Expected changes to the Division 7A rules present a hidden danger for trustees who may have related-party loans in place, a leading SMSF lawyer has claimed.
DBA Lawyers director Daniel Butler said the changes, which have been deferred to 1 July 2020, were a potential problem area for SMSFs because many related-party loans were likely to have a Division 7A impact.
“The Division 7A impact comes from where there’s a company loan to a shareholder or associate, the super fund is typically an associate, or we’ve got a family trust that distributes net income to a company and doesn’t visibly transfer the money. There’s this unpaid present entitlement (PE) which can give rise to a Division 7A deemed dividend,” Butler said.
“A lot of these related-party loan situations may become untenable in about 12 months’ time due to these changes, with the reason being that one of these proposals is that there’s going to be a maximum 10-year limit. The current limit is 25 years where it is secured sufficiently on real property.”
Butler said the shortened loan period also came with other changes that would require the principal to be payable annually in equal instalments, interest to be payable annually based on the opening balance, and an increase in the interest rate that would be around 3 per cent higher than the current Division 7A rate of 5.2 per cent.
He encouraged SMSF advisers to keep clients abreast of the changes, adding: “If they’re not doing cash flows and trying to get that loan in order, they might hit the wall, especially given diminished property prices. So really watch out for this one, it’s a hidden danger.”
He also highlighted that while 25-year loans would need to transition to a complying 10-year agreement by mid-2022, existing seven-year loans would need to convert to a new annual principal and interest repayment model, use a new benchmark interest rate and retain their existing term.
Under the changes, a deemed dividend that had been limited by a company’s distributable surplus will become uncapped, he pointed out.
“This is a big change. Some of your clients will be affected if it’s a related family company, or a new PE arrangement under a family trust or company, and unless these are compliant there will be a deemed dividend and that’s a big whack,” he said.
“The loss of franking credit and the deemed dividend could be an effective 80 per cent-plus tax to your clients. Given the substantial tax-flow increase and the shorter loan periods, how are your clients going to withstand this if they are in this predicament?”
