Division 7A – Private Company Loans

This article provides an overview of Division 7A of Taxation Law, focusing on private company loans. It discusses the scope of Division 7A, the need for its introduction, and the overall policy objectives. The article also evaluates whether Division 7A meets its objectives and suggests possible amendments. Expert advice on taxation law is provided.

Running head: TAXATION LAW
Taxation Law
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Table of Contents
Part A:........................................................................................................................................2
Letter of Advice.........................................................................................................................2
Part B: Division 7A – Private Company Loans.........................................................................5
Introduction:...............................................................................................................................5
Scope of Division 7A:................................................................................................................5
The need for introducing Division 7A:......................................................................................6
Overall policy objectives of Division 7A:.................................................................................8
Evaluation of whether the Division 7 meets the policy objectives:...........................................9
Necessary further amendment to Division 7A:........................................................................10
New single Loan Model:......................................................................................................10
No formal written loan agreement.......................................................................................11
Grace Period for outstanding pre-1997 loans:.....................................................................11
Abolition of distributable surplus.........................................................................................11
Adoption of Unpaid present entitlements (UPEs):...............................................................12
Conclusion:..............................................................................................................................13
References:...............................................................................................................................14

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Part A:
Letter of Advice
To Jenny and John
From Miller Tax Consultants
Date: 22-4-2019
Dear Jenny and John
The present letter of advice aims to address your residential status and income tax
consequences relating to the transactions that has been occurred by you and your wife Jenny.
As a primary note, we would like to make you aware that for income tax purpose an
Australian resident is required to pay tax on income earned from all the Australian sources
(Woellner et al. 2016). There are four types of residential status test however an individual is
only required to meet the criteria of one test to be treated as Australian resident under
“section 6 (1), ITAA 1997”.
We would like to inform you that the ordinary resides test is the primary test of
determining residential position of an individual. A person under the ordinary concept test is
held as Australian resident if he or she is actually living in Australia, regardless of their
citizenship or nationality. The taxation commissioner in “FCT v Miller (1946)” explained
that determining the residential status of an individual is based on the subject of fact
(Barkoczy 2016). Noteworthy factor such as the amount of time that is spend living in
Australia is held vital.
The domicile test is another test of residency where a person is held as Australian
resident if their domicile or place of abode is in Australian and the commissioner of taxation
is satisfied that their domicile is foreign country (Sadiq 2018). The federal court judgement

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handed in “Applegate v FCT (1979)” held that despite the taxpayer was successful in
retaining the domicile in Australian but he was considered as non-resident of Australia
because it was provided that the permanent place of abode was out of Australia (Morgan,
Mortimer and Pinto 2018). The 183 day’s test is another important test where a taxpayer is
held to be an Australian resident if the taxpayer has been present in Australian for more than
six months of the calendar year and the commissioner of taxation is content that the taxpayer
has the permanent place of residence out of Australia. Finally, we would like to inform you
that superannuation test is the final test of residency where an individual is held as Australian
resident if the person is the member of commonwealth superannuation fund.
On the basis of the reported facts it can be stated that both you and your wife Jenny
arrived in Australia with the employment contract for eighteen months. With respect to the
ordinary concept test both you and Jenny are not an Australian resident. You further
established that you have the fixed place of abode out of Australia, so you have successfully
passed the domicile test and cannot be treated as Australian resident under this test. However,
ever since you arrived in Australian from 1st December to 2018 it is understood that you have
been present in Australian for more than six months of the income year (Black 2018). As a
result of this, you have met the criteria of 183 days test and you and your wife Jenny will be
treated as Australian resident under this test. A noteworthy span of time has passed by ever
since you and your wife Jenny arrived. Both of yours behaviour reflect a habit or continuity
of residing in Australia.
Both you and your wife Jenny reported income from employment that amounted to
$130,000 and $38,000 respectively. The income constitute personal service income which is
taxable under the ordinary meaning of “section 6-5, ITAA 1997”. There are several
investment in US stock market is held by you and your wife jenny and also derived dividends
that amounted to $5,000 (Morgan and Castelyn 2018). We would like to inform you that your

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dividends will be taxable as statutory income under “section 44 (1) of the ITAA 1936”. You
also bought shares in Australian listed company but the dividend was paid to you on 10th July
2019. As the income is earned in following income year of 2019, so it will not be included
into your assessable income for assessment purpose.
You sold a land for $230,000 that was purchased for $200,000 for building petrol
stations. The sale of land resulted in “CGT event A1” under “section 104-10, ITAA 1997”.
The profits that is earned by you from the sale of land is an income and you should declare in
your assessable income as ordinary income (Robin 2019). You later rented out the Brisbane
property and received a lump sum in advance. Referring to judgement in “FC of T v
Adelaide Fruit and Produce Exchange Co Ltd (1932)” the rent received by you from sub-
letting of Brisbane property is an ordinary income under regular flow concept which will be
taxable under “section 6-5, ITAA 1997”.
We hope that the advice rendered in this letter has helped you in serving your purpose
and we are open to discussion if you further seek any information relating to the above stated
matters.
Thank You

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Part B: Division 7A – Private Company Loans
Introduction:
The introduction of Division 7A during 4 December 1997 was mainly for the
replacement of section 108. Division 7A was regarded as self-executing and for overcoming
the major deficiencies which was contained in section 108 (Jorgensen 2014). In the inventive
incarnation, Division 7A is mainly applied for the payment of loans and transactions related
to forgiveness of debt amid the private company and the shareholders, or the associates of its
shareholders. The collaboration of Division 7A with the unpaid current entitlements to the
trust distribution soon turned into an issue.
The purpose of the anti-avoidance provision makes sure that the shareholders and the
related parties would not be able to indirectly gain the access to realised or unrealised profits
of the private company without the quasi-distribution being the subject to tax. On a wider
note, “Division 7A of the ITAA 1936” makes sure that making of the payment or the loan by
the private company to the shareholders or debt forgiveness that is owed to the shareholders
to the private company is regarded as the assessable unfranked dividend for the shareholders
up to the sum of loan and debt forgiveness (Parker 2015).
The current report would critically evaluate and discuss the Division 7A as the anti-
avoidance provision. The report would consider the overall policy objectives of the Division
7A and would assess whether the Division 7A presently meets the policy objectives or
whether it requires additional amendments.
Scope of Division 7A:
“Section 109B to 109ZE” sets down the scope of Division 7A which is been
purposefully widened to preclude the probable opportunities of avoidance by;

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a. Treating the payment, loan or the debt forgiveness that are made by the private
company to the former shareholder as the dividend where the realistic person may
consider that the payment, loan or forgiveness of debt would arise since that person
was the shareholder at some previous time (Brydges 2017).
b. Estimating that the private company may have paid a loan or payment to the targeted
set of shareholders where such kind of loan or payment is paid to that targeted entity
through one of more interpolated entity.
c. Preventing the trust that has the unpaid distribution in arrears of the currently entitled
private company recipient from paying the amount or loans to the shareholders or
forgiving debt that is owed by the shareholders or associate.
Importantly, it is worth mentioning that the provision of Division 7A is inevitably
activated when any of the above stated situations happens and its application would
ultimately result the associates and the shareholders to earn an assessable deemed unfranked
dividend.
The need for introducing Division 7A:
Prior to getting on with the detailed discussion relating to all the numerous
constituents that underpins the Division 7A it is essential to understand the reason behind the
introduction of Division 7A from the effective date of 4th December 1997 (Mahar 2015).
Before this date, any kind of concealed distribution of profits made by the private company
was possibly treated as the deemed unfranked dividend under the previous “section 108 of
the ITAA 1936”.
On a wider note, the previous legislative provision of “section 108, ITAA 1936”
stated that where the private company paid or credited the sum including the loan of
shareholder to the associate, or shareholder, then the company would be considered to have

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made the payment of dividend to that person given the taxation commissioner is in the
opinion that the sum paid or credited amounts to the profits distribution. It is eventually
apparent that section 108 became a problematic provision for taxation commissioner and
decided to invoke it based on the following reasons;
a. The taxation commissioner would be characteristically required to perform a time-
taking and lengthy audit or review for obtaining an understanding of all the applicable
situations before forming an opinion whether or not there was any distribution of
company profits (Chan 2015).
b. The practical implementation of the provision was reliant on profits that was realised
which was disclosed in the accounts of company that may require the commissioner
to disagree with the accuracy of the company’s accounts where no disclosure of
profits was made.
c. The legislative provision of section 108 did not specifically addressed the unrealised
profits distribution that resulted in the opportunities of tax planning and avoiding the
scope.
d. The implementation of the provision to loans can become complicated where the
repayments of loan inconsistent in amount or uniformity.
e. The provision can be circumvented effectively where the private company made the
payment of loans through the unrelated interposed entities that was not considered as
the associates of shareholders for the purpose of income tax.
As evident from the above stated limitations, this resulted in the introduction of
Division 7A as the replacement of self-executing provisions that are activated where the
objective criteria of payment, debt forgiveness or loan transactions are satisfied (Koustas and
Geljic 2014). It is irrespective of the underlying purpose as the reason behind the payment or
loan or forgiveness of debt was entered into. Undeniably, in actual practice the most common

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breach of Division 7A originates where the private company makes the loan to the trust that
forms the associate of shareholders that is solely undertaken for the purpose of business to
provide the trust with the working capital. Upon enacting the Division 7A it also deals with
the above stated limitations of section 108 as it is automatically applied notwithstanding of
whether the estimated dividend is related to either realised or unrealised profits or whether
the payment of loan is directly made through single or multiple interposed entities.
Overall policy objectives of Division 7A:
Division 7A is regarded as the section of Tax Act which comprises of the anti-
avoidance provisions that are aimed in prohibiting the owners of private company and their
associates from avoiding the taxation of dividends by gaining an access to the profits of the
company in another form apart from dividends (Jorgensen 2017). Division 7A is only
applicable on the private companies, all loans, advances and other credits that are made by
the private companies to the shareholders. The overall policy of Division 7A states that the
provision is only activated when a private company makes the payment to shareholders
together with the transfer of shares or usage of property for lesser market value. Division 7A
happens when the private company lends the money to the shareholders or the associates of
shareholders without the specific loan agreement and the loan is not entirely repaid by the
lodgement day of that income year (Cardan 2016). Division 7A is applicable when the private
company forgives the debt that is owed by the shareholder or the associates of the
shareholder company.
According to the Division 7A any payment or other benefits that is provided to the
shareholder or associates by the private company can be treated as the dividend for the
purpose of income tax under the Division 7A even though if the participants treat it as some
sort of transaction namely the loan, advance, gift or writing off the debt (Athanasiou 2014).
Division is also applicable when the private company provides the payment or the benefit to

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the shareholders or associates with the help of another entity or if the trust has distributed the
income to the private company but has not in reality paid it and the trust has provided the
payment or the benefit to the shareholders of the company.
Division 7A being the part of ITAA 1936 and it is aimed to prevent the profits or
assets that is provided to the shareholders or their associates without charging any tax.
Division 7A considers the deemed dividend is usually unfranked (Richards 2014). The most
effective method of providing a payment or other benefit to the shareholder or their associate
is to pay the amount as the normal dividend and for the shareholder to the same into the
assessable income.
The overall policy objective of Division 7A is that it is not applicable to the amount
that are taxable to the shareholders or their associates under other parts of the income tax
laws namely the normal dividends or the fees of director’s. A payment or the benefit that
possess the potential will be subject to Division 7A is not considered as the dividend if the
loan is repaid or converted to the Division 7A complying loan by the company’s lodgement
day for the income year under which the payment or the benefit happens (Main 2014). If the
Division 7A is applied the amount that is paid or forgiven by the private company to the
shareholders or their associate are held as dividend unless the amount falls inside the certain
exclusion.
Evaluation of whether the Division 7 meets the policy objectives:
According to Heath (2019) there are several small business owners that use
company’s insider their private group to remain dependent heavily on their accountants and
tax agents to help them in complying with the requirements of the taxation system together
with the provision of Division 7A. Therefore, any communication of strategies employed by
the ATO to improve the general awareness and understanding of Division 7A must be

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directed towards accountants and tax agents. Amending or replacing the provision of
Division 7A is not likely to improve the understanding relating to the rules by the owners of
small business. With the broad nature of this review and it is likely that the number of
alternations would be made to the provision which may present the ideal opportunity of
rewriting the provision under ITAA 1997. The current policy of Division 7A is criticized by
Van der Velde (2016) as it is only limited to the private company’s distributable profits for
the year. Therefore, it can be stated that the current division does not meets the objectives and
requires further amendments.
Necessary further amendment to Division 7A:
New single Loan Model:
The new single model of loan that is suggested in the consultation paper comprises of
replacing the present 7 years and 25-year loan with the single model of loan with specific
features namely the maximum term of 10 years (Richards 2014). The new model of loan
proposes that yearly benchmark of interest would be applicable for the small business. Di
Blasio (2016) states that even though the method of calculating principle and interest is easy
but it is not computed in the way that is consistent with the commercial loans.
In addition to this, requiring the equal yearly principal payment together with the
interest over the term of loan would result in substantial negative effect on the cash flow for
several small business and medium businesses. Somers and Eynaud (2015) critically opinion
that the yearly benchmark rate of interest that is set is very high. Therefore, there is an option
of adopting alternative loan model. As the cash flow varies between the businesses and
industries and if the single 10 year loans is to be applied then it is suggesting that an
alternative model should be available under the Division 7A. For the business that has the
steady amount of cash flow and requires simplicity the single 10-year model of loan should

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be the option with the lower rate of interest will enable the repayment of principal and loan
interest as well.
No formal written loan agreement
The Chartered Accountants ANZ also supports the removal of requirements relating
to the formal written loan agreement for the complying Division 7A loan. Evidences relating
to the execution of loan must not be necessary because the loan is not the formal written
agreement and should have some form of evidence that would show the acknowledgement
between the parties that they are bounded by the loan agreement (Flynn 2014). A
recommended stated by the CA ANZ suggest that the computation of minimum yearly
repayment should be reworked in a manner that it would reflect the repayments of
commercial loans.
Grace Period for outstanding pre-1997 loans:
Another recommendation made by Yuan (2017) suggest that the outstanding pre-1997
loans should be given a grace period of two years before the first repayment becomes due for
the loans that should be repaid subsequently for 10 years. The treasury should reconsider the
proposal of applying the Division 7A 10-year model of loan to the pre-1997 loans that are
used for business purpose in respect of the fact that from the real-world viewpoint, a large
number of Pre-1997 loans might not be repaid under the projected Division 7A 10 year terms
of loan. As a result, there will be several financial hardships because of sheer size of several
loans. If the government takes the decision of bringing the Pre-1997 loans under the regimes
of Division 7A, then there must be either much longer transitional period and they must be
permitted to be covert the 25 year secured loans.

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Abolition of distributable surplus
In an attempt to introduce simplicity, Mayo (2018) has suggested the abolition of
distributable surplus. To support this, CA ANZ has supported the simplification of the
distributable surplus calculations in the earlier Division 7A consultation. Should the
distributable surplus be removed, it is recommended that a provisions must be included to
make sure that the funds accessed by the shareholders or associates which represents the
return on capital must not be considered as deemed dividends. In addition to this, the
distributable surplus computation does not takes into the account the amount that are earlier
considered as deemed dividend under Division 7A making sure that there are no duplication
of the deemed dividends. Duplication can take place when the loan to the shareholders or
associates is considered as deemed dividend in the earlier income year however the loan is
still existent on the balance sheet of the company as the loan that is yet to be repaid.
Accordingly, a provision will be needed to take into the account the amount that was
previously treated as Division 7A dividends. As recommended by CA ANZ if the
computation of distributable surplus is removed then the provision should be included to
make sure that the funds which is accessed by the shareholders or associates representing the
return of capital should not be treated as deemed dividends. A provision is necessary to
exclude the sum which was earlier treated as the Division 7A dividends.
Adoption of Unpaid present entitlements (UPEs):
Tucker (2016) recommends the adoption of Unpaid present entitlements (UPEs) as it
would add greater values to the owners of small business and their advisers in clarifying their
position in light of the treatment of the UPE as loans with the help of legislative amendment.
For UPEs that is arising from 16th December 2009 to 30 June 2019, UPEs that have been
reinvested in the specific income generating asset of the trust must be excluded from the

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proposed treatment of the group of UPEs as there are trust law considerations that tries to
convert the amounts into the Division 7A loans.
Additionally, it is recommended that Division 7A 10-year should be applicable only
on the interest for the UPEs that have been reinvested under the Option 1 and Option 2 of the
PS LA 2010/4. Furthermore, for UPEs that originates prior to 16 December 2009, if the
amount of UPEs has been used for business purpose, then from the perspective of equity,
they must be grandfathered. Nevertheless, if the substantial implications of Division 7A is to
be attained then the UPEs must be included into the Division 7A (Voogt 2019). The inclusion
should include the longer transitional period and should include the concessional loan terms
for Division 7A compliance.
Conclusion:
On a conclusive note, the objective of the Division 7A is very much clear and
reasonable but the provision have turned into something that are the major source of
complexity and confusion for the private companies. Presently, there are two sets of un-
legislative changes has been announced for Division 7A. As evident these proclaimed
changes provide suggestion that there should be a substantiate rewrite and simplification of
Division 7A is under way. But a risk is always prevalent that these would turn into another
example of tampering with the provisions and may fail to deliver the simplification which is
promised.
For private companies and group something is very clear that the landscape is
changing and strategies that worked in the previous years would not be likely to work in
future. Overall, the private companies and their consultants should bear in mind that Division
7A is presently the most common tax issues in reviews of the private groups and high wealth

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individuals. Therefore, new strategies and actions of dealing with the legacy is regarded as
the good chance of coming under the scrutiny of ATO.

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Australia, 49(5), p.279.
Barkoczy, S., 2016. Foundations of taxation law 2016. OUP Catalogue.
Black, C., 2018. Taxation of Intellectual Property Under Domestic Law and Tax Treaties:
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Brydges, N., 2017. Trusts: Div 7A and UPEs-New ATO guidelines. Taxation in
Australia, 52(4), p.204.
Cardan, T., 2016. The increased impact of div 7A on family law settlements. Taxation in
Australia, 51(5), p.253.
Chan, C., 2015. TR 2010/3 on UPEs and Div 7A: An unwelcome U-turn?. Tax
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Di Blasio, C., 2016. Recovering overseas debts: Quagmires and quandaries. Bulletin (Law
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Heath, S., 2019. Tax files: Deemed dividends and private companies. Bulletin (Law Society
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Specialist, 20(3), p.118.
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