Division 7A – Think Twice, It’s Alright!
If you own a small private company, perhaps with a family member, think twice before borrowing money from that company.
If the transaction is not recorded correctly you could end up paying tax on any loan due to the tax rules known as Division 7A. You, as an individual, and your company are different legal entities, so using your company to fund private expenses may attract adverse tax consequences if proper tax advice is not obtained.
The adverse tax consequences don’t only arise when you borrow money from your company. There are other transactions made between you as a shareholder and your company that may attract the rules in Division 7A. As these rules are complicated, we recommend that you contact us before putting any arrangements in place.
What is Division 7A?
Division 7A is a group of anti-avoidance provisions in the income tax laws that prevent private companies distributing tax-free profits or assets to shareholders or their associates (e.g. spouse, child or relative of the shareholder) in the form of informal transactions such as loans, payments or forgiven debts. The use of certain company assets, for example a holiday house by a shareholder, is also caught by the rules.
If Division 7A applies, the amount received by the shareholder will be included in his or her income as unfranked dividends and will be taxed at the marginal tax rate without receiving any credit to reduce the tax bill.
How does Division 7A apply to some transactions?
The main arrangements and situations that are caught by Division 7A are these:
Loans
If a shareholder borrows money from the company and the amount is not repaid before the company lodges its tax return for the financial year in which the loan was made, the amount of the loan will be deemed an unfranked dividend paid to the shareholder. However, loans made for a maximum term of 7 years (or 25 years if secured by a mortgage) with an interest rate at least equal to the prescribed benchmark interest rate will comply with the rules and not be treated as an unfranked dividend.
Payments
Division 7A also applies when a company makes payments to a shareholder, including the use of a company’s asset for less than market value. The use isn’t limited to actual use, but includes availability for use. For example, a yacht is available for a shareholder’s use because the shareholder holds the keys, even though the actual use is relatively infrequent.
If the payment is provided to a shareholder in their capacity as an employee of the private company, e.g. as a director, fringe benefits tax (FBT) will apply instead of Division 7A. Note that benefits received by the shareholder-employee valued at less than $300, say for a Christmas gift or food hamper, are exempt from FBT.
Debts forgiven
The amount of a debt owed by a shareholder to the company that the company forgives will be deemed a dividend.
Interposed entities
Division 7A can also apply when a private company provides a payment or loan indirectly to a shareholder by using another entity. The other entity, known as an “interposed entity”, can be an individual, company, partnership or trust and sits between the private company and its shareholder.
What about family trusts?
Family businesses are often structured as discretionary trusts with “bucket” companies set up as beneficiaries for the purposes of income distribution. Therefore, if you are the trustee of the family trust (or a director of it), be aware that when you declare a distribution of income to the company beneficiary and it remains unpaid (known as unpaid present entitlement (UPE)), that UPE will be treated as a loan from the private company to the trustee which gives rise to a deemed dividend under Division 7A.
Need more help?
The rules in Division 7A are complex and far-reaching, so please talk to us to review your circumstances and arrangements to prevent any unintended adverse tax outcomes.
For expert advice and assistance in dealing with your Business Private Company Tax in Australia, please contact Mathews Tax Lawyers on 1800 685 829
Disclaimer: The information on this page is for general information purposes only and is not specific to any particular person or situation. There are many factors that may affect your particular circumstances. We advise that you contact Mathews Tax Lawyers before making any decisions.