Division 7A

Division 7A is the part of the tax law that stops profits being taken out of a private company without tax being paid on them. Where a company lends money to, pays money to, or forgives a debt of a shareholder or an associate of a shareholder, the amount can be treated as an unfranked dividend assessable to the recipient.

It catches ordinary commercial behaviour. An owner draws on the company during the year. A company pays a personal expense. A family trust has an entitlement to company profits that is never actually paid. None of these feels like a dividend, and all of them can be treated as one.

The usual answer: a complying loan agreement

A payment or loan will generally not be treated as a dividend if it is put on the terms the legislation requires before the company's lodgment day for that year. In broad terms that means a written agreement, a minimum rate of interest set by reference to the benchmark rate published each year, a maximum term of seven years for an unsecured loan or twenty-five years for one properly secured over real property, and a minimum repayment made each year for the life of the loan.

Two points matter more than the drafting:

• The deadline is real. The agreement has to be in place by the lodgment day. After that the opportunity to put the loan on complying terms for that year has generally gone.
• The agreement is not the end of it. A complying loan requires a minimum repayment every year. An agreement signed once and then ignored produces a shortfall that is itself treated as a dividend.

Unpaid present entitlements

Where a trust makes a company presently entitled to trust income and the money is never actually paid across, the arrangement has been the subject of sustained attention from the Commissioner and of changing administrative positions over the years. Whether and when such an entitlement is treated as a loan for these purposes, and what has to be done about it, depends on when it arose and on the Commissioner's view applicable to that period.

This is an area where the position has shifted more than once, so arrangements set up on advice that was correct at the time may not be correct now. If your structure involves a corporate beneficiary with entitlements that have not been paid, it is worth having the position confirmed rather than assumed.

What goes wrong

• The loan is identified at the accounts stage, after lodgment day has passed.
• An agreement exists but minimum repayments have not been made, in some cases for years.
• The loan is repaid shortly before year end and redrawn afterwards, which the anti-avoidance provisions are designed to catch.
• Payments to an associate, such as a spouse or a family trust, are not recognised as being caught at all.
• A debt is forgiven informally, or a loan is simply written off, without appreciating the consequence.
• The company has no distributable surplus, which limits the deemed dividend, and nobody has checked whether that is so.

Where it interacts with the rest of your affairs

Division 7A loans do not disappear on death, on a sale of the business, or on a restructure. A loan account owing by a deceased owner to their company is a liability of the estate. A company being sold with loans outstanding to the vendor needs those dealt with in the transaction. A restructure that moves assets between entities can trigger consequences under these provisions that the commercial negotiation never contemplated.

What we do

• Prepare complying loan agreements, including secured agreements where the longer term is wanted.
• Advise on whether a particular payment or arrangement is caught.
• Advise on the options where a deadline has been missed, including whether relief may be available.
• Deal with loan accounts as part of an estate plan, a business sale or a restructure.
• Work directly with your accountant, who usually identifies the issue and holds the numbers.

This page is general information. It is not legal or tax advice. Division 7A is detailed and the consequences of a misstep are significant, so the position should be confirmed for your particular circumstances.