Division 7A (of Part III) of the 1936 Tax Act aims to stop shareholders and their associates taking money or benefits out of companies tax free. The rules can impact at times when clients do not expect them to, such as in relation to company guarantees and loans from trusts.
Division 7A can also apply in situations like transferring a family farm owned by a family company to a child in the next generation unless care is taken.
What is Division 7A?
Division 7A of Part III of the Income Tax Assessment Act 1936 was introduced in 1998 in an attempt to prevent people taking money out of companies in a tax free way.
Division 7A, generally, makes:
- payments by;
- transfers of property from;
- loans from; and
- guarantees by
Companies to shareholders or their associates taxable dividends in the hands of the shareholder or associate receiving the benefit.
Extreme caution needs to be taken when companies are allowing shareholders or their associates to use company property or when loans are made from companies to shareholders or their associates.
Division 7A does not stop companies making loans to their shareholders and associates. As long as an appropriate loan agreement is put in place the loan will not be treated as a dividend. The loan agreement must require:
- interest to be paid at the benchmark interest rate;
- require minimum principal repayments; and
- have a maximum term of 7 years if unsecured and 25 years if secured.
One often overlooked area of Division 7A is guarantees by companies to support borrowings by their shareholders or associates. If a company guarantees a loan from a bank to a shareholder or an associate of a shareholder the amount of the loan will be considered a dividend by the company to the shareholder or associate of the shareholder unless the company has an effectively non-contingent obligation to repay the loan.
That is, if the guarantee document does not state that the borrower, being the shareholder or their associate, must default before the company is liable then the amount of the loan will be a dividend.