Section 109RB of Div 7A gives the Commissioner a discretion to disregard non-compliance with Div 7A, where otherwise there would have been deemed dividend, where caused by an “honest mistake or inadvertent omission”, which terms are undefined. Section 109RB was introduced effective 21 June 2007, to deal with wide-spread misunderstanding of Div 7A (which was first introduced from 4 Dec 1997).

Whilst the introduction of s109RB was welcomed, it should have been accompanied by limitation of Div 7A to its original purpose, of taxing the liberation of profits from private companies into the hands of shareholders (or their associates) for private purposes. In this regard, Div 7A was a tightening of s108 where the Commissioner had to form an opinion that there had been a distribution of profits, to a more automatic application of a deemed dividend. Today, Div 7A still catches loans by accumulated profit private companies to related trusts, to fund their businesses i.e. there is no liberation of profits into the hands of shareholders for private purposes.

The First Case

In Building Company Owner and Commissioner of Taxation [2012] AATA 755 (1 Nov 2012), the Tribunal considered the Commissioner’s application of Div 7A, and his refusal to disregard non-compliance with Div 7A under s109RB.

Interestingly for the Tribunal, it did not refer to the Commissioner’s ruling on the topic of exercise of his discretion (TR2010/8) or his practice statement on the topic (PS LA 2011/29).

Three tax years were in question, 2005, 2006 and 2007. In the 2005 tax year, the shareholders borrowing from the company were incorrectly recorded in “trade creditors” in the company’s accounts. In the 2006 and 2007 tax years, the borrowings were recorded as loans, and there was a written loan agreement put in place within the required time, which provided for benchmark interest, but it did not specify a term.

The error in the 2005 tax year was blamed on an internal bookkeeper of the company, but the explanations of how the error arose were not accepted, especially as that internal bookkeeper was not called to give evidence. Whilst the assessment for 2005 was confirmed, the Tribunal reduced the penalties from “recklessness” (50%) to “carelessness” (25%), stating: “Division 7A is complex. Even experienced tax agents struggle with it.”

Tax Agent’s Evidence

In relation to the 2006 and 2007 years, the Tribunal exercised the Commissioner’s discretion in favour of the taxpayer. It did so principally because the tax agent gave evidence which showed he was 72 years of age at the time, and was not entirely comfortable with written English, such that whilst the agent believed the loan agreement was sufficient for Div 7A purposes, in fact it was not. The mistake was honest. The fact that before the 2005 tax year there had been no Div 7A problems, and that there had been significant repayments of loans, were also considered relevant.

The case shows that the Tribunal appreciates the problems faced by taxpayer’s in this complex area. However, one of the difficulties, is that it will often be the case that the tax agent will have to give evidence to save the client, which might leave the agent at some risk of admitting negligence. However, by giving the evidence, it may be that any damage to the client is minimized.

What should you do  

Where you think there has been non-compliance with Div 7A, you should seek advice about the potential to rely on the s109RB discretion, as soon as the concern arises. We are happy to assist with any Div 7A issue you may have.

For further information, or if you have any queries relating to this area, please contact Anthony Pointon of our office on 03 9614 7707.