The ATO Division 7A loan changes are a ticking time bomb that may result in a hefty repayment...
Being across tax change events and educating your clients to give them the power to make the most informed decisions results in the best outcome for them, builds your connection, shows them your value, and reinforces your worth.
There have been a number of significant tax change events over the last couple of years, including Section 100A Trust Distribution, PCG 2021/4 Professional Firm Profit Distributions, and the Owies Case Trust Deed Upgrades. Now, there are the ATO Division 7A changes from the 1st of July 2024.
What is Division 7A?
A payment or other benefit provided by a private company to a shareholder or their associate can be treated as a dividend for income tax purposes under Division 7A, even if the participants treat it as some other form of transaction such as a loan, advance, gift or writing off a debt.
Division 7A can also apply when a private company provides a payment or benefit to a shareholder or associate through another entity, or if a trust has allocated income to a private company but has not actually paid it, and the trust has provided a payment or benefit to the company's shareholder or their associate.
Division 7A doesn't apply to amounts that are assessable to the shareholder or their associate under other parts of the income tax law, such as normal dividends or director's fees.
A payment or benefit that is potentially subject to Division 7A isn't treated as a dividend if it's repaid or converted into a Division 7A complying loan by the company's lodgement day for the income year in which the payment or benefit occurs. The term for repayment of a Division 7A Loan is 25 years if the loan is secured over property or seven years for all other loans.
What are the ATO Division 7A changes?
Starting the 1st of July 2024, the Australian Tax Office has increased the interest rate on Div7A loans from 4.77% to 8.27%. That’s an increase of 73% and could represent a hefty repayment increase for your clients.
For many years, we’ve had very small changes, but this is a big increase that will be with us for the life of the loan, typically seven years.
If your client has a $200,000 Div7A Loan
The 2023 minimum annual repayment = $34,276
But the 2024 minimum annual repayment = $38,223
That’s an increase of $3,947!
Impacts of the Division 7A change
That might not seem like a lot, but as well as a potential increase in repayments, think about the extra tax that will be needed for this, or if your clients have larger or multiple loans, and don’t forget to consider the compounding impacts on the future years of the loan.
Increased cost of compliance
These changes also impact the cost of maintaining compliance. The advice you gave your clients in the past may no longer be relevant and may not provide the best outcome for them anymore.
Impact on Bank Covenants
As well, the changes may impact bank covenants, with the interest paid on a Div7a loan usually appearing as an interest expense on a Profit and Loss statement, overstating the cost of servicing debt in the entity of the borrower.
Balance sheets not telling the true story of the business
Along with asset values in the era of the Temporary Full Expensing - the impact of a Div7A loan can misrepresent the operating business you’re trying to get the bank to lend against.
The good news is that every time a tax law changes, it is an opportunity for us to offer new services to our clients and provides a great opportunity to help them save interest and build our business.
Strategies to Consider
Increasingly, the role of the accountant is to think about tax decisions, tax deductibles, and tax minimization strategies over a longer time frame than just the current year. With that in mind, here are some strategies to consider for dealing with your clients’ Division 7A loans.
Use cash from other sources to immediately repay all Division 7A loans.
Making the extra repayments reduces the interest payable on this non-tax-deductible loan.
Allocate additional taxable income to individuals so they can use this income to accelerate repayments.
There will be extra tax on the profits paid to the individual, but in future years, they will save on non-deductible interest.
Investing in the name of a bucket company.
Investing through a bucket company means there is no Div7a loan to deal with, and earnings from investments are taxed at a company rate. This is a great strategy for those moving towards retirement.
Continue paying the Div7A loan over the maximum time allowed.
Doing nothing may be the best solution for your client.
Educate your Client
Don’t assume that your clients want to make the minimum annual payments or don’t want to be involved in this decision. Tax is not as simple as it used to be, and the key to getting the best results is to educate your clients so they can make the best decisions.
"Tax planning is not just reducing tax - it’s about helping clients to understand when they have to pay tax and the cashflow consequences, what they could do to reduce it, or alternatively, if they pay more tax, can they smash down a Div7A loan?" ~Timothy Munro, ChangeGPS Founder
Use the VPP method to explain how you can help them get the right results from this decision.
Explain it Now
Although the interest rate applies for the 2024 year, clients need time to consider their options. They may need time to plan for larger annual minimum loan repayments and may need to liquidate assets for this. Or they may prefer to start purchasing investments in a properly structured bucket company, which will need to be set up.
You should already be working on the balance sheet and income statement for the annual meetings, so including Div7a now can save you the added stress of trying to prepare this advice during the tax planning period.
ChangeGPS contains a 2024 Div7A Advice System to model the effects, communicate, explain and prepare the Elimination Advice Report. To find out more and see it in action, watch this product demo.
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