Does my company have a Div 7A problem?

What is Division 7A?

The ATO has defined the application of Division 7A as “payments or other benefits provided by a private company to shareholders or associates of the shareholders.” 

The following conditions are where Div 7A can be applied: 

1. 1. Loans borrowed by shareholders or their associates that are not repaid in full by the lodgement of the Company Tax Return; 
2. 2. Payments made by the company to its shareholders or their associates; and 
3. 3. Forgiven debts owed by a shareholder or their associate to the company 

Why do you need to be wary of it?

Division 7A is continuously monitored by the ATO. During ATO audits, adjustments are made because of the incorrect application of Div 7A. 

Here are some things to note regarding Div 7A which have led to common mistakes in regards to dealing with Div 7A: 

1. 1. A loan under a trust may be subject to Div 7A since it can be considered an “associate” of the shareholder. 
2. 2. A loan repayment using new loans is not counted as a repayment to the company, which will likely lead to an unfranked dividend rising. 
3. 3. It is important to record the correct borrower or payee in the financial statements of the company so that when an ATO audit occurs, they can properly determine who will be taxable on any imposed unfranked dividends. 

Common scenario:

Samantha took a $15,000 loan from ABC Pty Ltd at the beginning of the financial year. She then borrowed another $15,000 from ABC Pty Ltd two weeks before the lodgement of the CTR. After which, she repaid the first borrowed amount of $15,000 just in time before the lodgement of ABC Pty Ltd’s Company Tax Return. 

Under Div 7A Section 109D, the repayment of $15,000 for the original loan is not treated as a repayment and will then be an unfranked dividend subject to the distributable surplus of the company. This happened because it can be reasonably concluded that the second loan of $15,000 was borrowed to repay the original loan amount. 

How to solve Div 7A problems right away?

1. 1. Loan repayment: repaying the loan by May, which is before the Company Tax Return is lodged, so that it will not be an unfranked dividend as of June of the previous year. Using the salary and wages or dividends to pay out the loan is recommended.  
2. 2. Commercialising the loan: commercialising the Div 7A loan with a maximum period of 7 years, documenting it as per s109N ITAA36, and at least charging the benchmark interest rate can make the Div 7A loan not be treated as an unfranked dividend. 
   Through this method, the shortfall of a minimum repayment will be the only thing treated as a Div 7A dividend, not the entire loan. 
3. 3. Allocate to a shareholder with a low tax rate: Make the loan go to a shareholder with no or low income to take advantage of the low tax bracket of that shareholder. 
4. 4. Treat the shareholder or associate as a normal customer: The loan cannot be an unfranked dividend if it is made on a normal business operation and has the same terms as that of a normal customer. 
5. 5. Make the loan transaction to be between two companies in which the borrower is not acting as a trustee: Div 7A dividend is not triggered if the loan is between one company and another. 

Consult with us now for a personalised advice suited to you and your business and avoid being caught by the Div 7A regulations!