For many private company owners, the company bank account can appear closely connected with their personal finances. But a company is a separate legal and tax entity. Taking money from a private company for personal purposes can therefore have tax consequences that are very different from simply withdrawing your own funds.

Division 7A of the Income Tax Assessment Act 1936 is an integrity regime designed to prevent profits accumulated in private companies from being provided to shareholders or their associates without the appropriate tax treatment. In broad terms, certain payments, loans and forgiven debts can be treated as unfranked dividends.

When can Division 7A arise?

Division 7A should be considered whenever a private company provides money or benefits to a shareholder or an associate of a shareholder. The concept of a loan is broad and can include an advance of money, financial accommodation, or a payment made on behalf of a shareholder where there is an obligation to repay it.

Common examples include a director drawing funds from the company for personal expenditure, the company paying a shareholder’s private expenses, a shareholder loan account becoming overdrawn, or the company forgiving an amount owed by a shareholder or associate. Division 7A can also apply through interposed entities, so routing a transaction through another entity does not necessarily avoid the rules.

Why does it matter?

If Division 7A applies, the relevant amount may be treated as an unfranked dividend to the shareholder or associate, generally subject to the company’s distributable surplus. An unfranked dividend does not carry franking credits, which can create an unexpected personal tax liability.

The risk is often discovered after year end when the accountant reconciles the shareholder or director loan accounts. By then, what looked like a routine transfer during the year may require corrective action.

Complying Division 7A loans

A loan does not automatically become a deemed dividend. One important pathway is to place the amount under a complying written loan agreement by the company’s lodgment day. The agreement must satisfy the statutory requirements, including an interest rate at least equal to the applicable Division 7A benchmark interest rate and the permitted maximum term.

Once a complying loan is in place, minimum yearly repayments generally need to be made. The benchmark interest rate changes from year to year, so directors should not simply reuse the previous year’s repayment calculation.

Timing is critical

The company’s lodgment day is particularly important. A payment or benefit that might otherwise be caught may avoid being treated as a Division 7A dividend if the amount is repaid or converted to a complying loan by the relevant lodgment day. This is why shareholder loan accounts should be reviewed well before the company tax return is lodged.

Common mistakes to avoid

• Using the company bank account to pay personal expenses without recording the transaction correctly.
• Allowing a director or shareholder loan balance to accumulate without reviewing it before lodgment.
• Having a loan agreement but failing to make the required minimum yearly repayment.
• Assuming a transaction is outside Division 7A because it passes through a trust, another company or another related entity.
• Recycling repayments or entering arrangements whose practical effect is to circumvent Division 7A.

What should directors do?

Directors should keep company and personal expenditure clearly separated, maintain proper records, review shareholder and associate accounts regularly, and seek advice before extracting significant funds from a private company. A year-end review should identify outstanding loans, private payments, trust entitlements and related-party transactions so there is time to determine the correct treatment.

How Amerital can help

Amerital Advisory & Partners can assist with reviewing shareholder and director loan accounts, preparing Division 7A loan schedules, calculating minimum yearly repayments and considering the tax consequences of proposed distributions or funding arrangements.

Key references: Australian Taxation Office – Division 7A loans, managing Division 7A risks, and the Division 7A calculator and decision tool; Income Tax Assessment Act 1936, including section 109N.

Important Disclaimer
The information in these articles is general in nature and is not intended to constitute taxation, legal, financial or investment advice. Australian taxation and foreign investment rules are complex and may change. The application of the law depends on the facts and circumstances of each taxpayer or investor. Professional advice should be obtained before acting on the information contained in these articles.