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The recent increase in the benchmark interest rates for 2023-24 has significant implications for small business owners and company directors who have received money under Division 7A terms.
The benchmark rate for 2022-23 was 4.77%; for 2023-24, it is 8.27%, an increase of over 73%. This increase will affect the minimum annual repayment of existing loans as well as any future loans considered under Division 7A.
Keeping in mind the rising cost of doing business, we asked Reginald Kuek, a Principal in RSM's Restructuring and Recovery division based out of the Perth office, to share his insights on the implications to the changes to Division 7A.
Understanding Division 7A loans
Under Division 7A, loans made by a private company to a shareholder or an associate of a shareholder are deemed to be a dividend unless the loan is fully repaid by the company’s lodgement date for the year the loan is made or if the loan is specifically excluded by Division 7A.
Entities that have borrowed money under Division 7A should consider the effect the jump will have on repayments of their existing loans, as well as any loans they are considering taking out in the future. For a $100,000 loan, the change can mean an increase in total repayments of approximately $12,000, or over $2,000 in minimum yearly repayments over a 7-year loan.
In the current financial climate, with interest rates and costs of living on the rise, the burden of increased loan repayments will add to the worries of small business owners who have previously borrowed money under Division 7A. Companies also need to consider that the increase in the benchmark rate will create an additional taxation liability, as the interest on the loan is treated as assessable income.
In many insolvency cases, directors have simply withdrawn money from their companies rather than being paid a salary and remitting the PAYG tax to the ATO. This accumulation of debt is essentially a loan from the company to the director and, in many cases, the accountant classifies this as a Division 7A loan.
Insights from Reginald Kuek
We asked Reginald Kuek, a Principal in RSM's Restructuring and Recovery division based out of the Perth office, to offer suggestions for directors who find themselves challenged by the changes to Division 7A, especially in the current climate.
Background and general advice
Q: What’s the background to this decision?
A: The Australian Taxation Office (ATO) benchmark must be pegged to the interest rate that the RBA sets. The ATO pulls that rate from the RBA rate. It’s reflective of the RBA rate increases.
Q: What is the insight from your referrers having an interest in Division 7A loans?
A: This is an important announcement. The increase of 73% is a huge jump. The insight is really this: whereas previously the situation may have been manageable, for a loan of, say, a million dollars, this will make a huge difference.
Q: The change has a particular effect for directors who have drawn money from their companies rather than being paid a salary. What’s your general advice for company directors considering this practice?
A: The additional interest may now not be as tax effective as it previously was. Seek tax advice recommendations on how to manage the repayment of these loans.
Q: As you said, the benchmarked rate is an astonishing increase. What should a director do if they find they simply cannot afford this increase in the current climate?
A: Pick up the phone, as soon as you can. The earlier you ask about your options, the more likely you are to mitigate the risk. So speak to your tax accountant. Speak to your local RSM advisor.
Impact on business viability
Q: How do you expect this change to affect businesses on the cusp of being unviable?
A: It will only affect them if there’s already pressure to repay that loan. If no-one’s coming knocking, it’s the last loan that gets repaid. That’s the reality of it. My colleague Travis Kukura has some great advice for SME businesses in financial difficulty.
Q: What sorts of options is RSM R&R likely to discuss with you in the first instance?
A: Every situation is different, so the first thing we’ll do is drill down to look at the overall picture. We’ll ask questions like:
- What is the current situation with the company?
- What does the company do?
- Is it still trading and viable?
- What other debts are out there, besides the Division 7A loan?
- What does cash flow look like?
- What does the balance sheet look like?
Q: How can businesses prepare for that meeting?
A: It will serve you well if you come prepared with your latest financial statements. Get ready to share your:
- profit and loss statement
- balance sheet
- cash flow statements.
Again, every situation is different, so be prepared to share your story. For example, if the business has been sold to another entity, then all you have is a shell of a company with all the debts still there. The advice would be different depending on who owns and trades the business.
Navigating the new landscape
With this significant increase in the benchmark interest rate, it's crucial to understand the financial implications for your business of the Division 7A changes. It will be helpful to gain an expert perspective on how to navigate the changes and make informed decisions.
Take action now
If you're concerned about how these changes will impact your business, don't wait for the situation to escalate. Reach out to a tax accountant to discuss your specific circumstances.
FOR MORE INFORMATION
For more information, contact RSM to book a call for a free, initial consultation. The sooner you act, the more options you'll have to mitigate the impact and set your business on a path to financial stability.
