Recently, the ATO released taxpayer alert TA 2024/2 and draft tax determination TD 2024/D3, expressing concerns about specific private company guarantee arrangements. The alert warns that such setups could potentially breach Division 7A provisions.
* What is Division 7A?
Division 7A is an Australian tax regulation aimed at preventing private companies from improperly distributing profits to shareholders or related parties. Non-compliant financial assistance is treated as unfranked dividends, and shareholders are required to pay tax on these amounts.
* Key Points of the ATO Warning:
Guaranteed Loans: A financially robust private company acts as a guarantor for loans taken out by a related private company with little to no distributable surplus from a financial institution.
Improper Fund Flow: The borrowing private company transfers the loaned funds to the guarantor company’s shareholders or their related entities, either through loans or payments, without adhering to the strict Division 7A compliance standards.
These arrangements may appear legitimate but are effectively attempts to circumvent regulations. Under ITAA Section 109U, the guarantor company is deemed to have provided an unfranked dividend, requiring the shareholder to pay additional tax.
* Risk Alert
The ATO cautions that some taxpayers might misunderstand Section 109U’s scope, believing Division 7A provisions only apply if the third-party lender is a private company. In reality, any involvement of a private company in loans or payments can trigger the relevant tax laws, even if the entity receiving the guarantee is not a private company. This misconception may lead businesses to inadvertently breach tax laws, exposing them to additional tax liabilities.
* Points to Note:
While the ATO focuses on addressing actions that substantially circumvent Division 7A, the vague definition of “circumvention” increases compliance challenges for businesses.
* What Should You Do?
Review Current Guarantee Arrangements: Businesses should immediately assess whether they have guarantee arrangements for loans, particularly if the funds ultimately flow to shareholders or related parties.
Ensure Division 7A Compliance: Make sure all relevant arrangements strictly adhere to Division 7A provisions to avoid being deemed as providing unfranked dividends.
The ATO has intensified its oversight of private company tax compliance, issuing multiple warnings and determinations. Businesses must remain vigilant to avoid tax risks due to misunderstandings or non-compliance. For any questions about new tax requirements, consult a tax professional immediately to ensure all tax arrangements are handled legally and in full compliance. This proactive approach will help businesses safeguard their financial security and stability.
