A renewed focus on the Commissioner’s discretion for breaches of Division 7A

The ATO is increasing its focus on Division 7A compliance, leveraging data matching to uncover potential exposures within private groups.

Learn how the Commissioner’s discretion under section 109RB may apply to minimise negative consequences where there has been an honest mistake or inadvertent omission. Take steps towards corrective action and reminders on how to stay compliant.

By Tsae Liew and Tim Hall

Division 7A continues to be a key focus of the Australian Taxation Office (ATO) when reviewing private companies in understanding how wealth is being extracted from private groups.

Recently, data matching with insurance companies and other government bodies has supported the ATO in identifying where there may be Division 7A exposures within a private group.

To recap, Division 7A can apply to treat certain payments from a private company to its shareholders (or their associates) as an unfranked dividend (commonly referred to as a deemed dividend).

As CFOs continue to navigate the complexities of Division 7A, some critical questions to consider are:

• Have you reviewed your private group's loans, payments, and forgiven debts for potential Division 7A exposure?
• Do you have robust processes in place to ensure Division 7A compliance, and regularly consult advisors for updates from the ATO?
• Could you take corrective action in case of a Division 7A breach?

Commissioner’s discretion to disregard the operation of Division 7A or allow the dividend to be franked 

The Commissioner has discretion to disregard the operation of Division 7A or allow the dividend to be franked in circumstances where taxpayers have triggered a deemed dividend inadvertently because of an honest mistake or inadvertent omission. This discretion was introduced to reduce the tax impost where the Commissioner considers the outcome to be punitive and disproportionate to the tax mischief involved.

The terms ‘honest mistake’ or ‘inadvertent omission’ are not specifically defined, but the Commissioner sets out his view and guidelines within Taxation Ruling 2010/8 and Practice Statement Law Administration PS LA 2011/29.

Importantly, there appears to be a renewed focus on when the Commissioner may apply his discretion as the ATO has recently reminded taxpayers that in making (or refusing) a decision to grant his discretion, particular regard will be had on:

• the specific circumstances that led to the mistake or omission (including the knowledge and roles of the advisor and taxpayer), and
• whether corrective action has been taken and if so, how quickly that action was taken,

noting that Division 7A has been in effect for almost 30 years and should be generally well understood by taxpayers and their advisors by now.

Deliberate indifference or wilful blindness does not constitute an honest mistake.

Impact for private businesses

• Loans to shareholders or their associates that are not repaid by the required dates and/or placed on a complying loan agreement may be taxed as an unfranked dividend to the entity who benefits from the use of the funds.
• Non-compliance with Division 7A can result in the imposition of penalties and interest, where identified by the ATO during a review.
• Seek advice on any corrections required. Penalties and interest may be minimised where Commissioner’s discretion is granted, or a voluntary disclosure is otherwise made by the taxpayer. With the Commissioner’s renewed focus on this area, taxpayers should not assume that discretion will be exercised where errors are found and should seek advice before approaching the ATO.

Key takeaways 

• The ATO’s reminder highlights their expectation that private groups seek advice to ensure they are compliant with the requirements under Division 7A. 
• Regular review (at least annually) of loans, payments and debts forgiven by private companies is critical to ensure compliance. 
• Put in place a written tax governance policy for the business that details controls in place to manage potential tax risks in the group, including strategies of how Division 7A will be addressed and who is responsible to ensure compliance (i.e. designated roles). 

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