Division 7A – Loans and Payments from Private Companies
Cassandra Research — Tax Division
Research methodology: Reviewed against current ATO rulings, ITAA 1997, and Federal Court precedent.
Overview
Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) is an integrity measure designed to prevent profits or assets of a private company from being provided to shareholders or their associates tax-free. It treats certain payments, loans, and debt forgiveness by private companies as unfranked dividends for tax purposes.
Division 7A is one of the most commonly encountered anti-avoidance provisions in Australian tax practice, affecting virtually every private company and its shareholders.
Legislative Framework
Division 7A is contained in sections 109B to 109ZB of the ITAA 1936. The key operative provision is section 109D, which treats a payment by a private company to a shareholder or associate as a dividend. Section 109E treats loans as dividends unless they are placed on complying loan terms. Section 109F treats debt forgiveness as a dividend.
The minimum yearly repayment requirements for complying loans are set out in section 109E, and the benchmark interest rate is published annually by the ATO.
Practical Application
In practice, Division 7A most commonly arises when:
1. A shareholder or associate borrows money from their private company 2. A private company pays personal expenses of a shareholder 3. A private company provides assets for the private use of a shareholder 4. A trust with a UPE (unpaid present entitlement) in favour of a company does not deal with it correctly
To avoid a deemed dividend, loans must be placed on a written agreement with minimum yearly repayments at or above the benchmark interest rate, for a maximum term of 7 years (or 25 years for loans secured by a registered mortgage over real property).
Common Mistakes
- ⚠Failing to put a loan agreement in place before the lodgement date of the company's tax return
- ⚠Not meeting minimum yearly repayment requirements by 30 June each year
- ⚠Overlooking payments made by the company on behalf of a shareholder as potential Division 7A triggers
- ⚠Incorrectly treating a trust's UPE to a company — the ATO's compliance approach in PS LA 2010/4 must be followed
- ⚠Using the wrong benchmark interest rate for the relevant year
Worked Examples
Example: John is the sole shareholder and director of XYZ Pty Ltd. During the year, XYZ Pty Ltd lends John $100,000. If John does not enter into a complying loan agreement before the lodgement date of XYZ's tax return, the entire $100,000 will be treated as an unfranked dividend assessable to John.
Example: XYZ Pty Ltd pays John's personal credit card bill of $5,000. This payment is a Division 7A payment under section 109C and is treated as a deemed unfranked dividend unless it is otherwise dealt with (e.g., placed on a complying loan agreement).