As part of the changes recently announced regarding the application of Division 7A, the Australian Tax Office ("ATO") are providing taxpayers with an opportunity to undertake 'corrective action' to rectify any previous breaches of Division 7A. This opportunity follows the recent discretionary power granted to the Commissioner of Taxation ("Commissioner") to disregard the application of Division 7A in circumstances where an 'honest mistake' or 'inadvertent omission' has been made.
Division 7A was introduced with effect from 4 December 1997 as a way of preventing shareholders and/or their associates obtaining a tax-free financial benefit from a private company by way of loans, payments or forgiveness of debts. The provisions act to 'deem' a dividend to the relevant taxpayer(s) unless an exclusion applies.
Until recently there was no power for the Commissioner to disregard the (often punitive) consequences of breaching these rules. This position has now been softened with the introduction of a discretionary power which may allow a taxpayer the opportunity to comply with the relevant provisions in circumstances where there has been an 'honest mistake' or 'inadvertent omission'.
Further to this legislative change, an administrative concession has been provided by the ATO whereby this new 'discretionary power' will be exercised (essentially on a self-assessment basis) for errors made between 1 July 2001 - 30 June 2007. The detail of this announcement can be found in Practice Statement Law Administration (PSLA) 2007/20.
In order to benefit from the announcement made by the ATO regarding their retrospective amnesty, the following conditions must be satisfied:
- it is clear from the circumstances that failure to comply with the relevant provisions was the result of an honest mistake or inadvertent omission by the taxpayer;
- 'corrective action' (as defined) is taken prior to 30 June 2008;
- the relevant provisions that gave rise to the deemed dividend under Division 7A were breached between 1 July 2001 and 30 June 2007; and
- the taxpayer has lodged all income tax returns for the above-mentioned periods (to the extent that returns were required).
If the above-mentioned criteria are satisfied, the taxpayer will not need to apply to the Commissioner to exercise his discretion. But for this initial transitional period, ordinarily taxpayers would be required to apply to the Commissioner if his discretion to disregard a deemed dividend was being sought.
In effect, taking corrective action simply means taking steps to essentially treat a loan, payment or debt forgiveness as having satisfied the relevant provisions of Division 7A such that the loan, payment or debt forgiveness would not have given rise to a deemed dividend. At a practical level, 'corrective action' will depend on the circumstances of each case.
Generally speaking, taking corrective action is likely to mean putting a loan agreement in place (if an agreement doesn't already exist) and making the required payment(s) on the loan so that the balance is reconciled to what it would have otherwise been.
Paramount in determining whether your client(s) can benefit from this announcement will depend on whether the circumstances that gave rise to the non-compliance amount to an 'honest mistake' or 'inadvertent omission'. Unfortunately guidance in this area is limited and open for individual interpretation.
There are numerous factors that should be considered in determining whether an 'honest mistake' or 'inadvertent omission' gave rise to the deemed dividend. These may include (but are not limited to):
- whether the taxpayer and/or the company engaged the services of a Tax Agent;
- if a Tax Agent was used, whether the same agent acted for both the taxpayer and the company or whether separate agents were used;
- the skills and experience of the particular taxpayer(s) and Tax Agent(s) involved;
- the habitual transactions of the company and the taxpayer (i.e., was the breach an isolated instance or does the company make loans, payments or forgives debts on a regular basis?); and
- the specific nature of the non-compliance, for example, was it merely using the wrong interest rate when calculating a minimum loan repayment or have no loan repayments been made at all?
It should be noted that the above points may only represent some of the relevant factors and that a thorough review of each individual circumstance would be required in concluding whether the breach was as a result of an 'honest mistake' or 'inadvertent omission'.
Lawler Partners has extensive experience in dealing with non-commercial loans and the application of Division 7A. Should you have any clients that may be able to benefit from the ATO's announcement or would like further assistance, please do not hesitate to contact the Lawler Partners' Tax Team on (02) 4962 2688.
