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There are numerous financial benefits that come with being a company shareholder. Along with the value of the shares themselves,
shareholders can receive income from the business in the form of dividends and Division 7A loans. Though the former is widely understood,
the same can’t be said for the latter.
Put simply, a Division (Div) 7A loan is a loan made by a company to a shareholder or their associate. The Australian Tax Office (ATO) deems
the word ‘loan’ in this instance to include any advance of money, provision of credit, financial accommodation, or transaction equivalent
to a loan of money.
Div 7A loans operate in the same way as those issued by financial institutions - they offer borrowers an agreed-upon amount of money that
must eventually be repaid with interest.
Shareholders opt for Div 7A loans for the same reasons they pursue personal bank loans; to assist with cashflow, fund a new business venture, facilitate the expansion of business operations, acquire residential or commercial properties, or anything else.
A Div 7A loan may arise due to funds being used by a shareholder for personal use, not only business-related expenditure. For example, to cashflow personal drawings from a business that have not been managed through payroll due to working capital limitations. In certain circumstances trusts and bucket companies may find it beneficial to take advantage of the deferred payments offered by Div 7A loans.
Compliance refers to whether the loan meets the criteria outlined by the ATO in its definition of Div 7A loans.
To be compliant, the loan must be governed by a loan agreement, which demands interest be paid to the company at the ATO’s benchmark rate, a
maximum loan term of seven years (unless secured), and minimum principal repayments within a specified timeframe.
A loan that doesn’t meet the ATO’s Div 7A requirements can create significant issues for the borrower.
When the loan doesn’t fit within a suitable loan agreement, such a payment will be classified as an unfranked dividend. Unlike loans, these
contribute to the borrower’s assessable income for the year and are subject to taxation.
Depending on the amount borrowed, unfranked dividends may push the recipient into a higher income bracket, obliging them to sacrifice a
greater portion of their yearly earnings come ‘tax time’.
As mentioned above, Div 7A loans can be repaid across terms greater than seven years given certain conditions are met. In fact, it’s
possible to spread loan repayments over as much as 25 years with the right ‘security’.
Security refers to real property (ie. a residential or commercial property) that can be seized by the lender and sold if the borrower is
unable to pay the loan. It’s important to note that the value of the security offered in such a scenario must total at least 110% of the
loan amount.
Unfortunately, even though the legislation surrounding the Div 7a loan regime was introduced over 20 years ago, the numerous ATO audits
that have been undertaken in this area have revealed that countless shareholder loans still fail to correctly adhere to the Division 7A
requirements. The kea areas of focus and non-compliance for any company or shareholder pursuing these loans is generally as follows:
The definition of an ‘associate’ is intentionally broad in the legislation and it can include any trust from which a shareholder can benefit.
Offsetting of loan balances that span multiple years by consolidating their account balance against a single payment may trigger Division 7A concerns.
Many Division 7A dividends arise inadvertently when private expenses, accrued by a shareholder are paid using a company account. Be mindful of any such transactions.
This article just scratches the surface when it comes to Division 7A. There are innumerable factors to consider when issuing loans from
your company, and it’s important to first seek expert advice that considers your individual
circumstances.
The professionals at Sentrika can help you achieve optimal financial outcomes. Reach out to our friendly team to arrange
a no-obligation discussion about Division 7A.
We specialise in providing unrivalled self-managed super fund, accounting, and business advisory services for clients of all types.
Discover how you can achieve your financial goals with Sentrika - the leading Gold Coast accountants and business advisors.
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