Loans, dividends and Division 7A – TAX FACTS

Borrowing money from your own private company is completely legal and rather commonplace. However, failing to record any loans you make from the company properly can give you a lot of trouble when you go to complete your taxes, due to tax law Division 7A. To help you avoid any issues on the matter, here are a few key tips you should keep in mind whenever you go to borrow money from your business.

How to Implement a Proper Loan Agreement

The most effective and efficient way to avoid a dividend being classified under Division 7A is to create a loan agreement BEFORE lending to any shareholders or associates. In order to implement a loan agreement there are a few steps involved.

1. Before the company’s lodgement date be sure to put the loan in writing (the date when the company’s tax return is to be lodged or the due date for lodgement, whichever date will occur first)

A Division 7A Loan Agreement, as with any written agreement between two parties, must include:

  • Full Names of all parties involved
  • Loan terms and agreements including:
    o The amount of the loan
    o Date the agreement was made
    o Date the loan will be drawn from the company
    o Interest payable
    o Repayment dates and terms

While the agreement doesn’t have to be approved by the Australian Tax Office it does have to fulfil any and all Income Tax Assessment Act requirements. Therefore it’s best to consult a tax agent if you’re unsure about anything regarding the loan agreement beforehand.

2. Make sure the interest rate is above or equal to the Indicator Lending Rates (The bank’s variable housing loans’ interest rate last published by the RBA before the beginning of the income year of the lending entity)

3. Ensure that the loan does not exceed either of the maximum terms of:

  • 25 years in which a registered mortgage over property allows the loan to be 100% secured
  • 7 years in every other case

Minimum yearly repayments need to be made by the shareholder or associate. Failure to do will leave the remaining amount that has still not yet been repaid to become a dividend in the income year that it was not paid.

What is Division 7A?

Division 7A is primarily a measure implemented by the Australian Tax Office designed to stop private companies from handing out tax-free profits to any shareholders or associates. If the company gives out any loans, payments, advances or any other form of credits to shareholders or associates then they must be reported in your taxes. These payments are known as unfranked dividends and must be handled as assessable income. There are some specific exclusions, but you should always consult a tax agent about these before applying them to avoid any issues.

Who does Division 7A apply to?

In a private company Division 7A applies to the owners, any shareholders as well as any associates. The term ‘associate’ is a fairly wide definition but for any individual shareholders includes:

  • Spouse or child of the individual
  • Other relatives of the shareholder
  • Partner of the shareholder, or a partnership where the shareholder is the partner
  • Another company that is controlled by the shareholder or an associate

An ‘associate’ for a company shareholder can include:

  • Another individual or associate that controls the company
  • A partner of the company, or a partnership where the company is a partner
  • A different company that is controlled by the company or a company’s associate

When Does Division 7A Apply?

  • For the most part if a company does one of the following Division 7A applies:
  • Making payments to a shareholder or associate, including any transfers or even using a property for less than the market value
  • If any money is lent to a shareholder or associate and the loan has not been fully repaid come lodgement day of that income year, unless a specific loan agreement has been filed.
  • If there is a debt owed by a shareholder or associate of the shareholder and the company forgives it.

Payments not treated as dividends include:

  • Liquidators’ distributions
  • Loans or payments made to a company (not including an acting trustee company)
  • Repayments to a shareholder or associate for legitimately owed debts
  • Payments that are made to any shareholders or associates that may be seen as an employee or an employee’s associate.
  • Payments that may be otherwise assessable under another provision of the Tax Act

How to Avoid Division 7A?

Dividends that fall under Division 7A often occur when a private company starts failing to keep private and company expenses separated. In order to avoid Division 7A from applying to payments try to keep to the following guidelines:

  • Avoid paying private expenses from a company account
  • Keep complete records that explain all transactions the company makes, including any payments made to or receipts received from associated trusts, shareholders and associates.
  • If and when the company does lend money to shareholders or an associate be sure to create a formal written agreement with terms that ensure the loan is considered a genuine complying loan.

 

Unsure if Division 7A Applies to You?

If you’re still uncertain about whether any of your company’s payments fall within Division 7A’s classification, always seek out expert advice from a professional. Any further information you may want can also be found on the Australian Tax Office official website.