Division 7A is one of the most complex areas of a very complicated tax law system. As a result, expert advice is required prior to considering any relevant transactions.
There can be risks for private companies where such companies make a payment, loan, or engage in debt forgiveness and in the case of a payment, loan, or debt forgiveness by a trust, where a private company is a presently entitled income beneficiary but has not been paid its entitlement. However, for ease of understanding, this article focuses on private company loans only.
In the case of a private company subject to exclusions and exceptions, Division 7A (as presently enacted) may operate to deem a private company to pay an assessable dividend under certain circumstances.
Most people would be aware of the serious tax consequences that may result when a private company lends money or otherwise provides financial accommodation to one of its shareholders or an associate of a shareholder. Such advances, extensions or credits are usually treated as an unfranked dividend except in a number of circumstances, as outlined under Division 7A of the Income Tax Assessment Act 1936 (Cth).
Like many areas of tax law, Division 7A is constantly changing. As a result, to increase your understanding of this complex topic, we will now dive a little deeper into the rules.
Division 7A aims to prevent tax avoidance by private companies and their associates—specifically those attempting to access company profits in another form besides dividends.
An ‘associate’ of an individual shareholder may include:
An ‘associate’ of a company shareholder may include:
Division 7A is triggered when:
While it’s legal for business owners to lend money to shareholders and associates, Division 7A rules classify these transactions as unfranked dividends unless:
These are appropriate ways to avoid a Division 7A dividend. It’s pretty straightforward to repay the amounts by the lodgement time of the company’s tax return—but how do you implement a loan agreement?
Firstly, it’s important to create a loan agreement before lending money to a shareholder or associate. You’ll also need to:
If a company makes a loan to enable a person (whether an employee, existing shareholder or any third party) to acquire shares in a company, then the Corporations Act 2001 (Cth) ‘financial assistance rules’ will need to be assessed and complied with.
These are found in Part 2J.3 of the Corporations Act 2001. Subject to some limited exceptions (such as shareholder approved employee share schemes), the company will need to assess whether the loan prejudices its ability to pay creditors and is in the best interests of the company and its existing shareholders.
CCASA and our legal providers BlueRock Partners can provide advice and guidance with any financial assistance or documentation related to private company loans. To avoid penalties it’s always advisable to strictly comply with these rules.
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