As a business owner you may have heard your accountant talking about Division 7A and wondered what all the fuss it about.
If you are operating your business through a company, you might expect that your hard earned efforts to be profitable would mean that the money is yours to access, right? This is somewhat true. The problem is that a company is a separate legal entity. As the owner of that company you have the ability to access the profits but only through the correct mechanism – i.e. by payment of dividends to shareholders or payment of wages to directors.
A common trap for company owners is to think that they can withdraw money from their company bank account ad-hoc for private use and not pay the money back. This is perfectly acceptable for sole traders or partnerships, but not for companies.
The Australian Taxation Office (ATO) has enforced Division 7A to prevent shareholders from doing exactly this. Why would this matter to the ATO? Because if shareholders are taking money from companies without declaring it in their own tax returns (as you would with dividends and wages), the shareholder is essentially receiving a tax-free distribution. This is different to a sole trader or partnership where the owner is paying personal tax on all the profits anyway, whether he or she draws those profits or not.
Should you withdraw money from your company for personal use and do not pay the full amount back by the lodgement date of that year’s tax return, you will trigger Division 7A. If this occurs, and no action is taken then any payments made from the company to shareholders will need to be declared as unfranked dividend to the shareholders (an outcome which ought to be avoided).
One option to avoid an unfranked dividend being declared is to enter into a complying Division 7A loan agreement between yourself and your company. This allows the money withdrawn to be treated as a loan for which you must pay future minimum repayments and interest. This is often a better outcome, especially when cash flow is an issue and you can’t immediately pay the money back.
• Always be mindful when taking money from a private company if it cannot be paid back before tax return lodgement date
• Make sure your Division 7A loan agreement complies with all the requirements of the law for it to be valid
• Speak to your accountant about ways repayments can be made if a Division 7A loan agreement has been entered into
Author: Allan Edmunds