Money out of your company: Division 7A in plain terms
What happens when a director draws money from their own company, and what has to be done before the company return is lodged.
Written by Walch In Practice. General information, not advice for your circumstances.
Talk to usIf you take money out of your own company and it is not wages, a dividend or a repayment of something the company owes you, Division 7A is probably in play. The amount can be treated as an unfranked dividend in your hands unless it is repaid or documented as a loan before the company lodges its return. This is one of the most common surprises in an owner-managed group.
What Division 7A actually covers
Division 7A sits in the Income Tax Assessment Act 1936 and applies to payments, loans and forgiven debts from a private company to a shareholder or an associate of a shareholder. The rules and the current administrative guidance are set out by the ATO in its Division 7A guidance for private companies, and the provisions themselves sit in the Income Tax Assessment Act 1936, beginning at section 109D.
An associate is broader than most people expect. A spouse or a family trust can be caught, and so can a company credit card used for private spending, or a loan account that quietly drifts into debit over a year.
Another company is the exception rather than the rule. A payment or loan to a company is generally not treated as a dividend, unless that company is acting as trustee. That exception and its trustee limit are both in section 109K. An amount routed to a shareholder through an interposed entity can still be caught.
A family trust with a company beneficiary is the case owner-managed groups least expect. If the trust allocates income to the company, does not actually pay it across, and has also provided a payment or benefit to that company's shareholder or an associate, Division 7A can apply even though nothing has left the company.
The way out is the same as for any other Division 7A amount: repaid, or on a complying loan agreement, by the company's lodgment day.
The deadline that matters
The amount is assessed as a deemed dividend unless, before the earlier of the day the company lodges its return for the year and the day that return is due, one of two things has happened. Either the drawing has been repaid in full, or it has been put on a complying loan agreement.
That deadline is why this is a year-end conversation rather than a compliance-season one. Once the return is lodged, the options narrow considerably, and the amount that can be assessed is capped only by the company's distributable surplus, which section 109Y defines and caps.
What a complying loan agreement needs
A complying loan is a written agreement made before that deadline, carrying interest at no less than the benchmark rate the ATO publishes each year, with a maximum term of seven years where the loan is unsecured, as the ATO's Division 7A loan guidance sets out. A longer term is available where the loan is secured by a registered mortgage over real property that meets the test in the legislation.
From the year after the loan is made, a minimum yearly repayment is required. Miss one, and the shortfall itself can become a deemed dividend. The agreement is not a one-off piece of paperwork; it creates an obligation that has to be met every year until the loan is repaid.
What we do about it
Three things, in order. First, we look at the loan account before year end rather than after, because that is the only point at which every option is still open. Second, we work out whether repayment, a dividend, wages or a complying loan is the cheapest way through, which depends on your marginal rate and on what the company can afford to declare.
Third, we document it. The written agreement, the interest calculation and the repayment schedule all need to exist and to be findable next year, when the minimum repayment falls due again.
If your bookkeeping runs in Xero, the loan account is visible all year, which makes this a monthly check rather than an annual scramble. Our Xero bookkeeping and payroll work is often where the drift gets caught first.
Division 7A is rarely the reason a structure is wrong, but it is frequently the reason a good structure becomes expensive. If you are drawing on your company through the year, it is worth a conversation with us about business advisory and the way your group is set up, well before the return is due.
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