As a Company Owner/Director it’s normal to borrow funds from your company, however the ATO monitors any payments made to shareholders / Directors to ensure the Division 7A Rule is correctly applied come tax time.
Div 7A is often referred to as an anti-avoidance measure designed to prevent private companies distributing tax free profits to shareholders or associates. Associates can be a relative of the shareholder, partner, spouse or child or a company controlled by the shareholder/associate.
Under Div 7A these payments are categorised as unfranked dividends and treated as assessable income unless they are able to be excluded.
Div 7A applies to loans, advances and credits made by companies to their shareholders / directors / associates such as:
- Payments made to Shareholders/Directors/Associates
- Transfer of property to a Director/Shareholder/Associate at a lower amount which would have been received had it been sold on the open market
- Loans from the company to a Director / Shareholder or Associate without a loan agreement
- Debts which have been forgiven, having been owed by a Director or Associate
At the end of the income year, loans and payments made by a private company to Directors / Shareholders / Associates are generally treated as dividends (provided there are sufficient funds as surplus in the company) but that’s not always the case.
Loans / Payments NOT treated as Dividends:
- Loans / Payments to a company (not a company acting as a trustee)
- Loans / Repayments of a genuine debt owed to a shareholder or associate
- Employee Payments made to a shareholders who are also employees
- Liquidators distributions
- Loans fully repaid in the same year
- Loans made in the ordinary course of business on commercial terms
- Loans made for purchasing shares under an employee share scheme
- Loans which are assessable or meet the definition of an “excluded loan”
Tips to avoid triggering a Div 7 A Rule:
- Don’t pay private expenses from company accounts
- Keep correct records explaining all company transactions such as payments to and receipts from associated shareholders, associates and trusts.
- Create written agreements with terms before making a loan to a shareholder/director/associate, and ensure it is treated as a complying loan. The loan agreement should include the date the agreement is made, the names of the parties, the term of the loan, the amount, date the loan is drawn down, repayment term and dates, interest payable. Ensure the interest charged is equal to or above indicator lending rates and ensure the loan does not exceed 7 years except when secured by a registered mortgage.
- Repay at least the minimum due each year – if not, the amount not repaid will be treated as a dividend.
If you need advice on how to manage your payments to Directors/Shareholders/Associated, please reach out to your trusted PJT advisor.