means:

    • the full amount of the payment has been converted into a loan and a loan agreement has been entered into that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose, and
    • the taxpayer has made a payment, or payments, equal to the total of minimum yearly repayments that would have been payable had the loan existed from the start of the period that began with the year in which the deemed dividend arose.

    11

    If the deemed dividend arose in respect of a loan under section 109D then 'corrective action' means:

    • now having in place a loan agreement that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose, and
    • the taxpayer has made a payment, or payments, equal to the total of minimum yearly repayments that would have been payable had the loan existed from the start of the period that began with the year in which the deemed dividend arose.

    12

    If the deemed dividend arose in respect of section 109E or section 109E as modified for Subdivision EA, then 'corrective action' means that the taxpayer has made a payment, or payments, equal to the total of minimum yearly repayments under the loan that were required from the commencement of the loan.

    13

    If the deemed dividend arose in respect of a debt forgiveness under section 109F then 'corrective action' means:

    • the amount of the debt forgiven is treated as the principal of a loan and a loan agreement has been entered into that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose, and
    • the taxpayer has made a payment, or payments, equal to the total of minimum yearly repayments that would have been payable had the loan existed from the start of the period that began with the year in which the deemed dividend arose.

    14

    If the deemed dividend arose in respect of an assessable amount under section 109XB then 'corrective action' means:

    • in the case of a subsection 109XA(1) payment - that the subsection 109XA(4) amount involved in the actual transaction has been converted into a loan and a loan agreement is entered into between the taxpayer and the trustee that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose
    • in the case of a subsection 109XA(2) loan - entering into a loan agreement between the taxpayer and the trustee for the subsection 109XA(4) amount that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose
    • in the case of a subsection 109XA(3) forgiven debt - the subsection 109XA(4) amount involved in the actual transaction is treated as the principal of a loan and a loan agreement is entered into between the taxpayer and the trustee that complies with all the requirements of section 109N that now exist and all requirements that existed at any time during the period that began with the year in which the deemed dividend arose, and
    • in any of the situations covered by the three preceding dot points the taxpayer has made a payment, or payments, equal to the total of minimum yearly repayments that would have been payable had the loan existed from the start of the period that began with the year in which the deemed dividend arose.

    The corrective action will ensure that the taxpayer's actual loan balance is equivalent to what it would have been if the taxpayer had complied with the requirements of Division 7A throughout the period.

      Last modified: 14 Sep 2010QC 16852