Deemed Dividend Rules: New 10-Year Loan Model

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Division 7A is a long-standing tax integrity measure that treats certain payments by private companies to shareholders or their associates as unfranked “dividends” for tax purposes. Those deemed dividends are then assessable income of the recipient and taxed at the recipient’s marginal tax rate.

Current laws include an important exception to these rules: a payment is not treated as a dividend if it is converted into a loan that meets certain requirements, including a minimum statutory interest rate, certain minimum annual repayments and a maximum loan term of either 25 years for a loan secured by a registered mortgage over real estate, or seven years in any other case.

To simplify the rules for Division 7A-compliant loans and better align them to commercial practice, the government proposes to reform the laws from 1 July 2019 so that a compliant loan would instead be required to meet the following:

  • a maximum loan term of 10 years – regardless of whether the loan is secured;
  • a different benchmark interest rate that is considerably higher than the current benchmark; and
  • annual repayments of both principal (in equal annual instalments over the term of the loan) and interest.

The government also proposes transitional rules to help companies with existing loans transition to the new 10-year model. These would operate as follows:

  • All existing seven/25-year loans in place at 30 June 2019 would need to adopt the new, higher benchmark interest rate after that date.
  • Existing seven-year loans would retain their existing loan term and mature as originally planned.
  • Existing 25-year loans would need to convert to a 10-year term prior to the lodgement day of the company’s 2020-2021 tax return. However, it is not yet clear whether a 25-year loan with fewer than 10 years remaining as at 2021 would need to adopt a 10-year term.
  • Pre-December 1997 loans would become subject to Division 7A and need to convert to a 10-year loan by the 2020-2021 lodgement day.

The proposals have attracted criticism that a 10-year loan model and higher interest rate would create cashflow problems for those who rely on their corporate structures to access funds. For example, it may be difficult to convert an existing 25-year loan to a 10-year loan because the outstanding balance must be repaid over a much shorter period of time. Outstanding loans that are not converted to meet the new requirements would give rise to a deemed dividend.

Taxpayers in this situation will therefore need to decide whether to convert or pay out the loan by the deadline.

All taxpayers with existing Division 7A loans (regardless of the loan term) will also need to consider the impact of the reforms on their cashflow, given the higher interest rate that could apply from 1 July this year.

Now is also a good time to consider any planning opportunities. For example, if an existing 7-year loan is voluntarily converted to a 25-year loan before the proposed laws take effect on 1 July 2019, it would then convert to a 10-year loan after 2021 – creating a total effective term of more than 10 years. However, the parties would need to be able to arrange real estate as security in order to initially convert to a 25-year loan.

Review your corporate structures now 

While these proposals are not yet final and some aspects may change, the government has signalled a clear intention to cut the maximum term of compliant loans and introduce a higher benchmark interest rate. Businesses should not wait to consider the impacts. Talk to us today to start identifying possible consequences for your structures and to discuss strategies for managing future cashflow or restructuring.