Consequences of Division 7A: Part 2
- Arnold Shields
- Apr 28, 2010
- 2 min read
Updated: Jun 20
What is Division 7A?
Division 7A of the Income Tax Assessment Act 1936 is a powerful anti-avoidance provision designed to prevent private companies from distributing profits to shareholders (or their associates) tax-free. Where amounts are paid, lent, or forgiven by the company, the ATO may treat those transactions as deemed dividends, even if no formal dividend is declared.
These deemed dividends are included in the individual’s assessable income and taxed at marginal rates, potentially resulting in significant unexpected tax liabilities.
What Triggers a Deemed Dividend?
Division 7A applies to three types of transactions involving shareholders or their associates:
Payments made by the company to a shareholder or associate
Loans advanced by the company to a shareholder or associate
Debt forgiveness where the company forgives an amount owed by the shareholder or associate
If any of these transactions are caught under Division 7A and not properly managed, the amount involved is treated as an unfranked dividend. This means the recipient cannot claim a franking credit and must pay tax on the full amount at their individual tax rate.
Importantly, Division 7A applies regardless of whether the recipient is currently a shareholder. It only matters that they are treated as such under the legislation.
The Impact: Why Division 7A Matters
The consequences can be severe. A shareholder who receives a loan or benefit from the company and doesn't meet Division 7A compliance (such as putting a loan agreement in place and making minimum yearly repayments) may find themselves facing thousands of dollars in additional tax.
These rules can particularly affect small business owners and family-run companies that treat company funds informally or fail to document transactions properly.
What You Can Do
Proper planning can help avoid Division 7A pitfalls. Here are a few key strategies:
Implement and maintain complying loan agreements
Ensure minimum yearly repayments are made on time
Avoid informal drawings or undocumented loans
Seek professional advice before forgiving debts or making payments to associates
What's Next?
In an upcoming blog, we'll outline key exclusions under Division 7A and share practical structuring strategies that can help reduce or eliminate the risk of deemed dividends.
Disclaimer:
The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.
