The ATO is concerned that some taxpayers are entering into arrangements to circumvent the operation of Div 7A of ITAA 1936 through the guaranteeing by private companies of third-party loans.
Key takeaways
- Circumvention Concerns: The ATO is concerned about arrangements designed to circumvent Div 7A by using private companies to guarantee third-party loans.
- Review of Arrangements: The ATO is reviewing arrangements where a private company guarantees a loan to a related company, which then on-lends to shareholders without complying with Div 7A.
- Potential Consequences: These arrangements may lead to deemed dividends under Div 7A and potential tax benefits being cancelled under Pt IVA.
- ATO Guidance: Taxpayers involved in such arrangements are encouraged to seek ATO guidance, professional advice, and consider making voluntary disclosures.
Taxpayer Alert TA 2024/2 provides that the ATO is currently reviewing arrangements under which:
- A private company (the first company) guarantees a loan made by a financial institution to a related private company that has no 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 Div 7A of ITAA 1936.
The arrangements purportedly do not give rise to a deemed dividend under Div 7A. This is despite the fact that a deemed dividend may have arisen had the first company directly paid or on-lent the amount to its shareholders (or their associates).
The arrangements the ATO is reviewing typically display the following features:
- A private company (Trading Co.) guarantees a loan made to a related private company (Lending Co.) from a third-party financier that is not a private company, such as a bank.
- Lending Co. pays or loans some or all of the amount borrowed to the shareholders of Trading Co. (or the shareholders' associates). If Lending Co. does make a loan, the loan does not comply with the requirements of s 109N of ITAA 1936.
- The payment or loan made by Lending Co. is more than its distributable surplus.
- Trading Co. may pay the amounts required under the loan agreement with the third-party financier because Lending Co. defaults on its obligation to repay the amounts required under the loan agreement to the third-party financier and calls on the guarantee of Trading Co.
- Alternatively, Trading Co. may pay the amounts required under the loan agreement with the third-party financier directly or pay money to Lending Co. to enable it to repay the third-party financier, and to prevent Lending Co. from defaulting on its obligations under the loan agreement.
- On an objective assessment, Trading Co.'s guarantee and Lending Co.'s loan were provided as part of the same contrived arrangement for the purpose of avoiding the Div 7A consequences that would have arisen had Trading Co. directly paid or lent the amount to its shareholders (or their associates).
The ATO is concerned some taxpayers are entering these arrangements to circumvent the operation of Div 7A.
The ATO is also concerned that these arrangements may be entered into on the misunderstanding that s 109U of ITAA 1936 (within Div 7A) only applies if the third-party lender is a private company. This is not the case. Section 109U requires the entity which makes the payment or loan to the shareholders (in the arrangement outlined above, Lending Co.) to be a private company, but it does not require the entity to which the guarantee is given (in the arrangement outlined above, the third-party financier) to also be a private company.
From the ATO's review of these arrangements, it considers that the following consequences may arise:
- Div 7A may apply to deem the private company which gave the guarantee (Trading Co. in the arrangement outlined above) to have paid an unfranked dividend to the shareholders or associates who received the loan from the related private company (Lending Co. in the arrangement).
- The Commissioner may make a determination under Pt IVA of ITAA 1936 to cancel any tax benefit arising under the arrangement.
Taxpayers that have entered into, or are considering entering into, an arrangement of this type are encouraged to engage with the ATO through the contact details provided at the end of the alert or by seeking a private ruling. The ATO also encourages affected entities to seek independent professional advice and make a voluntary disclosure to reduce any penalties that may apply.
Source: Taxpayer Alert TA 2024/2, ATO website, 11 December 2024, accessed 11 December 2024.
