The Australian Taxation Office (ATO) has announced some key issues and concerns about the misuse of business funds for private purposes. While there are laws preventing companies from providing tax-free benefits to shareholders and associates, mistakes are so frequent that the ATO has made this an audit focus area and launched an education campaign to increase compliance.
What is Division 7A and why should you care?
Division 7A is part of the Income Tax Assessment Act 1936 and is essentially an anti-avoidance measure to prevent the profits or assets of a company from being given tax-free to shareholders or their associates.
Division 7A is triggered when certain kinds of payments or benefits are made and can include:
- private use of company assets
- transfer of company assets
- gifts
- loans and other forms of credit
- writing off (forgiving) a debt
- an advance of money
- payment of personal expenses such as school fees, mortgages
- guarantees
Under Division 7A, these types of transactions from a company are considered a loan to the shareholder/associate and must either be repaid or placed under a complying loan agreement.
If the loan is not repaid and there is not a complying loan agreement in place, the recipient is deemed to have received a dividend equal to the benefit received. Essentially, it is treated as an untaxed payment from the company to you or your associate.*
What does that mean for the company?
The deemed dividend will be considered unfranked (untaxed) and the company will not be able to claim a tax deduction for the amount.
What does that mean for the recipient?
The whole deemed dividend (without any franking credit) is assessable income and must be reported in your individual tax return. If it was your associate who took and used the money or assets for personal use, the associate must declare it.
*Division 7A can also apply when a private company provides a payment or benefit to a shareholder or associate through another entity, or if a Trust has allocated income to a private company but has not actually paid it, and the Trust has subsequently provided a payment or benefit to the company’s shareholder or their associate.
When doesn’t Division 7A apply?
Division 7A does not apply to amounts that are assessable to the shareholder or their associate under other parts of the income tax law, such as wages, normal dividends, director’s fees, expenses, repayments of loans etc.
A payment or benefit that is potentially subject to Division 7A is not treated as a dividend if it is repaid or converted into a Division 7A complying loan by the company’s lodgement day for the income year in which the payment or benefit occurs.
Learn more about taking money out of your company (loan repayments, dividends etc).
Who does the ATO consider an “associate”?
The definition of an “associate” can be quite broad and may include:
- For an individual shareholder – an associate includes a relative, partner, the spouse or child of that partner of the individual, a trustee of a trust estate under which the individual or an associate benefits, or a company under the control of the individual or associate.
- For a company shareholder – an associate includes a partner of the company, or a trustee of a trust estate under which the company or associate benefits, another individual or associate who controls the company, or another company that is under the control of the company or the company’s associate.
- For a trustee shareholder – an associate includes an entity or associate of the entity that benefits or is capable of benefiting under the trust.
- For a partnership shareholder – an associate includes each partner of the partnership or associate of the partner.
Avoiding Division 7A problem areas
Division 7A is not a new area of the tax law; it has been in place since 1997. Despite this, there are common errors that frequently trip up business owners. These include:
- Incorrect accounting for the use of company assets by shareholders and their associates. Often, the amounts are not recognised;
- Loans are made without complying loan agreements;
- Reborrowing from the private company to make repayments on Division 7A loans;
- The wrong interest rate is applied to the Division 7A loans (there is a set rate that must be used).
Avoiding problems can often come down to a few simple steps:
- 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; and
- If the company lends money to shareholders or their associates, make sure it’s based on a written agreement with terms that ensure it’s treated as a complying loan – so the full loan amount isn’t treated as an unfranked dividend.
Further help
Please contact our tax specialists if you require any clarification on Division 7A rules. In recent years, the ATO has aggressively pursued private company owners where company funds have been used for private purposes therefore company shareholders and directors should be vigilant about identifying and correcting potential Division 7A issues as they arise.
You can find out more about working with Marsh & Partners here. As your Absolute.Account.Ability partner we’re on a mission to make your business life better.
This article is intended to give an overview and is not a substitute for financial advice.
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