What is Division 7A? Part 1

If your accountant has ever mentioned Division 7A and you weren’t sure what it meant, you’re not alone. But understanding this part of the tax law is essential if you're involved with a private company.

Division 7A of the Income Tax Assessment Act 1936 stops private companies from making tax-free payments to shareholders or their associates by treating certain transactions as taxable dividends. This rule exists to prevent business owners from accessing company funds without paying the correct amount of tax.

Who and What Does It Apply To?

Division 7A applies when a private company:

• Pays money to a shareholder or their associate

• Lends money to a shareholder or their associate

• Forgives a debt owed by a shareholder or their associate

Unless the transaction meets specific exclusions or is properly structured (such as through a complying loan agreement), it may be treated by the ATO as a deemed dividend, even if the person receiving the funds isn’t technically a shareholder.

These rules apply to transactions that occur on or after 4 December 1997.

When Is the Deemed Dividend Taken to Be Paid?

The deemed dividend is taken to be paid at the end of the income year in which the payment, loan, or debt forgiveness occurs. It must be reported in the individual’s tax return and is taxed at their personal marginal tax rate.

And here’s the catch, these deemed dividends don’t come with any franking credits. That means there’s no tax offset to reduce the amount of tax you pay. You’ll be taxed on the full amount, just like ordinary income.

Why Division 7A Can Be Costly

The financial impact of falling under Division 7A can be severe. Many business owners are caught off guard when they use company funds for personal expenses or informal loans, only to later discover the ATO has deemed those amounts taxable.

Worse still, because there's no franking credit to help cover the tax, the full amount is added to your assessable income and taxed at your top rate.

That’s why pre-30 June tax planning is essential if you're accessing company funds. Without proper documentation or a complying loan agreement, you could be facing a major tax bill.

What’s Coming Next?

In Part 2 of this series, we’ll walk through the specific consequences of Division 7A, including real-world examples and how quickly costs can escalate if not handled correctly.

If you’ve borrowed funds from your company or used company money for private purposes, now is the time to take action. Speak to our team before 30 June so we can help you put the right structure in place and avoid unnecessary tax consequences.

Get professional advice before the ATO steps in.

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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.