Division 7A in plain words: loans from your company

Division 7A is a tax rule that stops shareholders taking money out of a private company tax-free. If the company lends money to a shareholder or their associate, pays for something on their behalf, or forgives a debt they owe, the amount can be treated as an unfranked dividend and taxed in their hands – unless it is repaid or put under a complying loan agreement in time.

It catches many small business owners, usually because they treat the company bank account as their own.

Why the rule exists

A company pays tax at the company rate, which is often lower than the owner's personal rate. Without Division 7A, an owner could leave the profit in the company, "borrow" it, and never pay personal tax on it. Division 7A closes that gap: money that reaches you from the company without being salary or a properly declared dividend is treated as a dividend anyway.

What it catches

Division 7A applies to private companies and to their shareholders and the shareholders' associates – which includes relatives, partners, and trusts or other companies connected with them. The main triggers are:

• Loans – including money you take from the company account and record as owed back.
• Payments – the company paying your private expenses, or transferring property to you.
• Debts forgiven – the company writing off money you owe it.

Less obvious arrangements can be caught too, such as a company guaranteeing a loan made to you, or a trust distribution to a company beneficiary that is left unpaid. The amount treated as a dividend is limited to the company's distributable surplus – broadly, its available profits.

How to keep a loan out of Division 7A

A loan is not treated as a dividend if, before the company's lodgment day for the year the loan was made (the earlier of the due date or the actual lodgement date of the company's tax return), it is either repaid or put under a complying loan agreement. The ATO lists three requirements:

1. A written agreement, in place before the lodgment day. No prescribed form is required, but it must exist on paper in time.
2. A maximum term of 7 years, or 25 years if the loan is fully secured by a registered mortgage over real property worth at least 110% of the loan when it is made.
3. Interest at least at the benchmark rate, with a minimum yearly repayment made by 30 June each year after the year the loan was made.

If a minimum yearly repayment is missed or short, the shortfall is treated as a dividend in that year.

The benchmark interest rate

The ATO sets the benchmark rate for each income year from the Reserve Bank's standard variable owner-occupier housing loan rate published before the year begins. The ATO publishes the rate for the current income year on its Division 7A benchmark interest rate page. It is used both as the minimum interest rate and to work out each year's minimum repayment. The ATO's Division 7A calculator works out the figure for you.

What it means in practice

• Plan drawings before you take them. Decide whether money leaving the company is wages, a declared dividend or a documented loan.
• Keep a loan account. Every private payment from the company should be recorded, so the balance is known at 30 June.
• Act before the company return is lodged. Repaying, declaring a dividend or signing a loan agreement after the lodgment day is too late for that year.

Common questions

Can I just repay the loan before 30 June?

Repaying before the company's lodgment day keeps that amount out of Division 7A. Watch for repaying with money borrowed back from the company soon after – the ATO looks through that.

Does Division 7A apply to sole traders?

No. It applies to private companies. Sole traders and partnerships have no separate company to lend from.

Is my salary from the company caught?

No. Wages and declared dividends are taxed in their own right. Division 7A catches money that reaches you in other ways.

Is the benchmark rate the same every year?

No. The benchmark rate is reset for each income year, so the minimum repayment changes too.

How we can help

We review company loan accounts before the return is lodged, prepare complying loan agreements and work out the minimum yearly repayment. See tax planning and business structuring, send us a question or call (02) 9386 0500.