Are you a shareholder of a private company?
Have you paid private bills from your company account?
Do you owe money to your company?
If you answered yes to any of the above questions then should understand how Division 7A (or “Div 7A”) works and how it affects you.
When is a Div 7A loan triggered? It is usually triggered when a payment or other benefit by a private company is provided to a shareholder or their associate. If this is the case, then a Div 7A loan can be treated as an unfranked dividend by the ATO in the hands of the recipient and income tax will be payable. This includes payments or other benefits made through another entity, or if a trust has allocated income to a private company (with a loan to a shareholder or their associate) but has not actually paid it.
If action isn’t taken in accordance with the rules set under Div 7A, the payment or other benefit is considered as a deemed dividend which is generally unfranked.
A payment or other benefit can include:
- private use of company assets
- transfer of company assets
- loans and other forms of credit
- writing off (forgiving) a debt
- payments or the loans by a trust where a company has unpaid present entitlements
- payments and loans through interposed entities.
A payment or benefit that is potentially subject to Div 7A isn’t treated as a deemed dividend if it is repaid or converted into a Division 7A complying loan by the company’s lodgement day for the income year in which the payment or benefit occurs.
Managing Division 7A in its simplest form includes:
- Avoiding the issue to begin with and keeping private affairs outside of the business
- Repay or convert a dividend (franked if credits available) by lodgement day.
In instances where the above cannot provide a suitable solution to alleviate the risk of the loan being treated as a dividend, a written loan agreement must be in place as mentioned above. The written agreement must include:
- the names of the parties
- the loan terms (that is, the amount of the loan and the date the loan amount is drawn, the requirement to repay the loan amount, the period of the loan and the interest rate payable)
- that the parties named have agreed to the terms, and
- when the written agreement was made – for example, the date it was signed or executed.
For an unsecured loan, the maximum term of 7 years is allowed or 25 years if 100% of the loan is secured against real property. Under the Division 7A loan agreement the ATO deemed benchmark interest rate is charged to borrowed funds and treated as taxable income in the name of the company, to which may not be deductible by the shareholder.