Running a business in the company structure – watch out for Division 7A application

Division 7A ITAA 1936 was introduced to prevent private companies from making tax-free distributions of profits to shareholders or their associates in the forms of payments, loans or debt forgiveness.

If Div7A applies, the amount or value of the payments, loans or debt forgiveness will be deemed dividends in the hands of the recipients.

A dividend will not arise if a complying loan agreement is entered into between the private company and the recipient.

Complying loan agreements 

• Loan agreement must be in writing, be in place by the lodgement date of the company tax return for the year the loan was made; loan term cannot exceed 7 years generally; interest rate must be at least as much as the benchmark rate. For 2024 income year, the benchmark rate has increased to 8.27%

Minimum loan repayment

• A minimum yearly repayment must be calculated and made made each year. If minimum loan repayment is not made in a subsequent year, the short fall will be deemed to be dividend for that year, capped at the company’s distributable profit for that year. The minimum yearly repayment is recalculated at the beginning of each year until the loan is repaid, based on the benchmark interest rate and the loan balance, as the formula provided by the tax law:

Use of company assets

• If you use the company assets for private purposes, the value of the benefit (what you will normally pay under commercial term) will be deemed dividend and taxed in your hand.

ATO key message: if you take money out of the company or use the company assets, there will be tax implications. There is no such thing as tax-free payment or benefit from a private company.

The ATO has started a specific awareness and education campaign focusing on Div7A. Once the campaign is completed, a lot of audits on the area are expected.