If you own a company and have drawn money from it that was not a wage or a dividend, Division 7A is the rule that decides whether the ATO treats it as a loan or as taxable income in your hands. It catches many owners by surprise, usually at tax time. Here is what triggers it, how complying loans work, where trusts fit, and how to fix problems from earlier years.
A company is a separate taxpayer from its owners. It pays tax at the company rate, and its profits only become the shareholders' income when they are paid out as dividends. Division 7A of the Income Tax Assessment Act 1936 exists to stop shareholders and their associates taking those profits out in other ways, such as loans that are never repaid, and enjoying them without paying the tax a dividend would attract.
In practice it affects almost every owner-managed company at some point. The owner pays a personal bill from the company account, draws living expenses through the year and sorts it out later, or the company lends money to a family trust or a related business. All of these are Division 7A events, whether anyone intended them to be.
The rules are mechanical and the ATO applies them closely, but they are also manageable if the position is understood before the company's tax return is lodged. That timing is the key to everything that follows.
Division 7A applies to a private company and to its shareholders and their associates, which includes family members, related trusts and related companies. The events that trigger it are broader than most owners expect.
Some things are excluded, such as payments that are assessable as salary or fringe benefits, and loans made in the ordinary course of business on commercial terms. The exclusions are specific and we check each one rather than assume.
A loan from the company to a shareholder is not a problem under Division 7A if it is placed on a complying loan agreement before the company's lodgement day for the year the loan was made. The agreement must be in writing, charge interest at least equal to the ATO benchmark rate, and run for no more than seven years if unsecured or twenty-five years if secured by a registered mortgage over real property with sufficient value.
From the year after the loan is made, a minimum yearly repayment must be made by 30 June each year, covering interest and a share of principal. The benchmark interest rate is published by the ATO for each financial year and has moved considerably in recent years, so we calculate the minimum repayment fresh each year rather than carry forward last year's figure. Missing a minimum repayment creates a deemed dividend for the shortfall.
Repayments can be made in cash or by declaring a franked dividend and applying it against the loan, which is a common and legitimate approach. What does not work is repaying the loan just before year end and redrawing it just after, which the rules specifically address.
Division 7A also reaches into family trusts. When a trust distributes income to a corporate beneficiary, often called a bucket company, but does not actually pay the cash across, the company has an unpaid present entitlement, or UPE. The trust keeps using the money and the company holds a paper asset.
The ATO's position has long been that a UPE left unpaid can be treated as a loan from the company to the trust, bringing it within Division 7A. The correct treatment of UPEs has been contested in the courts and the ATO's guidance has changed more than once, so what applies to a particular year depends on when the entitlement arose and the guidance in force at the time. We check the current position each year rather than relying on what applied previously. Our trusts and companies page explains how distributions to a bucket company can be structured.
The practical point for owners is simple: if a trust has distributed to a company and the cash has not moved, that needs a plan before the company's return is lodged.
When Division 7A applies and no exception or complying loan is in place, the amount is treated as a dividend paid by the company to the shareholder or associate at the end of the company's income year. It is unfranked, so there is no credit for the tax the company has already paid, and it is included in the recipient's assessable income at their marginal rate.
The deemed dividend is capped at the company's distributable surplus, broadly its net assets less paid-up capital, which is why the position of the whole balance sheet matters. There is no deduction to the company and no refund of the company tax. For an owner on a high marginal rate, the result can be the worst of both worlds: company tax paid on the profit and personal tax on the same amount. Avoiding this outcome is the reason Division 7A planning exists.
Timing within the year matters as well. A loan made during the year and fully repaid before the company's lodgement day is generally not caught, which is why we review the director loan account before the return is prepared rather than after. The lodgement day is the later of the due date and the actual lodgement date, so lodging early does not shorten the window.
Many owners come to us with a director loan account that has grown over several years with no agreement in place, or with a loan agreement that exists but has not had its minimum repayments made. The position is rarely as hopeless as it looks, but it has to be addressed with care.
Where a breach resulted from an honest mistake or inadvertent omission, the Commissioner has a discretion to disregard the deemed dividend or allow it to be franked, usually on condition that corrective action is taken, such as putting a complying loan in place and catching up the repayments. The application sets out what happened and why, and the ATO looks more favourably on taxpayers who come forward than on those found in an audit. Voluntary disclosure also reduces penalties. We prepare these applications and the corrective loan documentation together.
If a prior year's deemed dividend cannot be avoided, the right answer is to recognise it correctly, amend where needed and stop the problem recurring. A cleaned-up Division 7A position is also something buyers and lenders look for, so it has value beyond the tax.
The best Division 7A outcome is the one where it never applies, because the money left the company in a planned way. For owner-managed companies in Brisbane and Logan we build this into the annual tax planning process.
If you have taken money out of your company and are not sure where you stand, the time to ask is before the return is lodged. Call our Victoria Point or Jimboomba office, or book a video call from anywhere in Australia.
A Division 7A loan is money a private company lends to a shareholder or their associate, including drawings through a director loan account. If it is not repaid or placed on a written complying loan agreement with interest at the ATO benchmark rate and minimum yearly repayments by the company's lodgement day, Division 7A treats the amount as an unfranked dividend taxed in the borrower's hands.
If the money is not salary, a dividend or a complying loan, Division 7A can deem it an unfranked dividend at the end of the company's income year. It is then included in your assessable income at your marginal rate with no franking credit, up to the company's distributable surplus. The company gets no deduction, so the same profit is effectively taxed twice. Planning before lodgement day avoids this.
Take money out as salary through STP or as franked dividends, and for anything else put a complying loan agreement in place before the company's tax return is lodged, with interest at the benchmark rate and minimum repayments each year. Track the director loan account monthly so the balance is known before 30 June. Keep company assets used personally on commercial terms or outside the company.
Yes. A common approach is for the company to declare a franked dividend to the shareholder and apply it against the loan balance instead of paying cash. The dividend is assessable to the shareholder with the franking credit attached. What is not allowed is repaying a loan shortly before year end and borrowing the amount back again afterwards, which the rules treat as if no repayment was made.
It can. When a trust distributes income to a company beneficiary but does not pay the cash, the resulting unpaid present entitlement can be treated by the ATO as a loan from the company to the trust and brought within Division 7A. The law here has been contested and the ATO's guidance has changed, so the treatment depends on when the entitlement arose. We check the current position each year.
Often, yes. Where a breach came from an honest mistake or inadvertent omission, the Commissioner can disregard the deemed dividend or allow it to be franked, usually on condition that corrective action is taken, such as a complying loan agreement and catch-up repayments. Coming forward voluntarily improves the outcome and reduces penalties. Where a deemed dividend cannot be avoided, we recognise it correctly and stop it recurring.
