What is Division 7A (Div7a)?

Div7a is legislation introduced by the ATO to stop business owners drawing cash out of their companies without paying tax on it.

Why was Div7a introduced by the ATO?

Business owners were drawing cash out of their business as a ‘loan’ (with no real intention of ever paying it back) and not paying tax in their own name.

There are three ways to take cash out of a business legitimately:

1. As a wage – subject to PAYGW.

1. As a dividend – subject to normal income tax above any franking credits.

1. As a ‘proper’ commercial loan – with interest repayments (on which the company will pay tax at 30%) and principle repayments.

Taking the cash as a non-commercial loan means the ATO misses out on all counts.

How does Div7a work?

The ATO recognise that business owners legitimately may have money passing in and out of their business, particularly if it is a small business. So the line in the sand is at year end.

If there is a debit loan (i.e. the company is owed money by a related party) in the accounts as at the end of the year, the business has three options:

1. Repay it before lodgement of the income tax return (which can be either cash physically paid back in, or a credit to the loan account as either wages or a dividend declared and not paid out).
2. Manage it as a commercial loan, subject to the Div7a provisions (which specify the life of the loan and interest rate).
3. Let the shareholder cop a deemed dividend for the amount of the loan.
   
   

What are some tricks and traps?

Company-to-company loans are not subject to Div7a (because the tax rates are the same so no disadvantage to the ATO).

Limited partnerships are taxed as companies – so also have the same exclusion.

Unpaid Present Entitlements (UPEs) from trusts are not subject to the Div7a provisions specifically, however if they are unpaid and create a debit balance owed by a company beneficiary, they are deemed to be financial accommodation under some other provisions and must be considered.

What are the ‘warning signs’?

Debit loan balances. Check them regardless of the entity type and if they are not caught by Div7a, make a note on your workpapers as to why not.

Credit loan balances. A credit loan balance means a debit loan balance somewhere else (the other side). Check them and be aware of the ‘look through’ provisions.

How does it relate to the work we do for our clients?

When preparing compliance work for our clients, we must be able to identify and suggest how the client can best deal with any loans subject to Div7a.

For more information

https://www.ato.gov.au/Business/Private-company-benefits---Division-7A-dividends/