Division 7A is a section of the Tax Act that contains anti-avoidance provisions which are aimed at preventing private company owners and their associates from avoiding dividend taxation by trying to access company profits in another form besides dividends. Basically, Division 7A tax will arise when directors or associates take money out of the company in another form besides wages, a directors fee or dividends. Note, that Division 7A only applies to private companies.
The provisions of Div. 7A are extremely complicated and have been progressively amended to wipe out any loopholes devised by taxpayers.
Taking money out of the company is inevitable at some point, but it is important to pay this money back before the end of the financial year to avoid having a debit loan to the company – this is when Division 7A comes into play. If money is taken out of the company and not paid back before 30 June, you will need to work out whether or not the loan signifies the need for a Division 7A agreement or if the loan will be deemed a divided.
An agreement will NEED to be put into place at the end of the financial year if money has been taken out of the company by a shareholder or associate. The agreement needs to outline the amount of loan, length of loan (7 years), interest rate (either an agreed rate or the ATO benchmark interest rate) and parties involved. This can be drawn up by your accountant or a lawyer. From the date of the loan you will be paying interest on the total loan amount – this rate can be either agreed upon in the terms of the agreement or can be the ATO benchmark interest rate (2018/19 FY is 5.20%). This interest will be added to your company’s income and will increase the loan each year. You must also make minimum repayments each year based on the ATO’s division 7A calculator tool.
Your accountant should ALWAYS notify you when there is a debit loan sitting on the company’s balance sheet. We here at Initiative will let you know on your cover letter – so keep an eye out for the heading ‘Debit Loan’.
If you have a debit loan to your company and a Division 7A agreement was not drawn up by the end of the financial year, the loan will be deemed a dividend by the ATO and will need to be paid to the director/shareholder as a unfranked dividend. We want to avoid this at all costs!
This is because a Division 7A dividend isn’t frankable even though it’s taken to be paid out of the company’s profits. This means that the whole amount of the dividend is taxed in the hands of the shareholder, without any accompanying tax credit.
A loan agreement needs to be put into place to avoid this happening. An agreement can be put in place after the income year has ended but will need to be completed before the company’s tax affairs are lodged.
So a Division 7A agreement has been put into place, what now? The loan will need to be repaid within the timeframe outlined in the agreement. There are various ways in which the loan can be paid down to nil, these include:
- Paying off the loan from personal monies
- Paying a directors fee
- Paying the directors/shareholders a wage (keep in mind you will need to be registered for PAYG Withholding & lodge a BAS)
- Paying out a dividend to the directors/shareholder with a franking credit attached – the most effective option tax wise
Wise words from the ATO in regards to managing the risk before it happens:
‘Division 7A may inadvertently arise as a consequence of a failure to keep private expenses separate from company expenses. To avoid this:
- don’t pay private expenses from a company account
- keep proper records for your company that record and explain all transactions, including payments to and receipts from associated trusts and shareholders and their associates
- if you lend money to shareholders or their associates make sure it’s on the basis of a written agreement with terms that ensure it’s treated as a complying loan – so the loan amount isn’t treated as a Division 7A dividend’
We here at Initiative aim to never deal with Division 7A and pride ourselves on always managing the risk by letting you know what you need to do in order to avoid Division 7A! If you want more information on this topic or think you are in need of a Division 7A loan please do not hesitate to contact our office on 07 5437 8888 to discuss.