Division 7A is an integrity provision in the Australian income tax legislation aimed at preventing private companies from making tax-free distributions of profits to their shareholders or associates.
It’s common for business owners to utilise company resources for their personal use. The business is often such a part of their life that the line distinguishing ‘the business’ from their life can be blurred.
There are multiple ways in which owners may access private company money, such as through salary and wages, dividends or complying Division 7A loans. Division 7A is an area where the ATO sees many errors, across both the basics and more complex aspects.
Here are the key points about Division 7A:
Overview
- It applies when a private company provides financial benefits to a shareholder or their associate, such as loans, payments, forgiven debts, or asset transfers for less than market value.
- These benefits are treated as unfranked dividends from the company to the shareholder, unless they meet certain exceptions or comply with specific rules.
- This prevents shareholders from accessing the company’s profits in a tax-advantaged way compared to receiving dividends.
Complying Loans
- One exception is if the benefit is structured as a complying Division 7A loan agreement with specific terms, including:
- In writing
- Minimum interest rate (benchmark rate)
- Maximum term (7 or 25 years depending on security)
- Minimum yearly repayments
Broadly, under Division 7A, certain loans and payments by private companies to shareholders (and associates of those shareholders) are taken to be unfranked dividends. An unpaid present entitlement may also be taken to be an unfranked dividend. A loan will not be taken to be an unfranked dividend if it meets certain minimum rate and maximum term criteria.
Implications
Division 7A aims to maintain integrity in the corporate tax system by ensuring private companies cannot distribute profits in a tax-advantaged manner to shareholders or associates, except through complying loan arrangements or other specific exceptions.
- Non-compliance can result in significant tax liabilities for shareholders, as the benefits are taxed as unfranked dividends.
- Division 7A can impact family settlements like divorces, where asset transfers between entities may trigger deemed dividends.
- Careful tax planning is required, especially for family businesses with common related-party transactions.
The ATO has reminded taxpayers that they need to:
- Keep adequate records;
- Properly account for and report payments and use of company assets by shareholders and associates; and
- Comply with rules around Division 7A loans.
It’s essential that you understand Division 7A to:
- Make informed decisions when receiving private company money and using private company assets;
- Avoid unexpected and undesirable tax consequences.
The rules around Division 7A are complex. Talk to our KMT tax adviser if you operate your business through a company (including if using a trust structure) and you intend to receive money from the company or use assets of the company.
About our advisers:
Chrisanthe Lekatis is renowned for her expertise in management accounting, virtual CFO services, and top-tier business advice. She empowers management with tailored strategies for success, streamlining processes to achieve efficient and cost-effective outcomes. Her commitment to building trust and lasting relationships goes beyond professional excellence; it’s a personal ethos. By actively listening and understanding her clients’ businesses and goals, Chrisanthe thrives on collaborative efforts to navigate challenges and collectively achieve their aspirations. Please do not hesitate to reach out if you need assistance.
Michael Fox has been dedicated to the success of his clients, devising comprehensive wealth strategies for both personal and business growth for over 4 decades. With extensive expertise in business governance and family business succession, Michael specialises in empowering emerging businesses and family enterprises by fostering renewal, enhancing value and smooth transitions to the next generation. Please do not hesitate to reach out if you need assistance with your business valuation.
This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or get professional advice from a qualified accountant or financial adviser at KMT Partners.
