Entities that entered into complying Division 7A loan agreements and are unable to meet the minimum yearly repayment due to circumstances beyond their control may be given additional time beyond year end to make the repayment without a deemed dividend arising.
Where the inability to make the repayment is due to the effects of COVID-19, entities may apply to the ATO using a streamlined process to obtain an additional 12 months to make the repayment. This streamlined process that was introduced for the 2019-20 income year has been extended to minimum yearly repayments due in the 2020-21 income year.
What are the rules about?
Section 109RD of the Income Tax Assessment Act 1936 allows the Commissioner of Taxation to decide, in writing, that a deemed dividend arising as a result of a failure to pay the full amount of a minimum yearly repayment may be disregarded in particular circumstances (i.e. where the inability was due to circumstances beyond the entity’s control). The deemed dividend will not arise if the minimum repayment shortfall is repaid within a time specified by the Commissioner.Importantly, the Commissioner may only make such a decision after the failure to make the minimum yearly repayment has occurred (i.e. after year-end). Additionally, the relief only applies to pre-existing complying loans and does not extend to new loans made in the prior income year. That is, section 109RD does not permit the Commissioner to allow additional time to repay the loan or put the loan on complying terms.
What relief is the ATO providing due to COVID-19?
Where the reason the borrower has failed to make the full minimum yearly repayment by the end of the 2020-21 income year (generally 30 June 2021) is due to the on-going effects of COVID-19, they may request a 12-month extension to make the repayment (i.e. until 30 June 2022) through a streamlined online process (see website link here). This requires the borrower to confirm the shortfall in the required repayment and confirm that adverse effects of COVID-19 resulted in the inability to make the repayment, but otherwise not having to provide further evidence.The ATO states that it expects to provide a response within 28 days of the application. Where successful, the deemed dividend is disregarded so long as the shortfall is paid by 30 June 2022.
Note that where the private company does not have a distributable surplus for the 30 June 2021 income year this relief should not be necessary as no deemed dividend arises.Further details of when the ATO considers that an entity is unable to pay is also contained on the website link which covers borrowers that are individuals as well as other entities such as partnerships and trusts.
What are the other consequences of obtaining relief?
If an entity is given additional time to make the minimum yearly repayment, this does not replace its requirement to make the minimum yearly repayment the following year if the loan terms extend beyond 30 June 2021. In effect, the entity would have to make two minimum yearly repayments by 30 June 2022. Further, the payment that would ordinarily be required for the 30 June 2022 year would be higher as the repayment would be calculated on the balance of the loan on 30 June 2021 that has not otherwise been reduced due to the minimum yearly repayment for that year not having been made. Whether this 30 June 2021 loan balance includes the unpaid interest for the income year will depend on the terms of the Division 7A loan agreement and whether it provides for the capitalisation of interest. The unpaid interest would need to be paid in accordance with the loan agreement, whether not it affects the calculation of subsequent minimum yearly repayments.The ATO website contains a detailed worked example of how future minimum yearly repayments are affected.
Are there any other forms of relief available?
More generally, borrowers can seek longer additional time to make the repayment for reasons other than COVID-19, seek more than 12 months to make the repayment or otherwise seek relief from making the payment at all on the grounds of undue hardship by writing to the ATO outside of the streamlined process.This streamlined application process is an extension of that introduced for a shortfall in a minimum yearly repayment in the 30 June 2020 year. Entities that obtained relief last year were required to make up the shortfall by 30 June 2021. Where this repayment is still not able to be made within the extended timeframe the borrower can write to the ATO for further relief (either additional time or permanent relief) outside of the streamlined process.
What are the next steps?
If you are unable to meet your annual Division 7A obligations due to COVID-19 circumstances, contact your Pitcher Partners representative to review your existing arrangements and determine what action is required.