The ATO has announced that borrowers unable to make Div 7A yearly minimum loan repayments by 30 June because they are affected by COVID-19 may be granted an extension of time to make the 2020 minimum repayments by 30 June 2021 but ATO approval must be sought. However, care must be taken in relation to this, as the application form requires details of why the borrower is unable to make the minimum repayment. Also, note that the extension will also result in a higher minimum repayment required for the 2021 year.
It is also a timely reminder to exercise caution if using journal entries to make Div 7A loan repayments as a number of important legal requirements apply.
Extension to make Div 7A loan yearly repayments
On 26 June 2020, the ATO announced an extension of time to make minimum yearly repayments (MYR) for borrowers affected by COVID-19. Taxpayers must complete an application form to allow the extension of time. Once approved, the MYR shortfall must be paid by 30 June 2021 to avoid a deemed dividend under Division 7A.
Ordinarily, when there is a complying loan agreement between a private company and a borrower under s109N ITAA 1936, the borrower must make the MYR by the end of the private company's income year. This avoids the borrower being considered to have received an unfranked dividend, generally equal to the amount of any MYR shortfall.
As a result of COVID-19, some borrowers are facing circumstances beyond their control. To offer more support, the ATO has announced that it will allow an extension of the repayment period for those borrowers who are unable to make their MYR by the end of the lender's 2019-20 income year (generally 30 June) under s109RD ITAA 1936.
Borrowers can request the extension by completing a streamlined online application form available on the ATO website here. Once the ATO approves the extension application, they must pay the MYR shortfall by 30 June 2021 to avoid Division 7A consequences. This decision to extend the time for payment of the shortfall also does not alter or amend the loan agreement that a taxpayer has with the lender. This includes penalty interest remedies (if any) for default under the loan.
Lodgement extension for company and trust tax returns
The extension of time to make MYR follows the ATO’s announcement on 25 May 2020 of key lodgement and payment deferral dates owing to COVID-19. This includes company 2018-19 income tax returns due on 15 May 2020 now being due by 5 June 2020. The ATO have also updated Division 7A lodgement dates for companies and trusts on their website here.
Repayments on Division 7A loans made by a company during the 2018–19 income year must, therefore, have been repaid before the deferred lodgement date of 5 June 2020 (or the actual date of lodgement of their 2018–19 income tax return, if earlier). Trust tax returns (UPEs and sub-trusts) could also lodge 2018–19 income tax returns by the 5 June 2020 concessional date provided any liability was paid by that date.
Using journals to make Div 7A loan repayments
The lead up to the end of the financial year is also a timely reminder to exercise caution if using journal entries to make Div 7A loan repayments. Repayments must usually be made by way of actual cash repayment or dividend whereas those made by way of journal entry, i.e. by capitalising the repayment onto the loan balance, are generally not accepted unless there is an agreement to offset existing obligations to pay. A journal entry cannot of itself constitute a payment without the debtor and creditor who mutually owe each other an obligation agree to set off their liabilities against each other and a number of important legal requirements apply.
The dividend must be duly declared by 30 June by the directors in accordance with the company constitution to an eligible shareholder and reflected in minutes or a resolution, which must be filed in the corporate register within one month of the meeting. The company must also give a distribution statement to the shareholder within four months of year-end. Assuming the dividend is declared on 30 June (and not earlier), the minutes/resolution needs to be filed in the corporate register by 31 July following the end of the income year in which the dividend is declared.
Please note that there are a number of Corporations Law issues with respect to paying dividends, therefore legal advice should be obtained if there are any concerns.
Taxpayers should note that ATO approval of an extension to make MYR will not be automatic and the criteria a borrower signs up to will be amenable to later checking by the ATO. Furthermore, the practice of using a journal to pay a dividend to make a Div 7A repayment is possible, but legal requirements must be navigated as the courts do not accept backdated documentation. Contact BDO to prevent an adverse outcome when facing the ATO during an audit or review.