Shareholder Taxed on Private Use of Company Assets
We would like to highlight proposed changes to Tax Laws (Division 7A) for shareholders who use assets such as boats and holiday houses owned by private companies. The new laws set out in the Bill and the Explanatory Memorandum (EM) contain a number of important changes. These changes are explained below. The Bill is being reviewed by a Senate committee, but if the Bill becomes law, the amendments will apply retrospectively from 1 July 2009.
Licence to Use or lease of property
Under the current rules, the mere use of an asset owned by a company is not caught by Division 7A. Division 7A of the Income Tax Act provides that loans, advances or property transfers for less than market value made by a private company to a shareholder (or associate) are automatically treated as dividends unless they come within specific exclusions. This can result in significant tax payable by the shareholder. These rules currently exist however, the Bill extends the scope of the law so that the provision of an asset (other than the transfer of property) for use by a shareholder (or their associates) under a licence or other right to use will now be caught by Division 7A.
Therefore if a Company has a house or a boat (or any other asset) that is available to the shareholder (or their associate) for their personal use, the shareholder is deemed to have a Division 7A Loan. But what is the value of the benefit?
There are two ways of valuing the benefits:
- where the shareholder or associate has the control over the asset to the exclusion of the company (whether or not they actually use the asset) the value is based on availability to use the asset by the shareholder (or associate); or
- in other cases the value is based on actual use of the asset by the shareholder (or associate).
This is illustrated by the following examples that have been adapted from various examples provided by the ATO.
Available to use
A Division 7A payment may occur where the asset is available for the shareholder or associate to use to the exclusion of the company (where there is no formal agreement and where the asset is available for use during the year whether or not it has actually been used).
Joe is a shareholder of a private company that owns a holiday house. He does not have a formal agreement with the company to use the holiday home but Joe stays at the holiday house with his family every school holidays. Joe keeps the keys to the house and also stores personal belongings there.
Joe's use of the beach house during the school holidays is considered to be a "payment" under Division 7A. The availability of the house for Joe's use (at other times of the year) is also subject to Division 7A because the house is not readily available for use by the company. As Joe has the holiday house available for him for the full year to the exclusion of the company, the EM to the Bill indicates that Joe would have the right to use the house for the whole year, and therefore the value of the payment is based on 12 months of availability of use, even though Joe does not use the house every day of the year.
As Joe has control of the property by holding the keys to the house, this will result in a higher deemed dividend compare to the actual use of the house. To limit the deemed dividend to the value of actual use the EM indicates the company would need to arrange for Joe to return the keys while he is not using the holiday house and may need to arrange for the removal of Joe's personal items before using the house.
In these circumstances Joe would owe the company an amount equal to the rental market value of the property.
Where there is merely a general entitlement to use the company's asset but the shareholder does not have control over the asset (for example, by not holding the keys when not using the asset), the asset is not considered to be available for the shareholder's use to the exclusion of the company.
Carol is a shareholder of a private company that owns a holiday apartment. The apartment is generally available for rent and the real estate agent holds the keys. However, Carol asks the company not to rent the apartment for two weeks in January each year so her and her husband can stay during their summer holidays.
Carol's use of the apartment for the two weeks in January each year is a payment under the proposed amendments to Division 7A. For the remainder of the year the apartment is not available for Carol to use as it is generally available for rent. Therefore the deemed dividend is restricted to the market value rent for the two weeks actual usage.
How to limit availability of usage
If a company asset is available for use at any time of the year and the shareholders have control over the asset, the payment is likely to be the market value of its use for the full year. Where shareholders can limit their control over the use of company asset they may only be taxed on the value of use for the time they use it.
However, where the shareholder who uses the asset is also the controller of the company (e.g. sole director of the company) the capacity in which the shareholder/director is controlling the asset may not be clear.
In these cases it may be worthwhile for the shareholder to enter into a formal agreement, which clearly specifies the entitlements of shareholders to use the assets of the company at specific times. This may effectively limit the value to the actual usage of the asset. However care is needed as the Tax Office has not yet indicated whether such an agreement would be effective to limit the value of the actual usage.
It appears that if an asset such as a house or a boat is genuinely available for rent or hire and the keys are held by an agent or charter company, the value of the shareholders use of the asset should be based on their actual usage. However, the EM indicates you may also need to consider the effect of the shareholder's personal items being kept on the property or boat.
There are not guidelines on how to limit availability of usage as yet. However, we expect the Tax Office will issue appropriate guidelines in due course.
Changes to exceptions
Dwellings used by a shareholder
The exception for the use of a dwelling has been changed.
To access the exception, the draft legislation required that the business be carried on by the shareholder(s) living in the dwelling.
From the examples provided by the ATO, it is clear the business being carried on may be the shareholder's business but it may also be the business of an associate such as a family trust.
An additional main residence exception
The Bill contains a second residence exception for a company providing a main residence to a shareholder (or an associate).
Where a private company owns a home acquired before 1 July 2009 and the house is used by the shareholder as their main residence, the private use of the house by the shareholder is disregarded for Division 7A purposes. This is provided there is no substantial change in ownership of the company. That is, the same shareholders must continue to own the majority of the share of the company.
These exception provides additional concessionary relief from Division 7A for many hobby farmers and other shareholders whose main residence is a farmhouse or other residences owned by a company before 1 July 2009.
If you have any queries regarding the changes to Division 7A Laws, please do not hesitate to contact us.