BY
|
What is the Division 7A Loan?
From reinvesting in the business to offering dividends, companies have several choices, including the Div 7A loan, for managing their profits. It can also use it to pay down debt, or, among other things, reinvest in new technology and equipment.
But in most cases, private companies will choose to distribute their profits via dividends, wages, or director fees.
Shareholders must declare these dividend distributions or wages as income on their individual tax return. However, a private company may also explore alternative ways to distribute its profits without triggering certain tax obligations. For example, they could do this by “loaning” or “advancing” money to its shareholders.
However, in recent years, the Australian Tax Office (ATO) started clamping down on these tax-free distributions or loans. It introduced a new set of rules in the Income Tax Assessment Act that essentially branded these transactions as tax avoidance.
These rules are known as Division 7A (or Div 7A loan for short).
The new legislation doesn’t necessarily bar companies from lending or advancing money to their shareholders, but it does require them to follow very specific rules to record loan agreements and ensure the transactions are compliant.
That’s where a Div 7A loan comes in.
What is a Private Company Div 7A Loan?
The Division 7A rules activate when a company engages in specific transactions with a shareholder or associate. These transactions can include:
- Lending money or transferring property for less than its market value
- Lending money without a formal credit agreement
- Lending money that’s not fully repaid by the financial year’s tax return lodgement date
- Relieving (or forgiving) debt.
A Division 7A loan agreement is imperative for ensuring these transactions comply with ATO guidelines.
Why Will You Require Division 7A Loan Agreement?
Unless a Division 7A loan agreement exists, these transactions will form part of the shareholder’s income and be subject to income tax at their marginal rate. So, a Division 7A loan is essentially a way that companies can make a financial accommodation for their shareholders and treat it as a loan rather than a distribution of income.
Shareholders, however, should be aware of the interest costs involved, as they must adhere to a benchmark Div 7A interest rate. In this case, this loan does not evade paying taxes; it simply defers it until later while meeting the benchmark interest rates set by the Reserve Bank of Australia (RBA).
So, companies must draw up a complying loan agreement before either one of the above transactions (or before the end of the income year).
How to Establish a Compliant Division 7A Agreement?
If a compliant Division 7A loan agreement is in place before the transaction, the Div7A loan will be transferred tax-free and won’t form part of the shareholder’s assessable income.
According to the ATO, there are two types of Div 7A loans:
- An unsecured loan: No security is provided by the shareholder. These loans have a maximum seven-year term.
- A secured loan: The company holds security (at least 110% of the loan amount) over the shareholder’s property. These loans have a maximum term of 25 years.
To ensure compliance, shareholders must meet the Div 7A interest rate specified in the agreement (a benchmark interest rate generally based on the home loan rate) and repay the full loan balance by the end of the term.
Note: This rate contributes to the company’s interest income.
Other Considerations when Entering into a Div 7A Agreement
When entering into a Div 7A loan agreement and weighing up if they’re good or bad, you must consult with legal and accounting professionals. It could be considered non-compliant if it doesn’t meet the requirements proposed by the relevant legislation. If the loan is not compliant, the payment will form part of the shareholder’s assessable income.
Here are some key points to ensure your agreement is compliant:
- Make sure the agreement is signed before the private company lodges its tax return for the financial year.
- Ensure the shareholder meets the minimum yearly repayment.
- Ensure that the company’s distributable surplus isn’t miscalculated (a company can only lend or advance money that falls within its distributable surplus); and
Note: Division 7A also affects trust transactions.
How Does Div 7A Apply to Trust Transactions?
Division 7A rules can also apply to trusts, particularly when there is a private company beneficiary involved. In cases of unpaid present entitlements, the rules will apply under specific conditions, such as
- Where the unpaid present entitlement is a loan or an advance
- Where the trustee lends funds to a shareholder of the beneficiary company; or
- Where the trustee relieves the shareholder (or forgives) of the debt due to the beneficiary company.
Key Takeaways
While there may be legitimate reasons for lending or advancing money to shareholders, companies must ensure that they comply with the necessary Division 7A rules to avoid triggering tax obligations for the shareholder.
This involves establishing a compliant Division 7A loan agreement that sets out the minimum yearly repayment amount, the interest rate, and the loan term.
This article aimed to provide a broad overview of what you can expect from Div 7A loans, but this is a relatively complex area of law and accounting and requires you to seek professional advice.
Our expert team of advisors and chartered accountants at Box Advisory Services can assist you in managing compliant Division 7A loans by recording the necessary information for your company tax return.
Speak With Us Today to Learn More About a Div 7A Loan
Interested in learning more about the strategies and requirements to manage a deemed dividend to a company’s shareholders property, minimum repayment amounts, when a company lends money and more?
Contact us today to learn more about how we can help you manage your Division 7A obligations.
FAQs
What is the Div 7A Calculator?
The ATO offers a Div 7A calculator tool to help companies assess loan compliances, including the term of the loan, the benchmark interest rate you may charge and the minimum yearly repayments throughout the income year.
How is the Div 7A Interest Rate Determined?
The Div 7A interest rate is generally based on the home loan rate and is specified in the Division 7A loan agreement.
What is the Benchmark Interest Rate?
The benchmark interest rate is a standard or guideline interest rate set by the ATO. It serves as the minimum interest rate that should be charged on a Div7A loan to ensure compliance with Division 7A rules.
How Does the Income Tax Assessment Act Relate to Div 7A Loans?
The Income Tax Assessment Act contains the Division 7A rules, which govern how private companies can lend or advance money to shareholders without triggering adverse tax consequences.
What Are Minimum Yearly Repayments?
Minimum yearly repayments refer to the smallest amount that must be repaid within each financial year to keep the Div 7A loan compliant with the rules. Failure to meet these repayments can result in tax penalties.
What is Distributable Surplus?
Distributable surplus refers to the amount a company can legally lend or advance within its available resources.
How Can I Make My Div7A Loan Compliant?
To make your Div 7A loan compliant, you must establish a Division 7A loan agreement that meets ATO guidelines, including terms, interest rates, and minimum yearly repayments.s
What is a Private Company Div 7A Loan?
The Division 7A rules trigger when a company:
Why Will You Require Division 7A Loan Agreement?
Unless a Division 7A loan agreement exists, these transactions will form part of the shareholder’s assessable income and be subject to income tax at their marginal rate. So, a Division 7A loan (or Div 7A loan for short) is essentially a way that companies can make a financial accommodation for their shareholders and have it treated as a loan rather than a distribution of income.
In this case, this loan does not evade paying taxes; it merely defers it until later while meeting a benchmark interest rate.
Therefore, companies must draw up a complying loan agreement before either one of the above transactions takes place (or before the end of the income year).
How Must the Compliant Division 7A Loan Agreement Be Established?
Suppose you have a Division 7A-compliant loan agreement in place before effecting the transaction. In that case, the Division 7A rules will no longer trigger, and the loan or advance will be transferred tax-free and won’t form an assessable part of the shareholder’s income.
According to the ATO, a company can draw up two different types of Division 7A loans:
- An unsecured loan: this is when the shareholder doesn’t provide security for the loan. Unsecured loans have a maximum seven-year term.
- A secured loan: these are where the company has security (of at least 110% of the loan amount) over the shareholder’s property to secure the loan. Secured loans have a maximum term of 25 years.
As long as the shareholder pays the minimum interest required (a benchmark interest rate generally based on the home loan rate) in the loan agreement and repays the full loan balance by the end of the term, they won’t breach the Division 7A rules.
What Support Is Available for Creating a Loan Agreement & Introducing a Minimum Interest Rate?
The ATO provides companies with a useful Division 7A calculator and division tool they can use to assess whether the loan is compliant with the necessary rules, including the term of the loan, the benchmark interest rate you may charge and the minimum yearly repayments throughout the income year.
Other Considerations when Entering into a Div 7A Loan Agreement
You may wish to seek professional advice from a legal team and your accountants when it comes to drawing up and entering into a Div 7A loan. If it doesn’t meet the necessary requirements proposed by the relevant legislation, it could be considered non-compliant. If the loan is not compliant, the payment will form part of the shareholder’s assessable income.
Here are a few things to consider when checking that your agreement is compliant:
- Ensure that the agreement is signed before the company lodges its tax return for the financial year in which it lent or advanced money to the shareholder;
- Ensure that the shareholder is meeting the minimum yearly repayment (otherwise, the shortfall is considered assessable income);
- Ensure that the company’s distributable surplus isn’t miscalculated (a company can only lend or advance money that falls within its distributable surplus); and
- Ensure that the company recognises that Division 7A also affects trust transactions.
How Does Div 7A Apply to Trust Transactions?
Division 7A rules can apply to trusts if the trustee allocates money to a private company beneficiary but does not pay, known as unpaid present entitlements. The Division 7A rules will then apply:
Key Takeaways
While there may be legitimate reasons for lending or advancing a sum of money to shareholders, companies must ensure that they comply with the necessary Division 7A rules to avoid triggering tax obligations for the shareholder.
This involves establishing a compliant Division 7A loan agreement that sets out the minimum yearly repayment amount, the interest rate, and the loan term.
This article aimed to provide a broad overview of what you can expect from Div 7A loans, but this is a relatively complex area of law and accounting and requires you to seek professional advice.
Our expert team of advisors and chartered accountants at Box Advisory Services can assist you in managing compliant division 7A loans by recording the necessary information for your company tax return.
Speak With Us Today to Learn More About a Div 7A Loan
Interested in learning more about the strategies and requirements to properly manage a deemed dividend to a company’s shareholders, minimum repayment amounts, when a company lends money and more?
Contact us today to learn more about how we can help you manage your Division 7A complying loans.
