The Australian Taxation Office (ATO) regularly identifies Division 7A as an area where private companies and their shareholders can make mistakes.
If you are a shareholder of a private company, using company money or assets for personal purposes can have tax consequences. In some circumstances, Division 7A can apply and result in an amount being treated as an unfranked dividend in your personal tax return.
Understanding how Division 7A works can help you avoid unexpected tax liabilities and ensure company funds and assets are being used appropriately.
What is Division 7A?
Division 7A is an anti-avoidance provision in Australian tax law designed to prevent private companies from providing tax-free benefits to their shareholders or their associates.
For example, a shareholder might use a company credit card to pay for their child’s school fees, use company funds to pay for a private holiday, or take money from the company for personal expenses.
Where certain conditions are met, Division 7A can apply to these payments, loans or other benefits.
If Division 7A applies and the amount is not appropriately dealt with, it may be treated as an unfranked dividend. This can mean the amount is included in the shareholder’s assessable income and taxed at their applicable marginal tax rate.
Why do Division 7A mistakes happen?
One common source of Division 7A errors is misunderstanding that a company is a separate legal entity from its shareholders.
This means shareholders should not simply use company funds or assets for private expenses without considering the tax and legal implications.
A practical way to reduce the risk of mistakes is to keep business and personal finances separate. Using separate bank accounts and credit cards can make it easier to identify private and business expenditure and maintain accurate records.
Common examples of Division 7A issues
Division 7A can potentially become relevant where a private company:
- Pays a shareholder’s personal expenses
- Provides a loan to a shareholder or their associate
- Allows a shareholder or associate to use company assets for private purposes
- Pays private expenses using a company credit card
- Provides funds or benefits to a shareholder without properly recording or repaying the amount
The tax treatment will depend on the circumstances, so it is important to identify and deal with these transactions correctly.
How can you avoid Division 7A problems?
If a private company has provided money or a benefit to a shareholder or their associate, there may be different ways to deal with the transaction depending on the circumstances.
One option may be to repay the amount in full within the relevant timeframe.
Another common approach is for the amount to be treated as a Division 7A loan under a complying loan agreement.
What is a Division 7A complying loan agreement?
There is no prescribed format for a Division 7A loan agreement. However, the agreement needs to meet the relevant requirements.
Generally, a complying Division 7A loan agreement should set out details including:
- The identity of the borrower and lender
- The loan amount
- The requirement to repay the loan
- The interest rate payable, which must generally be at least the applicable Division 7A benchmark interest rate
- The term of the loan, which is generally a maximum of seven years, or up to 25 years where the relevant loan is secured by a registered mortgage over real property
Importantly, a Division 7A complying loan agreement must generally be in place by the company’s lodgment day for the income year in which the loan is made.
There are also ongoing requirements, including minimum yearly repayments and other conditions that need to be met for the loan to continue receiving the intended tax treatment.
Don’t get caught out by Division 7A
Division 7A can be complex, particularly when company funds, loans, assets and private expenses are involved.
If you are a private company shareholder and are unsure whether a transaction could trigger Division 7A, it’s worth getting advice before the end of the financial year.
Our team can help you understand your Division 7A obligations, review shareholder transactions and ensure any relevant loan arrangements meet the applicable requirements.
Have questions about Division 7A? Get in touch with our team today.
