ATO concerned about compliance with Division 7A
Division 7A of the Income Tax Assessment Act 1936 was introduced as a way to uphold the integrity of the tax system by ensuring the fair taxation of transactions between private companies and their shareholders.
Division 7A addresses scenarios where private companies provide benefits or loans to shareholders or their associates.
The primary objective of Division 7A is to prevent the misuse of private companies for the tax-free distribution of profits to shareholders or their associates.
Duplicate the above container for more 2 column sections OR Duplicate the below container for 1 column text only sections. (DON’T FORGET TO DELETE THIS CONTAINER)
What is Division 7A? When and how does it apply?
Division 7A applies to transactions between private companies and their shareholders or associates, covering loans, payments, debt forgiveness, and the provision of company assets below market value.
When such transactions occur, they are treated as assessable dividends in the hands of the shareholder or their associate and subject to income tax at the shareholder or associate’s marginal tax rate.
While there are exceptions and safe harbor provisions allowing the above types of transactions to occur without being treated as a deemed dividend, compliance with Division 7A is crucial to avoid severe tax penalties and additional taxes for both the company and the shareholder.
In addition to the above, Division 7A can also apply in circumstances where a private company provides a payment or benefit to a shareholder or associate through another entity, or in instances where a trust has appointed or allocated income to a private company (but has not yet actually paid the income), the trust then pays the income to the private company’s shareholder or their associate.
However, Division 7A does not apply to amounts that are assessable to shareholders or their associates under other parts of the income tax law (e.g. dividends, director’s fees, salary and wages).
ATO concerns about compliance with Division 7A
Because Division 7A is a complex area, the ATO is working in partnership with tax professionals in 2024 to raise awareness of common errors and issues in the Division 7A space.
According to the ATO, the most common errors identified include:
- keeping adequate records
- properly accounting for and reporting payments
- use of company assets by shareholders and associates
- complying with rules around Division 7A loans – documenting loan agreements, making minimum yearly repayments (MYR), including the use of journal entries and declaration of dividends to make MYR
- rectifying historical Division 7A issues.
Complying with Division 7A and avoiding adverse tax consequences
For private companies that have provided their shareholders or associates with what would otherwise be considered Division 7A distributions (e.g. loans, payments, debt forgiveness, use of assets etc), one of the most crucial tasks is maintaining thorough records to ensure compliance and avoid adverse Division 7A consequences.
This includes having a written loan agreement that outlines the terms whenever a private company extends a loan to a shareholder or an associate. Such an agreement should detail the interest rate, the schedule for repayment, and the maturity date of the loan – all of which must be in accordance with the Division 7A rules.
It is also essential to keep detailed records of any loan repayments, including the dates and amounts paid. At the end of each financial year, companies should document resolutions that pertain to the treatment of benefits provided to shareholders or their associates. These transactions should be accurately reflected in the company’s annual financial statements.
Maintaining these records is essential for demonstrating compliance with Division 7A during ATO reviews and in helping to avoid potential penalties. The records must be sufficient to demonstrate that all transactions have been treated correctly for tax purposes and that any payments or loans are either being repaid in accordance with the Division 7A requirements or have been treated as dividends.
When it comes to historical Division 7A issues, application can be made to the ATO to exercise a discretion to ignore the effect of Division 7A that would otherwise apply. But this is only available in certain limited circumstances.
Mathews Tax Lawyers have successfully obtained a favourable exercise of this discretion for a number of clients, thereby avoiding significant tax and penalties.
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.