The income tax law provides that certain payments and loans made to shareholders or their associates and debts owed by them which are forgiven by private companies may be deemed as dividend income for taxation purposes unless they come within specified exclusions.
The relevant provisions are in Division 7A of the Income Tax Assessment Act 1936. This is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders and/or their associates.
The recent changes which generally apply from 1 July 2006, reduce the double-penalty nature by removing the automatic debiting of the company's franking account when a deemed dividend arises.
The changes provide more flexibility for taxpayers and reduce the extent to which they can be inadvertently caught by the provisions. The changes, for example, include:
- a 'payment' can be converted to a loan that can be either fully repaid before a private company's tax return lodgment day for an income year, or be placed on a commercial footing by putting in place a qualifying loan agreement
- where minimum yearly repayments fall short of the required amount by a due date the amount of the deemed dividend that arises is the shortfall amount in an income year
- certain loans can be refinanced without triggering a deemed dividend, and
- a private company may frank a deemed dividend that arises because of a family law obligation. Franking can apply in the same circumstances as capital gains tax rollover relief applies to spouses.
Compliant loans will be exempt from fringe benefits tax.
The Commissioner has a discretion to disregard a deemed dividend and extend the period for repayments where minimum yearly repayments have not been made due to circumstances beyond the taxpayer's control.
The Commissioner also has a discretion to disregard a deemed dividend or allow it to be franked where it arises from an honest mistake or inadvertent omission. In deciding whether to exercise this discretion the Commissioner must consider a range of factors including the circumstances that lead to the deemed dividend, whether any corrective action has been taken and whether there is a history of breaches of the relevant provision. This discretion can be exercised subject to conditions being complied with.
This discretion is retrospective and applies to the 2001-02 and later income years.
The ATO is providing business owners a one-off opportunity up until 30 June 2008 to self correct past mistakes regarding payments and loans from their private companies and avoid penalties under Division 7A, without applying for the Commissioner's discretion. Your tax advisor will be able to help you with this.
The offer applies to mistakes made in respect of the 2001-02 to 2006-07 income years and the fact sheet Division 7A - A guide to calculating payments forming part of the 'corrective action' in Law Administration Practice Statement PS LA 2007/20 sets out how taxpayers can take corrective action to fix these mistakes.
For more information on these changes and the transitional period, please visit the Tax Office website ato.gov.au/Businesses and select - Investments, shares & options - Division 7A Essentials.
You can also access the Division 7A calculator and decision tool for help in determining how to comply with the requirements of Division 7A for your situation.
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