Income tax: Draft Tax Determination: disregarding certain payments under section 109R of the Income Tax Assessment Act 1936 in determining how much of a loan has been repaid in situations where notional loans are involved.
See link     Date published: Mar 05, 2025

What TD 2025/D2 Is About

TD 2025/D2 is a draft Taxation Determination which addresses how section 109R (an anti-refinancing rule) applies when notional loans are involved, specifically in the context of Division 7A.

What section 109R does (in simple terms)

Section 109R of the Income Tax Assessment Act 1936 is an integrity provision designed to prevent shareholders or their associates from avoiding the application of Division 7A, which seeks to stop private companies from making tax-free profit distributions disguised as loans.

In simple terms, section 109R disregards certain repayments of loans made to private companies if a reasonable person would conclude that the repayment was made using funds borrowed from the same company. Specifically, this applies in two scenarios:

1. Subsequent Borrowing (109R(2)(a)): If an entity repays a loan and then borrows a similar or larger amount from the same private company, the repayment may be disregarded if it appears the borrowing was intended to fund the repayment.
2. Prior Borrowing (109R(2)(b)): If an entity borrows a similar or larger amount from a private company before making a repayment, and it seems the borrowing was intended to facilitate the repayment, the repayment may also be disregarded.

By disregarding such repayments, section 109R ensures that these transactions do not reduce the amount of a loan subject to Division 7A, thereby preventing shareholders or associates from circumventing tax obligations through refinancing arrangements

What happens if Div 7A applies

If Division 7A applies to a payment or loan from a private company to a shareholder or their associate, significant tax consequences arise. Here’s what happens:

1. Deemed Dividend
   • The payment or loan is treated as an unfranked dividend for income tax purposes, meaning it is included in the recipient’s assessable income but does not carry franking credits to offset tax liabilities 3, 6.
   • The deemed dividend amount is limited by the company’s distributable surplus. If the surplus is insufficient, the dividend amount is reduced proportionately 4.
2. Tax Liability for Shareholders
   • The deemed dividend is taxed at the shareholder’s marginal tax rate, which can be as high as 47% for individuals in the highest tax bracket6.
   • This can result in significant additional tax liabilities, especially if the shareholder was expecting the transaction to be treated as a loan rather than income 3, 6.
3. Penalties and Interest
   • Non-compliance with Division 7A rules can lead to penalties and interest charges imposed by the Australian Taxation Office (ATO)37.
   • For example, failing to repay a Division 7A loan within the required timeframe or using refinancing arrangements that trigger anti-avoidance provisions may result in penalties 6.
4. Restrictions on Tax-Efficient Structures
   • Division 7A prevents private companies from distributing profits to shareholders or associates through loans or other benefits that avoid taxation. This limits opportunities for tax-efficient cash flow arrangements within private groups 5, 7.

Avoiding Division 7A

To mitigate these impacts:

• Enter into a Division 7A-compliant loan agreement before the company’s lodgment day. Such agreements must be in writing, specify minimum yearly repayments, and meet interest rate benchmarks set by the ATO 4, 7.
• Repay loans fully or convert them into dividends (preferably franked) before the due date for lodging the company’s tax return 3, 6.
• Avoid refinancing arrangements that could trigger section 109R anti-refinancing rules under Division 7A.

Example Scenario

If a shareholder borrows $100,000 from their private company but fails to repay it by the lodgment due date, Division 7A will deem this amount as an unfranked dividend. The shareholder must include this $100,000 in their taxable income and pay tax at their marginal rate, potentially resulting in a significant tax burden6.

TD 2052/D2 in detail

The determination provides the ATO’s view on two key issues:

1. Whether section 109R can apply to disregard certain loan repayments made to a private company where the repaying entity is taken to have obtained a loan from the company by the interposed entity rules in sections 109T and 109W of the ITAA 19362.
2. Whether section 109R can apply to disregard certain repayments when determining how much (if any) of a notional loan has been repaid, where a private company is taken to have made a notional loan under sections 109T and 109W2.

The draft determination includes detailed examples that illustrate how these rules would apply in practice:

• Example 1: A trust obtains a notional loan from a private company to repay a loan from the same private company
• Example 2: A trust obtains a loan from a private company to repay a notional loan from the same private company1

Who TD 2052/D2 Applies To

This draft guidance is particularly relevant to:

• Private company owners 17
• Private groups using corporate structures involving interposed entities and loans
• Tax practitioners advising on Division 7A matters involving loan arrangements 17

When It Takes Effect

When finalized, the Determination is proposed to apply both before and after its date of issue, meaning it will have retrospective effect. It will not apply to conflicting terms of prior dispute agreements.

The draft guidance is currently open for consultation until April 17, 2025.

Authoritative Commentary

As TD 2025/D2 is a recent draft determination, published commentary specifically addressing it is still emerging. However, several professional sources have noted its release:

PwC Monthly Tax Update (April 2025)

PwC’s Monthly Tax Update makes reference to TD 2025/D2, noting that it “sets out the ATO’s view on the application of section 109R of the ITAA 1936” in relation to notional loans 4.

Pointon Partners (Mid-March 2025 Tax Update)

Pointon Partners has summarized the determination 14.

ATO Business Bulletin

The ATO itself has published information about the draft determination, noting that they are “providing more comprehensive guidance about s109R because we want to ensure that private groups don’t inadvertently trigger a Division 7A deemed unfranked dividend, which may result in an unexpected tax bill” 17.

Wider concerns

While not specifically addressing TD 2025/D2, there are broader professional concerns about the ATO’s recent approaches to Division 7A.

For example, in relation to section 109U, CPA Australia has raised concerns that the ATO’s approach “does not provide certainty for legitimate guarantee arrangements” and suggested the ATO could “better target arrangements of concern instead of [taking] a blanket approach” 16.