Division 7A: even the name sounds intimidating!
As the owner or shareholder of a private company, it’s relatively normal (and completely legal) to receive or borrow money from your own business – assuming you do it properly, that is.
Borrowing money from your own business comes with several unique accounting requirements. If these requirements aren’t followed, you may land yourself in hot water with the ATO.
Why does Division 7A exist?
Division 7A was written into the tax code as part of a crackdown on avoidance measures many owners and shareholders would use to enjoy the profits from their businesses completely tax-free.
In short, it’s a system put in place to ensure that certain payments to shareholders are treated as dividends, and thereby ensure it receives proper tax treatment.
Under Division 7A, certain loans, advances and other credits made by a business towards shareholders and their associates are categorised as unfranked dividends (dividend payments that haven’t had company tax applied to them yet).
As such, they are treated as assessable income on your tax return and subjected to a 5.2% tax rate. This is the interest rate charged on the loan, not the tax rate. The interest is assessable as income to the business.
Who does Division 7A apply to?
Division 7A applies to a wide range of parties. In addition to the owners and shareholders of a business, it also applies to “associates” of private companies.
“Associates” includes anybody who has a relationship to an owners or shareholder, which may include:
- Business partners
- Spouses or children
- Other businesses under the same ownership
- Management staff
- Businesses with an ownership stake
What counts as a Division 7A loan?
For the purposes of Division 7A, the word “loan” takes on a broader meaning – in addition to lending out money, it also includes transactions such as:
- Advance payments
- Provision of credit
- Private use of company assets
- Payments made on your behalf (with the expectation of future repayment)
- Debt write-offs
What triggers Division 7A? And more importantly, what doesn’t?
So now you know what Division 7A is – the next question is whether or not you’ll have to account for it when making payments at your business.
Under Division 7A, the majority of transactions made to shareholders and associates may be taxed by the ATO.
For example, say a business owner withdraws $10,000 from the company bank account to pay for a private purchase – under Division 7A, this would add $10,000 taxable income to the owner’s tax return, to be paid at the benchmark rate.
To find out whether or not your payments are considered loans under Division 7A, the ATO has created a dedicated online calculator to help you determine your liability.
Does your loan fall under Division 7A? If your loan satisfies certain conditions, you may not be required to pay additional tax…
Division 7A complying loans
If certain conditions are met, payments and loans may be excluded from being a Division 7A dividend:
- A written loan agreement must be in place before the company’s lodgement day for the year the loan was paid
- Loan interest must equal or exceed the Division 7A rate (5.2% as of 2019)
- Terms must not exceed 25 years for loans secured by mortgage, or 7 years for other loans
Additionally, the terms should be written out in a way that clearly identifies both the lender and borrower, as well as all the essential dates and conditions.
Loans that are already treated as part of assessable income
Certain types of loans taken from a business will fall under other areas of the tax code.
Since they’re already covered, these payments won’t be covered, as to do so would result in you being taxed twice for the samy payment.
Repay the loan before lodgement day
Finally, any loans that are paid off before EOFY are automatically exempted from Division 7A.
Confused? A Melbourne tax accountant can help
While the ATO has taken steps to make things easier, business tax accounting is still a confusing mess. Division 7A is simply one example of the many, many rules you’ll have to remember when tax time comes around.
We don’t blame you if that’s too much to keep track of on your own – that’s why your Melbourne tax accountant is here!
At Bruce Edmunds & Associates, our specialty is helping business owners get their time and financial freedom back.
We do this by taking the slog of business tax accounting off your hands.
Our team of Melbourne tax accountants specialise in all areas of business accounting. When you’re with us, you can be confident that your taxes are in order – that includes the most obscure parts of the tax code.