Jan 2025 Round Up | The looming Div 7A problem areas

The warning on Division 7A and guarantee arrangements - it's broader than you might think!

Plus, the ATO's concerted focus on foreign residents disposing of Australian property and who (and what) to look out for.

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Inside this month, Michael Carruthers (Tax Director), Jason Hurst (Tedchnical SUperannuation Adviser), Ann Dai (Tax Adviser) and Lisa Armstrong (MD) bring you:

Division 7A and guarantee arrangements

Reference:

• TD 2024/D3
• TA 2024/2
• Division 7A Myths debunked

The ATO has issued draft detremination TD 2024/D3 that considers the potential application of section 109U ITAA 1936 when a private company guarantees a loan made by another entity.

Under section 109U, a private company is taken to make a payment or loan to a shareholder or an associate of a shareholder (the target entity) if:

• The private company guarantees a loan made by another entity (first interposed entity);
• A reasonable person would conclude (having regard to all the circumstances) that the private company gave the guarantee solely or mainly as part of an arrangement involving a payment or loan to the target entity;
• Another private company (which may be the first interposed entity or another interposed entity) makes a loan or payment to the target entity; and
• The amount paid or loaned by the other private company to the target entity exceeds that company's distributable surplus.

In this draft determination, the ATO confirms that for section 109U to apply, there is no requirement that the first interposed entity needs to be a private company. For example, section 109U could potentially apply even if the loan is provided by an unrelated public company bank or financial institution. However, the entity making the ultimate payment or loan to the ‘target entity’ must be a private company for these rules to apply.

The ATO has also issued a taxpayer alert (TA 2024/2) in respect of arrangements that seek to circumvent Division 7A through guarantees of third-party loans by private companies. The ATO is reviewing arrangements where:

• A private company guarantees a loan made by a financial institution to a related company that has nor or minimal distributable surplus
• The related company on-lends (or pays) some or all of the amount borrowed from the financial institution to the first company's shareholders (or their associates) on terms that do not comply with the requirements of Division 7A.

The ATO is concerned that taxpayers are entering such arrangements to circumvent Division 7A, or on the incorrect misunderstanding that section 109U (which deals with guarantee arrangements) only applies if the third-party lender is a private company. Section 109U requires the entity which makes the payment or loan to the shareholders to be a private company, but it does not require the entity to which the guarantee is given (e.g., third party financiers) to also be a private company.

The ATO indicates that the following tax implications could potentially arise in situations like this:

• Division 7A might apply to deem the private company which provided the guarantee to have paid an unfranked dividend to the shareholders or associates who received the loan or payment from the related private company.
• The Commissioner may make a determination under Part IVA to cancel any tax benefit arising under the arrangement.

Division 7A mistakes and myths

• Shareholders who believe they can freely use company money in any way they like. No, the company is a separate legal entity, so Division 7A may apply to any money or other benefits provided to shareholders and associates.
• Division 7A only applies to the shareholders of a private company. No, Division 7A also applies to associates of shareholders, which is broadly defined.
• Dividends can be put in a journal entry after an income year has ended, to effectively offset any minimum yearly repayment obligation for that income year. No, agreements and offsets must be made by the relevant deadline, which is usually 30 June.
• Division 7A can be avoided if payments or loans to shareholders and their associates are made through other entities. No, Division 7A may still apply where the private company’s shareholder or their associate is the target entity to whom the payment or loan is ultimately directed.
• The interest rate that is applied on a Division 7A loan is the same every year. No, the benchmark interest rate generally changes each year.
• Division 7A can be circumvented if the loan is temporarily repaid before the lodgement day, using the company’s money for the repayment. No, repayments may not be taken into account where taxpayers reborrow similar or larger amounts from the company after making the repayment.
  
  

CPI triggers 1 July TBC increase

Following the release of the December 2024 CPI figures, the general transfer balance cap (TBC) will increase from $1,900,000 to $2,000,000 from 1 July 2025. For some clients, this could provide a tax effective retirement pension and non-concessional contribution opportunities for some of your clients.

Retirement income streams

Individuals who commence a retirement phase income stream for the first time after 1 July 2025 will have access to the full $2,000,000 limit. For some individuals there may be a benefit in deferring the commencement of a retirement income stream until on or after 1 July 2025.

For clients who commenced a retirement phase income stream before 1 July 2025, the proportional indexation rules mean that clients could have a personal TBC anywhere between $1,600,000 and $2,000,000. Your client’s personal TBC and eligibility for indexation is in the ATO Portal under their My Gov Login – this should be checked before commuting or commencing any retirement phase pensions.

What about non-concessional contributions?

The indexation of superannuation contribution caps is based on earnings figures (AWOTE) which won’t be released until late February, however total super balance (TSB), which impacts non-concessional contributions (NCCs) is linked to the general transfer balance cap.

Currently those with a TSB of over $1,900,000 on the prior 30 June cannot make any NCCs. For the 2025-26 financial year, individuals with a TSB under $2,000,000 on 30 June 2025 will be able to make a NCC of at least the annual NCC cap.

Foreign residents disposing of property

Reference: 

• Foreign residents disposing of taxable Australian property
• Foreign resident capital gains withholding overview
• Australian residents and clearance certificates
  

The ATO is focusing on foreign residents who dispose of taxable Australian property (TAP) and fail to lodge returns that correctly advise the ATO of any gain or loss. The ATO is also looking at purchasers who fail to withhold FRCGW from foreign residents.

Foreign residents are subject to capital gains tax (CGT) in Australia if they dispose of TAP, which comprises:

• Taxable Australian real property (TARP) (e.g., land and buildings located in Australia).
• Indirect interests in Australian real property (e.g., shares in a company which holds land or buildings in Australia).
• Assets used in carrying on a business through a permanent establishment in Australia.
• Options, or rights, to acquire any of the above assets.

The ATO is focusing on foreign residents who:

• Hold significant direct or indirect interests in TAP assets
• Dispose of TARP or indirect interests but do not meet their CGT obligations in relation to the disposal
• Characterise or value or assets in a way to fall within the CGT exclusion
• Enter into a series of transactions such as 'staggered sell-down' arrangements to avoid paying Australian CGT
• Lodge returns that are not in accordance with new ‘associate-inclusive test’ in determining total participation interests
• Fail the principal asset test by inappropriately allocating significant market value to non-TARP assets
• Are unlikely to have sufficient funds or assets remaining in Australia to meet their tax obligation relating to the disposal of TARP assets.

Purchasers are generally required to collect FRCGW at 15% and remit this to the ATO, unless the foreign resident vendor has a variation notice specifying a reduced rate of withholding, before or at settlement. Foreign resident vendors can apply to the ATO (via the online form) if they believe the withholding rate should be varied, at least 28 days before settlement.

The 1 January 2025 changes to the foreign resident capital gains withholding regime

The ATO has updated its website guidance to reflect changes to the foreign resident capital gains withholding (FRCGW) regime that apply from 1 January 2025.

In particular, the rate of FRCGW for property sales for contracts signed on or after 1 January 2025 is now 15% (increased from 12.5%). Further, there is no longer any minimum threshold for property values for FRCGW purposes (previously $750,000).

For Australian residents disposing of Australian real property, unless they have provided the purchaser with a clearance certificate at or before settlement, the purchaser must withhold FRCGW.

While most clearance certificates take a few days to issue, they can take up to 28 days to process, which means that clients seeking to avoid cash flow implications under the withholding rules should seek a clearance certificate from the ATO as soon as possible.