If you answered yes to this question, then the legislative provisions of Division 7A of the Income Tax Assessment Act 1936 could potentially affect you.

What is Division 7A?

Division 7A is essentially designed to prevent shareholders and their associates from using private company profits without paying tax at their marginal tax rates.

With the highest individual marginal rate sitting at 45%, opportunistic tax planners might attempt to structure their tax affairs to access the lower company tax rate of either 30% or 27.5%. However, the anti-avoidance provisions of Division 7A operate to prevent this kind of activity.

Division 7A rules determine what kinds of benefits to shareholders and their associates are treated like unfranked dividends and therefore subject to personal income tax without any credit for company tax paid.

Does Division 7A apply to me?

You may potentially be affected by Division 7A if you are a:

• private company
• non-resident private company
• closely-held corporate limited partnership
• trust
• interposed entity
• shareholder or associates of a shareholder. 

Note! The term ‘associate’ in this case extends to a shareholder’s spouse, child, relative or trustee of a trust under which the shareholder benefits.

What transactions does Division 7A apply to?

Division 7A can apply to a broad range of transactions, including:

• loans
• payments
• debt forgiveness
• payments or loans where a trust has an unpaid present entitlement (UPE)
• payments and loans through interposed entities
• private use of company assets
• transfer of company assets
• gifts

Note! An unpaid present entitlement (UPE) is a payment or distribution that you are entitled to but have not been paid.

When does Division 7A not apply?

Division 7A does not apply to:

• payments to a shareholder or associate in his or her capacity as an employee. In such situations, fringe benefits tax (FBT) may apply rather than Division 7A.
• amounts that are assessable to the shareholder or their associate under other parts of the income tax law, such as normal dividends or director’s fees.
• a payment or benefit that is potentially subject to Division 7A 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.

What is a complying loan?

A loan is a complying loan if the loan has satisfied the minimum interest charge and maximum term requirement and is made or put under a written agreement before the private company’s lodgement day (currently 7 or 25 years depending on the terms).

Note!

• Complying loans will have tax implications for the company and shareholder (eg the taxation of interest will need to be considered).

When is Division 7A triggered?

Division 7A can be triggered if:

• a private company provides a payment or benefit to a shareholder or associate; or
• a trust has allocated income to a private company but has not actually paid it, and the trust has provided a payment or benefit to the company’s shareholder or their associate.

Note!

• A payment or other benefit provided by a private company to a shareholder or their associate can be treated as a dividend for income tax purposes under Division 7A even if the participants treat it as some other form of transaction such as a loan, advance, gift or writing off a debt.
• 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 provided a payment or benefit to the company’s shareholder or their associate.

What is considered a payment by a private company?

A payment may include:

• the provision of an asset for use by a shareholder or their associate (other than a transfer of property)
• when a company asset is available for use by a shareholder or their associate to the exclusion of the company, but not where there is a general entitlement to use the company’s assets
• a right to use assets under a licence or lease, but which does not involve a transfer of property. It does not matter when the right to use the asset is granted.

Note! An asset may also be available for use by a shareholder or their associate without a formal agreement or where there is no actual use.

When is a payment treated as a dividend?

A private company may be taken to pay a dividend to an entity at the end of the company’s income year if it pays an amount to the entity during the year:

• when the entity is a shareholder or an associate of a shareholder of the company; or
• a reasonable person would conclude that the payment was made because the entity was a shareholder or an associate of a shareholder at some time.

Note!

• However, the total of all dividends a private company is taken to pay under Division 7A is limited to its distributable surplus for that income year.
• Division 7A applies even if the participants treat the payment or benefit as some other form of transaction such as a loan, advance, gift or writing off a debt.

What is considered a loan by a private company?

A loan may include:

• an advance of money
• a provision of credit or any other form of financial accommodation
• a payment for a shareholder or their associate, on their account, on their behalf, or at their request if they have an obligation to repay the amount
• a transaction (whatever its terms or form) that is the same as a loan of money.

When is a loan treated as a dividend?

A private company may be taken to pay a dividend to an entity at the end of the company’s income year, if it loans an amount to an entity during the year:

• when the entity is a shareholder or an associate of a shareholder of the company; or
• a reasonable person would conclude that the payment was made because the entity was a shareholder or an associate of a shareholder at some time.

Note!

•  However, the total of all dividends a private company is taken to pay under Division 7A is limited to its distributable surplus for that income year.

Transactions that will create deemed dividends

Certain transactions between a private company and shareholder or associate are deemed to create an unfranked dividend assessable to the shareholder or associate.

Note!

• The shareholder or associate need not be a shareholder or associate at the time the transaction occurred, as long as a reasonable person would conclude that the transaction occurred because the person was a shareholder or associate at some time.

Payments treated as deemed dividends

These include:

• an amount paid or credited to the shareholder or associate
• an amount paid or credited on behalf of, or for the benefit of, the shareholder or associate
• a transfer of property to the shareholder or associate.

Case study 1

Matt owns shares in a private company, ABC Pty Ltd. On 30 June 2017, ABC Pty Ltd makes a payment of $5,000 to Matt’s mother, Norma.

Norma is not an employee of ABC Pty Ltd and she is not an associate of an employee of the company. However, she is an associate of Matt.

The payment will be taken to be an unfranked dividend paid to Norma and she must include the $5,000 as assessable income on her 2016-17 tax return.

Loans treated as deemed dividends

These include:

• loans made to a shareholder or an associate of a shareholder
• loans that are not fully repaid before the private company’s lodgement day for the year when the loan is made. A private company’s lodgement day is the earlier of the due date for lodgement, or the actual date of lodgement of the private company’s income tax return for the income year
• loans that are not excluded specifically by other sections of Division 7A.

Case study 2

Charlotte is a shareholder in a private company, XYZ Pty Ltd. Charlotte’s credit card bills, totalling $10,000, are paid with company cheques throughout the income year and debited to her loan account. Interest is not payable on the balance of the loan account.

If Charlotte repays the $10,000 to XYZ Pty Ltd by the end of the company’s income year, no amount should be treated as a deemed dividend under Division 7A. If she does not repay all of the $10,000, an unfranked dividend may arise.

There may be other tax implications for Charlotte and the company.

Consequences of triggering Division 7A

Generally, if Division 7A has been triggered, the shareholder would be deemed to have received a dividend equal to the amount of the payment, loan or benefit received.

What if I borrow an asset from my company for personal use?

Case study 3

Bruce is a shareholder of a private company that owns a luxury yacht. Bruce does not have a formal agreement with the company in relation to the yacht, however, he borrows the yacht and takes it out every second weekend. Bruce keeps the yacht at the company’s business premises, but takes the key home. Bruce stores his personal items on the yacht.

Bruce’s fortnightly use of the yacht is effectively treated like a payment under Division 7A. The availability of the yacht for Bruce’s use is also subject to Division 7A because the yacht is not readily available for use by the company.

The company would need to arrange with Bruce to get the key and for the removal of his personal items before using the yacht. The asset is available for Bruce’s use to the exclusion of the company.

Case study 4

Nicole is a shareholder of a private company that owns a city apartment. The apartment is generally available for rent. However, Nicole asks the company not to rent the apartment out for a week so that she and her family can borrow it over a long weekend. Nicole’s use of the apartment may be a payment for the purposes of Division 7A.

What if my company provides a loan to a shareholder?

Case study 5

Conway Pty Ltd loans $20,000 to Angie, a shareholder of Conway Pty Ltd. The money is loaned to Angie on the basis that she pays it back when she can. The $20,000 is a loan from Conway Pty Ltd to Angie because it is an advance of money. Consequently, Division 7A may apply.

Case study 6

Wayne Pty Ltd provides $10,000 to Bob, a shareholder of Wayne Pty Ltd, by way of a promissory note. The note places no obligation on Bob to repay the amount. The $10,000 is a loan from Wayne Pty Ltd to Bob because it is a form of financial accommodation. Consequently, Division 7A may apply.

What if my company provides a car for use by a shareholder?

Case study 7

Carla is a shareholder of a private company that owns five cars for company use. Shareholders and their associates have general permission to use the cars on weekends if they are not being used for company business. Carla regularly takes one of the cars home.

Carla’s use of the car that she takes home will be subject to Division 7A. This will include driving the car (actual use) and the availability of the car for her use to the exclusion of the company, such as when it is parked at home, or at a restaurant that Carla is visiting.

Although Carla may have general permission to use all five of the cars, she does not use all of them for the purposes of Division 7A. The four cars that Carla leaves at the company premises are available for the company to loan to another shareholder, employee, customer, or other party. That is, these cars are not available to Carla to the exclusion of the company.

Note! Providing cars or other residual benefits (eg a holiday house) to shareholders may be caught by FBT instead of Division 7A. Speak to your tax adviser to find out more.

Government’s proposed changes to Division 7A

The Government recently released for public consultation a paper proposing changes to Division 7A.

The proposed changes to the legislation are intended to apply from 1 July 2019 and may impact you if you are a company owner, a shareholder of a private company or an associate of a shareholder.

What do the changes mean?

The proposed changes are intended to make it easier for businesses to comply with Division 7A. The amendments will comprise:

• a self-correction mechanism to assist taxpayers to promptly rectify breaches of Division 7A;
• clarification that unpaid present entitlements (UPEs) come within the scope of Division 7A;
• simplified loan rules. As mentioned above, complying loans are not treated as dividends under Div 7A. Under the current law, there are 2 types of complying loans (7 years for an unsecured loan or 25 years for a secured loan). Under the proposed changes, there will be one single 10-year model.

What next?

Division 7A is always on the ATO’s radar. Speak to your tax adviser if you have been involved in transactions that you think may trigger Division 7A.

Read our complete November 2018 Taxwise Business Newsletter here