In 1998 Division 7A was introduced as an anti-avoidance clause to prevent individuals taking money out of companies in a tax-free manner. Caution needs to be taken when companies are allowing shareholders or associates of the company to use the company’s property or where loans are made from companies to shareholders or their associates. Division 7A does not prevent a company from making loans to their shareholders and associates, it requires companies to hold a loan agreement so the loan is not treated as a dividend.

The loan agreement needs to include;

– Interest paid at the benchmark interest rate;
– minimum principal repayments; and
– a maximum term of 7 years if the loan is unsecured and 25 years if the loan is secured.

1. Amounts paid by the company to a shareholder or shareholder’s associate. The payments can include transferring of property for less than the amount that would have been paid in an arm’s length dealing.
2. Amounts lent by the company to a shareholder or shareholder’s associate that is not repaid in full by the company’s lodgment day in respect of the financial year when the loan was made.
3. Debts that are forgiven, which were owed by a shareholder or shareholder’s associate to the company that the company forgives.

Treatment of payments in a company

Payments made by a private company to a shareholder or shareholder’s associate are generally treated as a dividend, provided there is sufficient distributable surplus in the company.

A payment made by a private company to a shareholder or shareholder’s associate will not be treated as a dividend if;
● A repayment of a genuine debt owed to a shareholder or its associates
● A payment that is otherwise accessible under another provision of the Act
● A payment made in the capacity as an employee or employee’s associate
● A liquidator’s distribution

Loans

When a private company makes a loan to a shareholder or shareholder associate and it is not paid back in the same income year as that the money is lent. The loan will be treated as a dividend provided there is sufficient distributable surplus in the company.

A loan made by a private company will not be treated as a dividend if it is a;
● pre-December 1997 loan
● loan that is fully repaid in the same year
● loan to a company (but not a company acting as trustee)
● loan made in the ‘ordinary course of business on commercial terms’
● loan made for the purpose of enabling the acquisition of shares or rights under an employee share scheme
● loan that is otherwise assessable
● loan that meets the definition of an ‘excluded loan’

Forgiveness of debt

Debt forgiveness is treated as a dividend when the;
● Debtor’s obligation to pay the debt is released, waivered or otherwise extinguished

● Creditor loses its right to sue the debtor for the recovery of the debt due to the expiration of the statutory limitation period
● Debtor is effectively released from the obligation to repay the loan notwithstanding the existence of arrangements which imply that the loan remains
● Creditor assigns its rights under a loan to a third party, the third party is an associate of the debtor and a reasonable person would conclude that the new creditor would not exercise the assignment right.
Debt forgiveness will not be treated as a dividend if;
● The debtor is a company
● The debt is forgiven because the shareholder or shareholder’s associate has become bankrupt
● The loan giving rise to the debt which is forgiven has been treated as a dividend
● The commissioner exercises discretion to exclude the forgiven debt from the operation of this Division where satisfied that the shareholder or shareholder’s associate would otherwise suffer under hardship.

Common Division 7A mistakes

● Poor timing – not repaying a loan on time or not entering into a complying Division 7A loan agreement
● Not making the required minimum repayments
● Miscalculating the distributable surplus
● Not recognising that division 7A can affect trusts
● Family law situations are not protected from Division7A

This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances and seek advice from Holden Accountants. Information is current at the date of issue and may change.

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