What is Division 7A?

Division 7A is a section of the Income Tax Assessment Act 1936 designed to prevent private companies (or their associates) from making tax-free payments to shareholders (or their associates). It treats certain payments, loans, or forgiven debts to shareholders as unfranked dividends, meaning they’re taxed in the hands of the recipient—even if no money was formally declared as a dividend.

ATO debunks Division 7A 'myths'

The ATO has recently published a document 'debunking' various Division 7A 'myths'.

Division 7A of the tax legislation is intended to prevent profits or assets being provided to shareholders or their associates tax free.

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 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 (as well as in other circumstances).

Myth 1: If I own a company, I can use the company money any way I like.

ATO response: A company is a separate legal entity, and there will be consequences every time the taxpayer takes money or accesses other benefits from their private company.

Myth 2: Division 7A only applies to the shareholders of my private company.

ATO response: Division 7A applies to both shareholders and their 'associates'. The definition of an 'associate' is broad.

Myth 3: I don't need to keep records when my private company makes payments, loans or provides other benefits to other entities.

ATO response: Taxpayers are legally required to keep records of all transactions relating to their tax affairs when they are running a business.

Myth 4: I can avoid Division 7A by temporarily repaying my loan before the private company lodges its tax return, and using the company’s money to make my repayments.

ATO response: A repayment made on a loan may not be taken into account if similar or larger amounts are reborrowed from the same company after making the repayment. 

Myth 5: There are no tax consequences if I use my private company's money to fund another business or income earning activity.

ATO response: Division 7A may apply to any loan a private company makes to its shareholders or their associates, regardless of what the loan recipient uses the amounts for.

Example

Sarah owns 100% of a private company, SarahCo Pty Ltd. The company has $200,000 sitting in retained earnings.

Sarah decides to take out $50,000 from the company to buy a car in her personal name, but instead of declaring a dividend or paying herself a wage, she takes it as a "loan" without any formal agreement or repayments.

Under Division 7A, that $50,000 could be treated as a deemed dividend and taxed in Sarah’s personal tax return, unless:

• It’s repaid before the company's tax return is due, or
• A Division 7A loan agreement is put in place (with required interest and minimum yearly repayments).

Disclaimer: The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek independent professional advice.