Division 7A tax rules “single biggest tax headache” for SMEs, say tax experts

Australian small businesses are faced with expensive compliance costs because of the unnecessarily complex Division 7A tax regulations, according to small business tax experts.

But changes to the regulations, and the broader operation of business trusts, could be on the way as a result of the Board of Taxation’s review of the regulations.

The government tax board is now seeking public submissions on its second discussion paper into reform of the anti-avoidance regulations, which are designed to discourage businesses from distributing loans to shareholders or their associates for personal use and enjoyment.

Since the introduction of Division 7A in the 1990s, the regulations have become more and more complex and now capture all sorts of transactions, increasing the compliance costs for businesses.

Paul Drum, head of policy at CPA Australia, told SmartCompany the private company loan rules are “the single biggest tax headache for small to medium-sized business” and are often “inadvertently triggered, resulting in a raft of adverse and unintended tax consequences for businesses”.

Drum says the rules needs to be simplified “to make it easier for companies to reinvest business profits as working capital”, and commended the Board of Taxation’s recommendation that all loans made by a private company to a shareholder or associate have a common 10 year term, with flexible principal repayments.

“If adopted, this would go a long way to slice through red tape,” he says.

Flexibility around interest and principal repayments would also recognise that “a company’s economic fortunes vary over time and that the loan principal and interest should be repaid in the good profitable years and not in the challenging years when funds are tight,” he says.

Drum says the board’s proposal for “a more streamlined legislative self-correction mechanism” in reform of the regulations will mean that business owners and their advisers can take corrective actions that will put them in the same position as if the regulations were complied with as intended.

“This option will allow taxpayers to become fully compliant with Division 7A and allow tax agents who take on new clients to identify any Division 7A breaches and take appropriate remedial action rather than be penalised for notifying the ATO of such mistakes,” says Drum.

Similar sentiments were expressed by Pitcher Partners tax partner Greg Nielsen, who told SmartCompany the regulations were originally intended to be an integrity measure but now “involve significant compliance costs and do not deal with commercial transactions in cases where there is no tax mischief”.

“It is safe to say that Division 7A is responsible for some of the highest compliance costs faced by small to middle-market business taxpayers,” he says.

And Nielsen says there is likely to be extra pressure on these costs as a result of the government’s decision to reduce the corporate tax rate and increase the top marginal tax rate for individuals in its 2014-15 budget.

Like Drum, Nielsen says the board’s proposed reforms will “make it easier for middle-market business taxpayers to get on doing business”.

“The main proposal contained in the Board’s report is to allow business trusts to access a corporate tax rate, provided that they do not access capital gains discount concessions (other than in relation to the sale of a business),” says Nielsen.

“We have long advocated the ability for a business trust to access the corporate rate for business profits. The proposals will help taxpayers invest in their business working capital using profits taxed at the corporate rate. The proposals will support business growth in the middle market, at a much needed time,” he says.