Division 7A – What, When, How and Why?
Division 7A loans represent a critical yet often overlooked aspect of financial management for business owners. Designed to prevent tax-free distributions of profits to shareholders and their associates, Division 7A of the Income Tax Assessment Act 1936 imposes stringent regulations on loans, payments, and other benefits provided by private companies. In this guide, we delve into the intricacies of Division 7A, highlighting common problems, key considerations, and strategies for compliance.
Division 7A loans – Common problems
- Recognizing that companies are separate entities
- Keeping, maintaining and retaining records
- Planning ahead when it comes to payments and use of company assets
- Maintaining separate bank accounts and loan accounts for individual entities
- Undertaking basic annual checks to ensure complying loan agreements are in place and minimum yearly repayments are made by required dates
Business owners wear many hats:
- Director
- Shareholder
- Employee
Taking money or benefits from a company:
- Salary and wages and directors fees
- PAYG withholding
- Superannuation
- Single touch payroll
- Fringe benefits
- FBT return
- Claim tax deduction and GST
- Tax free to the recipient
- Dividends
- Company:
- Company pays tax @ company rate
- Issues a franked or unfranked dividend
- Dividend statement must be issued
- Shareholder:
- Includes dividend with franking credit (if applicable) in tax return
- Receives a credit for the tax paid by the company (franking credit)
- Company:
- Debtor/creditor
Loans to shareholders & associates must comply with Div 7A if not repaid in full by the company’s lodgement date
- Interest derived on loans is income of the lender (company)
- Interest is not deductible for the borrower if the money is used for personal expenses
- Interest is deductible for the borrower if incurred in generating income or carrying on a business
Div 7A basics
- It prevents profits from being provided to shareholders & associates tax-free
- It may apply to a loan, payment or other benefit (incl. use of company assets or debt forgiveness given) to its shareholders & associates
- Where it applies, the recipient of the loan, payment or other benefit is deemed to have received an unfranked dividend that is included in their assessable income
- Some payments and loans are excluded from being a deemed dividend, including loans on Div 7A terms or assessable payments like salary and wages and dividends
- Div 7A can apply when a company provides loans, payments or benefits to shareholders & associates through another entity(s), i.e. other company, trust or individual
Div 7A loan agreements
A complying loan agreement must be in writing and include
- The identity of all parties
- An interest rate for each year equal to the benchmark interest rate
- A maximum of 7 years for unsecured loans (25 years for certain secured loans)
- The amount of the loan
- The requirement to repay
- A signature and dated by the parties
Div 7A repayments
- Minimum yearly repayments must be made by the end of the income year for complying loans made in earlier years
- A shortfall in a minimum yearly repayment may be a deemed dividend
- Some repayments may not be taken into account when working out the minimum yearly repayment or how much of the loan has been repaid, including reborrowings from the same company
- Some repayments will always be taken into account, i.e. if they are made by offsetting a shareholders entitlement to a dividend declared by the company or salary and wages or directors fees payable to a shareholder or associate
Common Div 7A errors
- Loans made without complying loan agreements or not in place by lodgement date
- Loan agreements not between the right entities
- Incorrect calculation of minimum yearly repayments
- A lower than benchmark interest rate
- Late or underpayment of minimum yearly repayments
- Reborrowing from the private company to make repayments on the loan
In conclusion, Division 7A loans demand meticulous attention to detail and proactive compliance measures from business owners. By understanding the nuances of Division 7A regulations, implementing robust record-keeping practices, and seeking professional advice when necessary, business owners can navigate this complex terrain with confidence. Remember, accurate reporting is key to ensuring compliance and safeguarding the financial integrity of your business.
It’s not your money……. until it is reported correctly.
