You own the company, so the money in the company account is your money — right? Not according to Division 7A. This single provision produces more unwelcome surprises at tax time for Australian small business owners than almost anything else, and the surprises are entirely avoidable with a bit of planning.
What is Division 7A?
Division 7A is an integrity rule in Australian tax law designed to stop shareholders extracting profits from a private company without paying tax on them. Companies are taxed at a flat rate that is lower than the top marginal rate for individuals, so without Division 7A an owner could simply leave profits in the company, pay the lower rate, then "borrow" the money out permanently. The rule closes that door by treating certain payments, loans, and debt forgiveness as dividends.
What actually triggers it?
Three things. A loan from the company to a shareholder or an associate — which includes a spouse, family member, or a related trust. A payment by the company of a private expense on the shareholder's behalf. And forgiveness of a debt the shareholder owed the company. The second one catches the most people: using the company card for groceries, school fees, or a family holiday is a Division 7A payment, whether or not anyone called it a loan at the time.
What is a deemed dividend, and why does it hurt?
Where Division 7A applies and no exclusion is available, the amount is deemed to be a dividend paid to the shareholder. Critically, it is generally unfranked — so the shareholder pays tax on the full amount at their marginal rate with no franking credit for the company tax already paid on those profits. The same dollar effectively gets taxed twice. On a six-figure loan balance, that is a very expensive accident.
How do you make a company loan compliant?
Put it under a complying loan agreement. That means a written agreement in place before the company's tax return lodgement day for the year the loan was made, interest charged at no less than the ATO benchmark rate, and a maximum term of seven years — or twenty-five years where the loan is secured by a registered mortgage over real property. From then on, the shareholder must make the minimum yearly repayment of principal and interest each year. Get those elements right and the loan is not treated as a dividend.
What happens if the repayment is missed?
The shortfall between the minimum yearly repayment and what was actually paid becomes a deemed unfranked dividend in that income year, taxed in the shareholder's hands. The ATO does have a discretion to disregard the outcome where the failure resulted from an honest mistake or inadvertent omission, but you have to apply for it and the outcome is not guaranteed. Far better to make the repayment on time — and note that repaying with money the company lends you again does not count.
How do trusts get caught by Division 7A?
Through unpaid present entitlements. Where a family trust distributes income to a corporate beneficiary and the cash is never actually paid across, that unpaid entitlement can be treated as a loan back from the company to the trust, bringing Division 7A into play. Any structure combining a family trust with a corporate beneficiary needs the entitlements tracked and dealt with properly each year rather than left sitting on the balance sheet indefinitely.
How do you stay out of trouble?
Keep business and personal money genuinely separate — that alone prevents most Division 7A problems. Pay yourself through wages or franked dividends, both of which are properly taxed and predictable. Where you do need to draw money out, document it as a complying loan from the start rather than reconstructing it a year later. And review the shareholder loan account before 30 June, not in the following May, because most of the fixes only work if applied before lodgement day.
Division 7A is technical, unforgiving, and completely manageable when it is monitored throughout the year. The Metier Group reviews shareholder loan accounts and structures drawings for Perth company owners as part of our tax accounting services. Contact us if there is a loan account you would rather not find out about at lodgement time.