As a company director, you may have considered lending money to a shareholder or forgiving a loan that you provided in the past. However, these transactions have the potential to trigger tax liability if they are not completed in accordance with the relevant tax legislation. In such circumstances, it is important to consider Division 7A of the Income tax Assessment Act 1936 (Cth).
What is Division 7A?
Division 7A is a provision that requires private companies to fulfil certain criteria when making transactions to avoid tax liability. It applies to all loans, advances and other credits made by private companies to shareholders or their associates. In this way, it aims to prevent private companies from distributing profit tax-free.
Some transactions where Division 7A may apply include:
- Amounts paid by the company to a current or former shareholder or shareholder’s associate.
- Amounts lent by the company to a shareholder or shareholder’s associate, which is not repaid in full by the date when the company lodges its tax return in respect of the financial year when the loan was made (Division 7A does not apply to loans fully repaid by the end of the year).
- Payments including transfers of property for less than the amount that would have been paid in an arm’s length dealing.
- Forgiven debts which were owed by a shareholder or shareholder’s associate to the company.
The requirements vary depending on the transaction type. For example, the criteria for a loan involves a minimum interest rate and maximum term.
Compliance with Division 7A
In usual circumstances, these payments loans and debts would be treated as assessable income of the recipient for tax purposes. However, this can be avoided through ensuring that you establish a written agreement that complies with Division 7A. In this case, the relevant loan amount will be treated as a loan by the company to the shareholder and not as assessable income for tax purposes.
Non-Compliance with Division 7A
If a company make a distribution that does not abide by Division 7A, it is considered non-compliant and triggers a penalty from the ATO. For example, if your company loans money to a shareholder or its associates without a compliant Division 7A agreement, the loaned amount will be included in the shareholder’s assessable income for the tax year.
Keystone Lawyers can assist with preparing Division 7A compliant agreements.