ATO Div 7A Benchmark Interest Rate
The Division 7A benchmark interest rate for an income year is the ‘indicator lending rates – bank variable housing loans interest rate’ last published by the Reserve Bank of Australia before the start of the income year.*
For 2017/18 the deemed dividends benchmark interest rate (TD 2017/17) is 5.30%.
For 2016/17 the deemed dividends benchmark interest rate (TD 2017/17) is 5.40%.
Division 7A does not apply to loans to associates made under a conforming loan agreement if the rate of interest payable satisfies the benchmark interest rate requirements.
The benchmark interest rate is relevant to private company loans made or deemed to have been made after 3 December 1997 and to trustee loans made after 11 December 2002.
(Note: Div 7A benchmark interest rates are not applicable for FBT purposes. For benchmark rates applicable to the calculation of loan fringe benefits – see FBT Benchmark Interest Rate)
Application of Div 7A
In brief, the application of Div 7A is to treat loans or debts as deemed taxable unfranked dividends. The amount of the deemed dividend is limited to the extent of the company’s distributable surplus.
The following fall for consideration under Div 7A:
- Debts forgiven after 3 December 1997 (regardless of when the debt was created)
- Private company loans made or deemed to have been made after 3 December 1997.
- Pre-3 December 1997 loans which have increased in amount or had the term extended
- Division 7A applies to trustee loans made after 11 December 2002.
Interposed payments – reasonable person test
Draft Tax Determination TD 2017/D3 sets out the view that section 109T can apply to a payment or loan made by a private company to an interposed entity, even if it is an ordinary commercial transaction.
Section 109T would apply if a reasonable person would conclude that the payment or loan is made solely or mainly as part of an arrangement involving a payment or loan to a shareholder or shareholder’s associate.
Corrective Action – Commissioner’s Discretion
A Div 7A deemed dividend outcome can be disregarded at the discretion of the Tax Office, in circumstances considered to have arisen as a result of an “honest mistake or inadvertent omission”.
A Tribunal case which reviewed the Commissioner’s refusal to exercise discretion is discussed here.
In that instance, the Tribunal reduced the penalties for non-compliance from “recklessness” (50%) to “carelessness” (25%), whilst noting that: “Division 7A is complex. Even experienced tax agents struggle with it.”
The Tax Office advise that exercise of the discretion will depend on the extent to which the taxpayer has taken corrective action, or has given undertakings to do so, and the speed with which that occurs.
An example of corrective action is the establishment of a compliant loan agreement and the payment of catch-up payments to create a position at least equivalent to that of having complied from the time of non-compliance.
A Tax Office description of corrective action and example calculations are provided here.
- PS LA 2011/29 Exercising the discretion under section 109RB of Division 7A
- TR 2010/8 Income tax: application of subsection 109RB(1) of the Income Tax Assessment Act 1936
Trusts with unpaid present entitlements owing to private companies
Budget 2018 (8 May 2018):The Government announced its intention to ensure that unpaid present entitlements come within the scope of Division 7A of the Income Tax Assessment Act 1936 from 1 July 2019. This will apply where a related private company is made entitled to a share of trust income as a beneficiary but has not been paid that amount, known as an unpaid present entitlement.
In 2010 the ATO published a view (TR 2010/3) that unpaid present entitlements owed by a trust to a private company within the same closely held family group were essentially ‘loans’ for the purposes of Division 7A. This raises the possibility of UPEs being taxed as unfranked dividends.
PSLA 2010/4 provides guidance and examples of the application of TR 2010/3 , detailing ways (apart from deploying a Division 7A loan agreement) to avoid the ATO applying Division 7A to UPE balances.
Practical Compliance Guideline PCG 2017/13 sets out sets out the ATO’s compliance approach for Option 1 loans entered into on or before 30 June 2011 for which a 7 year loan term would mature in the 2017 and 2018 years.
- Division 7A and unpaid present entitlements (UPEs) – Commissioner provides relief for Option 1 UPE loans
- Taxpayers and advisers take note: it will soon be time to pay-out UPEs or convert them to Division 7A complying loans to avoid paying deemed dividends
Div 7A compliant loans
The standard escape hatch to the deemed dividend application of Div 7A is provided under Section 109N ITAA1936 for loans meeting the criteria for minimum interest rate and maximum term.
The loan must be:
- in writing, with an agreement in place at least one day before the lodgement day of the income tax return for the year in which the loan is made:
- made at the specified benchmark interest rate
The term of the loan must not exceed
- if secured over property at net market value of at least 110% of the loan value – 25 years
- otherwise, including an unsecured loan, 7 years
The Benchmark Interest rate is determined on an annual basis, so the loan agreement interest rate should be expressed in terms of equivalence to, or exceeding the prevailing benchmark rate.
Section 109E provides a minimum repayment formula, essentially based on the declining loan balance in relation to the remaining term of the loan, and commencing in the year after the loan was made. Interest is provided at each year’s benchmark rate.
Loans complying with Section 109N are also exempt from FBT (since July 2006).
Essential Reference: Tax Determination TD98/22
The Division 7A benchmark interest rate is updated annually by the issue of a Tax Determination.
- Div 7A – Loans By Private Companies
- Free checklists – Division 7A and UPE – CPA Australia
- Div 7A checklist © ICAA and Thomson Reuters
- ATO – Div 7 calculator and decision tool
This page was last modified 2018-05-08