Company lends you money -- new dangers in Div 7A

QUESTION:
In 2004/5 I warned you that your clients could turn around and sue if you, as their accounting professional, failed to alarm them of the perils of Division 7A of the Income Tax Assessment Act 1936 http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/.

On 13 June 2007, the Tax Laws Amendment (2007 Measures No 3) Bill 2007 http://www.comlaw.gov.au/ComLaw/Legislation/Bills1.nsf/0/BE7DAA6919BF1BA4CA25... was passed by the senate. It appears that Division 7A is no longer a problem.

Is this the case?

ANSWER:
Division 7A tries to stop gifts or "fake loans" from your company to you and your family. Companies pay tax at 30%. Humans pay tax at the top marginal tax rate of 46.5%. It is therefore useful to have the company pay only 30% tax and then "lend" you the money. You then never pay off the loan. This was easy to do under section 108 (pre-Div 7A loans). You can keep your pre-Div 7A loans fresh by building a Debt Recognition (including pre-Div7A Loans) http://www.lawcentral.com.au/CreateDoc/createlink.asp?docId=44&SessionID=... statement at LawCentral www.lawcentral.com.au.

Division 7A stops your company from making tax-free distributions of profits (gifts and fake loans) to you and your associates.

For the 620,000 companies in Australia, the rules were too harsh. Innocent mistakes couldn't be rectified leading to an effective tax rate of almost 100%. Accountants were being unfairly sued by uneducated and angry clients.

Most of the recent changes are advantageous to your clients. Innocent breaches can often be rectified at a later time.

1. Keep franking credits
For me, the best change is removing the automatic debiting of your company's franking account when there is a "failed loan" (whenever a deemed dividend is triggered). You see, when your company pays its 30% tax rate that information is stored as a "franking credit". When your company then pays you a dividend, you don't pay that 30% again. Instead you are credited with this payment on your tax return (fully franked). You then only pay the difference. If, for example, your tax rate is 31.5% then you only pay 1.5% on the dividend.


Under the old Div7A rules you pay full tax on this "failed loan" at your own marginal tax rate (at the full 31.5% for the above example). You then still lose the franking credit, anyway. You were violently penalised because you broke the law. You caused mischief by not declaring distributions from the company as dividends (assessable income). You therefore suffer this terrible double penalty.


The double penalty is now considered too draconian so it has been removed. The automatic debit on your franking account also penalised all your company's shareholders; not just you who got the money out of the company.

Sure, this "failed loan" (deemed dividend) is still treated as unfranked dividends (fully taxed in your hand at your marginal tax rate with no franking credit entitlement). Under the above example you pay tax on this "deemed dividend" on your 31.5%. But your company keeps the franking credit when it next pays a dividend.

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[ForPropertyInvestors]

Thanks for the videos :).