Division 7A Private Company Loans and Payments
What is Division 7A?
Division 7A is an anti-avoidance measure designed to prevent shareholders and their associates from withdrawing funds from a private company that represent tax-free profits.
Division 7A is triggered when a private company lends, advances, makes payments on behalf of and other credits for the benefit of its shareholders, or their associates, and they are not fully repaid by the tax lodgement date for that income year. The shareholder or associate may be deemed to have received an unfranked dividend equal to the amount of the payment, advance or credit provided, which must be accounted for as assessable income in their income tax return.
When Division 7A may be triggered
Some examples of when Division 7A may be triggered are:
- A private company lends money to a shareholder or an associate of a shareholder (current or former) during an income year without a loan agreement being put in place and the loan is not fully repaid by the lodgement day for that income year. In many cases, where the loan was made during the 2021 tax year, the lodgement day for the company will be in mid-May 2022.
- A private company forgives a debt owed by a shareholder or associate to the company.
- A private company provides an asset to the shareholder or associate for less than market value. The difference between the market value and the amount, if any, paid by the shareholder or associate may be treated as a deemed dividend.
For example – if a private company rents a car for $100 per day and provides it to the shareholder or associate for $50 per day, the difference of $50 per day for the total number of days rented may be treated as a deemed dividend.
- A private company makes payments to or pays for private expenses of the shareholder or the shareholder’s associate, and the amounts are not treated as a loan.
Exclusions from Division 7A
Some loans and payments are not treated as Division 7A loans (and are not accounted for as unfranked dividends in the shareholder’s or associate’s income tax return). For example:
- A loan made by a private company prior to 4 December 1997, where there have been no variations to the term or amount of the loan on or after 4 December 1997.
- A loan made to a shareholder or associate by a private company which is made in the ordinary course of the company’s business and on the usual terms that it makes similar loans to unrelated parties at arm’s length.
- A loan that is otherwise assessable to the shareholder or associate.
- A loan, advance, payment made on behalf of, or other credit for the benefit of a shareholder or associate that is fully repaid in the same year, or by the company’s lodgement date for that year.
- A payment made to a shareholder or their associate in their capacity as an employee or an employee’s associate.
- A liquidator’s distribution.
How can you prevent the negative ramifications of Division 7A?
The simplest solution is for the shareholder or associate to repay a loan by the lodgement day of the company’s tax return for the year that the loan was made. Lodgement day is the earlier of the due date and actual date of lodgement of the company’s tax return and, for most small to medium sized companies, the due date is usually in mid-May of the following year. If the loan is repaid in full by the lodgement day, it will not be treated as an unfranked dividend in the income tax return of the shareholder or associate for the year that the loan was advanced.
An alternative to repaying the loan is to put in place a written loan agreement with terms that ensure that the loan is treated as a complying Division 7A loan. The complying loan agreement must be executed by the lodgement day of the company in respect of the financial year when the loan was advanced. If this occurs, there will not be any negative ramifications for the tax year that the loan is made.
For example, if a loan or advance was made to a private company’s shareholder or their associate in the 2021 tax year but was not repaid by the company’s lodgement day (say, mid-May 2022), the company and borrower will need to enter into a complying Division 7A loan agreement by the lodgement day to prevent Division 7A deeming a dividend to the shareholder or associate in respect of that loan.
Drafting the complying loan agreement
You should ensure that the terms of the agreement comply with the provisions of Division 7A. The terms of a complying loan agreement will include the following:
- The minimum interest rate that the private company must charge the shareholder or associate.
- The requirement to make minimum annual repayments.
- The term of the loan.
There are two types of complying Division 7A loan agreement:
- An unsecured loan with a maximum term of 7 years.
- A secured loan with a maximum term of 25 years, secured over real property. At the time that the loan is made the market value of the property must be at least 110% of the loan amount.
The tax and financial consequences of not complying with Division 7A can be significant! If you have withdrawn funds from a private company or the company has made payments to you for private purposes, you need to consider the Division 7A consequences. If you are unsure of your obligations, or would like to discuss your situation, please contact our office to book a meeting on (08) 7078 3505.
By Anurag Kakria – Senior Accountant – Venture Private Advisory