Division 7A of the Income Tax Assessment Act 1997 ensures that loans and other forms of financial assistance made by private companies to their shareholders or associates are treated as dividends and taxed accordingly.
This provision is designed to prevent private companies from avoiding tax by providing financial assistance to their shareholders in a way that is not taxed as a dividend.
However, there may be situations where Division 7A is triggered unintentionally due to an honest mistake or inadvertent omission. In such cases, the Commissioner of Taxation has the discretion to disregard a deemed dividend or allow it to be franked.
The decision to exercise the discretion is a two-step process. The first step is to determine if Division 7A was triggered due to an honest mistake or inadvertent omission. If the answer is yes, then the second step is to consider whether the facts and circumstances support the exercise of the discretion. The Australian Taxation Office (ATO) considers each case on its merits and must act in good faith and without bias, making the decision independently.
What is an honest mistake or inadvertent omission?
An honest mistake or inadvertent omission may be a mistake of law, a mistake of fact, or a combination of both. Examples of mistakes that may trigger Division 7A include an incorrect understanding of the law or a misunderstanding of the provisions of Division 7A.
Omissions that may trigger Division 7A include failing to document a loan or other form of financial assistance, or failing to include a loan in a private company’s financial statements.
It is the responsibility of the taxpayer to provide sufficient evidence of an honest mistake or inadvertent omission. If sufficient evidence is not provided, the Commissioner cannot exercise the discretion.
What other factors does the ATO consider?
In deciding whether to exercise the discretion, the Commissioner also considers the objects of section 109RB and Division 7A as a whole, as well as the specific facts and circumstances of the case. Factors that may be relevant include the extent to which the mistake or omission was significant, whether it was a one-off occurrence or part of a pattern of behaviour, and whether the company has a history of complying with tax laws.
If the private company has previously triggered Division 7A, it will be expected to show greater vigilance in avoiding future triggers. If there has been no increase in care taken in relation to the application of Division 7A, this may weigh against the exercise of the discretion. Additionally, if the private company was aware that substantially the same transactions had previously triggered Division 7A, this will generally weigh against the exercise of the discretion.
What is corrective action?
Corrective action refers to the steps taken by a private company to remedy a failure to comply with Division 7A. Taking timely and appropriate corrective action can also be a factor in favour of exercising the discretion. Corrective action should put the relevant parties in the position they would have been in if Division 7A had been applied correctly, and may include converting the payment, loan, or debt forgiveness to a loan that complies with section 109N or making catch-up or shortfall minimum yearly repayments as if the transaction always complied with section 109N.
If a relevant entity has not yet taken corrective action but is willing to do so as part of fulfilling the Commissioner’s discretion conditions, this will not weigh against the exercise of the discretion where a timely application is made. However, if it is reasonable for a relevant entity to have taken corrective action and they are unwilling to do so, this will weigh against the exercise of the discretion. On the other hand, if a relevant entity genuinely and reasonably believes that corrective action is not warranted, this will not weigh against the exercise of the discretion where a timely application is made.
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