Why ignorance of loan balances can lead to tax nightmares.

Do you own a private company? Have you received payments not accounted for as wages or salaries this financial year?

As 30 June approaches it is time to ensure your business affairs are in order. This includes ensuring you have Division 7A Loan Agreements in place, where necessary.

What is Division 7A?

Division 7A of the Income Tax Assessment Act 1936 (Cth) is intended to prevent private companies from making tax free distributions to shareholders or other related entities.

Division 7A treats the following amounts as deemed dividends in certain circumstances:

1. Amounts paid by the company to shareholders or other related entities,
2. Amounts lent by the company to shareholders or other related entities, and
3. Amounts of debts owed by shareholders or other related entities to the company.

When an amount is treated as a deemed dividend it is taxable as assessable income for that financial years in the hands of the applicable shareholder or related entity.

For Example

John is the shareholder of ABC Pty Limited. ABC Pty Limited had a great financial year. John withdraws $200,000.00 from the company to take his family on a holiday, buy a boat and make a large repayment towards his mortgage. This withdrawal is made without knowledge or regard for Division 7A. These payments are susceptible to being taxable income of John in that financial year. John already pays tax at the highest marginal tax rate. The net result of the withdrawal is that John would be liable for tax on the $200,000.00 which would amount to $63,547.00.

The Solution?

If ABC Pty Limited and John agree to convert the payment into a Loan Agreement satisfying the provisions of Division 7A, the relevant amount will not be treated as a deemed dividend.

To be a complying Division 7A Loan Agreement the Loan must be:

1. At an interest rate of not less than the “benchmark interest rate” prescribed by Division 7A (currently 5.45%), and

2. Repayable within seven (7) years, unless the loan is fully secured by a registered mortgage over real property and the market value of the property is at least 110% of the amount of the loan.

Contact us today if you or a related entity owe money to your company, and find out if you need a Division 7A Loan Agreements by 30 June.

Disclaimer

This is not exhaustive advice on the operation of Division 7A. You should obtain specific legal advice on any matters of interest arising from this article.

By Sam Roberts,
Managing Director, Accredited Specialist (Commercial Litigation)