Division 7A is an ATO integrity measure to ensure that private companies don’t make tax free distributions of profits to shareholders or shareholders’ associates in the form of payments, loans and debts forgiven. These rules only apply where the companies have retained profits.
Under Division 7A shareholders or associates who receive payments or loans from their private company must include the value of those payments or loans as unfranked dividends in their individual tax return. As these unfranked dividends will be taxed at the individuals marginal tax rate this is not a tax effective strategy.
The options to manage a Division 7A loan include:
- Have the payments or loans repaid prior to the date of lodgement of the company’s tax return with the ATO.
- Enter into a written Division 7A loan agreement prior to the date of lodgement of the company tax return. The Division 7A loan agreement must have a maximum seven year loan period (if the loan is unsecured) with interest and repayments dictated by the Division 7A legislation. The interest rate is based on the FBT interest rate.
- Pay directors’ fees or wages in the 30th June financials to eliminate the Division 7A loan. The directors’ fees will be taxable to the individual but the company will receive a tax deduction for the payment.
- Have the shareholder enter into a share buy-back with the company to eliminate the Division 7A loan (see Tax Strategy 114).
- Have the director sell assets to the company or take over some of the company’s liabilities.