Restructuring and Division 7A

Division 7A has caused its own peculiar problems for existing clients or inherited clients. What is clearly and self-evidently an existing problem, such as, for example, an extant loan which has yet to be repaid in accordance with the terms as set out in section 109N so as to avoid the operation of Division 7A, is an issue that needs to be dealt with.
The usual approach in addressing such issues is to take a proactive approach by effecting corrective action, in the form of making catch-up payments and making application to the Commissioner under section 109RB as it presently stands. However, there can be circumstances where prospective transactions that are, in substance, of a restructuring nature and could have a beneficial outcome.

In his paper, presented in Perth at the 'Division 7A Day' and excerpted here, Arthur Athanasiou CTA (Life), explores some of those circumstances, but at this point emphasises that any form of restructuring could give rise to an identifiable tax benefit and invoke the provisions of Part IVA. It should, in this day and age, be virtually mandatory that any restructuring attempt that is focused on avoiding the operation of Division 7A also have the Commissioner's approval under a private binding ruling. However, following the Full Federal Court's decision in Hacon there is now real doubt that the Commissioner would rule on the potential application of Part IVA to a transaction, particularly where the correctness of the ruling would depend on assumptions about a future event.

In addition to the tax risk, another area that is not so obvious, but is at least of equal importance, is the commercial risk of restructuring to avoid the operation of Division 7A. A simple example illustrates this potential exposure.

Assume a private company has two unrelated members, each holding an equal interest. One member has taken company property, say cash to be consumed for private purposes, and has been assessed to tax because of the value of the property is taken to be a payment, and is deemed to have received an unfranked dividend. Would it be fair to the other member not to expect the property to be returned to the company, despite being having already been assessed to tax?

Nevertheless, if a taxpayer is aware of the commercial and taxation risks involved, structuring can play a role in diminishing any prospective exposure to Division 7A. For example, loans could be assigned, or assets can be transferred in tax-effective ways that can give rise to real benefits by avoiding a future tax liability.

In his paper Arthur does not consider how consolidated groups might be involved in any form of restructuring. This is primarily because of the low “take-up” of tax consolidation by SME entities generally, but also because of the “single-entity” rule. Under this rule, transactions between group entities inter se are not subject to Division 7A, whilst transactions between a member of the group and an outsider to the group are treated without reference to the consolidation rules and are considered as being between the creditor private company, and debtor associate.

Furthermore, it does not consider any other areas that may have application to any form of restructuring, and these include GST and duty.
Obviously, any attempt to restructure any existing entity structure or business arrangement should be the subject of a private ruling from the Commissioner, preferably beforehand.

Finally, a Consultation Paper was recently released by Treasury entitled “Targeted amendments to the Division 7A integrity rules”. In that paper, a number of proposed changes to Division 7A have been suggested, seeking public response. Two of the main changes that affect this paper are:

1. Abolition of the “distributable surplus” calculation; and

2. Self-correction mechanism for dealing with prior breaches of Division 7A.

These proposed changes are considered throughout the paper in the context of restructuring for Division 7A purposes.

Arthur’s paper goes on to look at:

Restructuring – preliminary issues

  • Do you really know the current structure? 
  • What if you detect an earlier exposure? 

Restructuring – effecting certain transactions 

  • Debt Parking 
  • Utilising set-off transactions to effect payments 
  • What shouldn’t be done – Assigning UPE’s 
  • Tax analysis 
  • Cost Base 
  • Capital Proceeds 
  • Division 7A 
  • What shouldn’t be done – Forgiving UPE’s 
  • Recent developments – TD 2018/13 

Restructuring Principles

  • Restructuring and triggering gain? 
  • Can the Small Business Rollover Rules (SBRR) apply? 
  • Commentary on SBRR for Division 7A Purposes 
  • A trust estate that has a UPE owed to it from a related unit trust 

Is restructuring using rollover relief an option?

  • Viability – UPE restructuring 
  • Rollover 
  • Licensing 
  • Other forms of restructuring involving trusts & other entities 
  • Part IVA

The paper concludes that, in the absence of any specific anti-avoidance rules contained within Division 7A or the general antiavoidance rule in Part IVA, restructuring to avoid past or future Division 7A exposures remains viable alternative to a client's steadfast refusal to repay a loan or be assessed on an unfranked dividend.

However, rather than restructuring, nothing beats proper advice being obtained before establishing a business structure. In a nuclear family arrangement, a discretionary trust that carries on an enterprise should be the vehicle of choice to avoid Division 7A, and net profits should be distributed to individuals to obtain a consistent pattern of distributions.

Unit trusts are, in the author’s view, diminishing in importance for many reasons, not least of which are the trust loss rules and because of the potential impact of CGT event E4.

For whatever reason, if a private company must be chosen as a trading-vehicle, all stakeholders need to obtain proper advice beforehand, particularly on the commercial and tax consequences of trying to extract economic benefits that are untaxed or lesser-taxed.

The full paper is available for purchase here. Subscribers to the Tax Knowledge eXchange can access the paper free, along with all technical papers on our website. Find out more.

Arthur Athanasiou CTA (Life), Partner, Accredited Tax Law Specialist, of Thomson Geer Lawyers main area of practice is taxation advisory, with an emphasis on dispute resolution, particularly in the SME sector, with both the ATO and the SRO.

Arthur has many years’ experience in complex tax litigation and tax audit negotiations and settlements. He also has broad experience in the taxation of trusts and SME entities, with an emphasis on Division 7A and high wealth individuals and family groups.

Arthur has extensive experience in all areas of direct and indirect taxation and has qualified as a Chartered Accountant. He has also held senior taxation and management positions in the transport and motor vehicle industries with specialist experience in logistics, supply chain, chain of responsibility, and contract warehousing.

A former President of The Tax Institute, he has also chaired the Law Institute’s Tax Law Advisory Committee for a decade and now serves on the Industry Advisory Board of the IPA-Deakin University SME Research Centre.

Arthur is an Accredited Tax Law Specialist and a widely published writer on taxation issues. He regularly appears in the mainstream media, and presents at tax seminars and discussion groups.


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