Working out a company’s distributable surplus is a vital element of Division 7A as the extent to which a deemed dividend is assessable is limited to the distributable surplus amount. That is, if a company has a nil distributable surplus for a year, any deemed dividend that may arise due to the operation of Division 7A is reduced to nil.
The distributable surplus formula contains a number of components, notably the ‘net assets’ amount. This amount is defined as the amount by which the company’s assets exceed its legal obligations and certain provisions.
As a starting point, the value of a company’s net assets for the purposes of distributable surplus calculation is the accounting value as shown in the company’s financials. However, the Commissioner has the power to substitute a value deemed appropriate where there is a significant undervaluation or overvaluation of the company’s assets or provisions. This is particularly relevant for two classes of assets.
In TD 2009/5, the ATO states that its power to adjust the value of the company’s assets is extended to assets not shown in the company’s accounting records. For example, a private company may have substantial internally generated goodwill, the value of which is not shown in the accounting records of the company because accounting standards do not permit it. In this case, the ATO states that it is appropriate to substitute the real value of assets and include the value of the goodwill.
Another example mentioned in TD 2009/5 is where a private company operates from business premises owned by the company. Since the purchase, the value of its premises has substantially increased due to the burgeoning property market. However, the value of the premises are recorded in the company’s accounts using the historical cost model in accordance with accounting standards. In this case, the ATO states that it is appropriate to substitute the real value of assets and include a market value for the premises as the cost model used in the company’s accounts would lead to the overall assets of the company being significantly understated.
Once it is determined that a company has a distributable surplus, any deemed dividend will be limited to this amount. It is particularly important to work out the distributable surplus for a company where there has been a prior year Division 7A breach. If the breach occurred within the amendment period for the relevant taxpayer, the only remedy would be to seek the Commissioner’s discretion under section 109R.