Understanding Division 7A

Address Issues with Distributing Profits Tax-Free to Shareholders and Associates

What is Division 7A in relation to Directors, Companies and Shareholders?

Division 7A is an integrity rule that prevents companies’ profits from being distributed to shareholders or their associate’s tax free. If the recipients of the payment, either a loan or benefit, it is believed to be an unfranked dividend that is included in their assessable income. In other words, a benefit that hasn’t been taxed.

The Most Common Issues Associated with Division 7A:

Incorrect recording of company asset usage by shareholders and their affiliates.
Loans issued without adhering to the terms of the loan agreements.
Using funds from the private company to repay Division 7A loans.
Using an inaccurate benchmark interest rate for a division 7A loan.

Defining” Loan” Under Division 7A: a “Loan” Under Division 7A Includes:

An advance of money. Provision of credit or any other form of financial accommodation. A payment made to a shareholder or their associate, with an obligation to repay it (whether on their account, behalf, or at their request). Any transaction equivalent to a loan of money.

Example: Terry Pty Ltd lends $20,000 to Ann, a shareholder. Since it’s an advance of money, Division 7A rules may apply, requiring compliance with specific requirements.

What is the ATO Interest Rate Benchmark?

Income year ended 30 June,
Rate, ATO reference 2024, 8.27%.

This is the ‘Indicator Lending Rates – Bank variable housing loans interest rate’ published by the Reserve Bank of Australia on 7 June 2023. Reference: https://www.ato.gov.au/tax-rates-and-codes/division-7a-benchmark-interest-rate

How to Manage Division 7A risks and Corrective Steps to Take:

Accurate record-keeping and proactive planning are essential when shareholders and their associates utilise private company funds or assets.

Annual reviews are vital to verify compliance, including confirming that payments or loans are either fully repaid or converted to Division 7A compliant loan agreements before the company’s lodgment day.

Additionally, minimum yearly repayments should be made on complying loans from prior years by the end of the income year.

Distributing Retained Profits:

Division 7A, as an integrity measure, suggests that paying retained profits as a normal dividend (with or without a franking credit) may be the most effective approach.

Shareholders should report such payments as assessable income.

Avoiding Issues:

Division 7A dividends can inadvertently arise when private expenses mix with company expenses.

To prevent this:

Avoid paying private expenses from the company account.
Maintain proper records, detailing all transactions, including payments to and receipts from associated trusts and shareholders.
When lending money to shareholders or associates, use written agreements to ensure compliance with Division 7A rules.

Repay or Convert Dividends:

A payment or benefit subject to Division 7A isn’t treated as a division 7A dividend if:

Repaid or converted to a complying loan by the company’s lodgment day. The underlying transaction occurs by the lodgment day. Corrective action can be taken after the income year ends but before finalizing tax affairs and lodging the return.

Don’t rely on Commissioners’ Discretion:

If an unfranked dividend is triggered, don’t reply upon the commissioner’s discretion.

Discretion Options:

The Commissioner can either disregard the deemed dividend. Alternatively, the Commissioner may allow the dividend to be franked.

Decision Process:

Determine if the Division 7A breach resulted from an honest mistake or inadvertent omission. Based on this assessment, decide whether to exercise discretion. It’s best not to resort to this measure and ensure that corrective action is taken place immediately.

Tools and Resources:

The Division 7A calculator and decision tool consist of two components. They help assess the impact of Division 7A concerning payments, loans, or debt forgiveness from private companies and guide compliance with obligations related to complying loans.

You can access this tool via this link: Division 7A calculator and decision tool | Australian Taxation Office

Please visit the ATO page: Private company benefits – Division 7A dividends | Australian Taxation Office (ato.gov.au) for extra resources such as videos and online resources for more information.

References

Disclaimer

This content is provided for general purposes only and is not intended to constitute legal or other professional advice. Liability limited by a scheme approved under Professional Standards Legislation.

Prepared by: Connie Lacognata

Date: 14/06/2024

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Understanding Division 7A and its Risks