Company Shareholder Loans (Division 7A)

Division 7A Loan (Div7A) rules were put in place by the ATO to prevent shareholders (& associates) from using company funds (drawings) which have been taxed at the lower company tax rate when they should have been taxed at their higher personal tax rate

Base rate entity companies are taxed 25%
All other companies are taxed at 30%
Whereas Individuals are taxed at marginal rates (up to 47% including the 2% Medicare Levy)

If you borrow company funds and it is not paid back by the company's tax return lodgement date OR due date (whichever is earlier) then you must enter into a Div7A loan with the company to prevent the loan from becoming non-complying.

Complying loans must satisfy the following 3 criteria
1-Minimum interest rate
2-Maximum term
3-Written agreement

If a loan becomes non-complying then the balance owing will be a deemed unfranked dividend i.e. the dividend will be taxed in the shareholders tax return and they will not be able to claim a credit for the company tax which was previously paid on that income - they will effectively pay tax twice on the same income - first by the company and secondly by the shareholder.

Div7A loans can be paid back in 3 main ways:-

1-Physically paying the $ back to the company
2-Declaring a wage and not taking the $
3-Declaring a dividend and not taking the $

 

Option 1 - Paying the $ back

• You must pay the yearly minimum plus interest
• You can pay it all back at once if you prefer

 

Option 2 - Wages

• The net wage will be offset against your Div7A loan as a repayment
• Super guarantee (SG) is payable on the gross wage
• VIC work cover is payable on the gross wage + SG
• VIC payroll tax may be payable on the gross wage + SG

 

Option 3 - Dividend

• Preferred option provided company tax has been paid to the ATO by 30 June of the relevant year
• Declare a dividend
  • if tax has been paid on the company profits then the dividend will be franked
  • if tax has not been paid on the company profits the dividedn will be unfranked
• Instead of taking the dividend it will be offset against your Div7A loan as a repayment
• Dividends will be paid to the shareholders in accordance with their shareholding
• If the company profits have already been taxed at 25% - you get this back when you are paid a dividend also know as imputation credits – you only need to pay the difference – we call this ‘top up tax’ - see example 1

Example 1

Company Tax / Accounts

Company profit $100,000
Less 25% tax ($25,000) - this has been paid to the ATO
After tax profits = $75,000 (also known as retained profits)

The bank balance will also be $75,000

When paying a dividend of $75,000 the retained earnings will be reduced to nil and so will the bank balance

If the shareholder had previously taken the $75,000 the bank balance will be nil and there will be a $75,000 Div7A loan owing from the shareholder - by not taking the $75,000 dividend this will offset against the Div7A loan reducing it to nil

Individual Tax Return

You receive a dividend of $75,000
Add imputation credit $25,000
Grossed-up dividend $100,000
Tax thereon at say 30% + 2% medicare levy = $32,000
Less imputation credit $25,000
Equals top up tax payable $7,000

Benefits of Div7A Loans

• Allows you to take the money now and defer tax to a later date - if you are currently paying the highest marginal rate and are expected to pay a lower rate later in the future then this could be a beneficial strategy

Costs of Div7A Loans

• Interest is payable - refer to the ATO website for current rates
• IMPORTANT- If you do not strictly follow the rules the WHOLE Div7A loan will be deemed an unfranked dividend - you will NOT get the company 25% tax credit back
• If you earn $400k (lucky you!) every year then keeping your income low in year 1 and creating a Div7A loan may cost you additional tax in the long run
• Dividends cash push your Div.293 income over the $250k threshold in which case you'll have to pay an extra 15% tax on any concessional super contributions made during that year

Notes

• This is not a recommended strategy to reduce your individual income for Child Support purposes as Services Australia has the power to review your company financials and deem your income
• If you use company funds for private purposes the payments will need to be reallocated from the profit & loss to your Div7A loan
• If your spouse uses a company car for private purposes we will need to enter an adjustment against your Div7A loan for their private use
  • Option 1 = log book method (see Log Book)
    • business use % x actual expenses & depreciation & deemed interest
    • Must keep a seperate record of car expenses
    • The FBT year runs from 01/04 - 31/03
  • Option 2 = statutory method
    • 20% x cost of the car
    • the car cost is reduced by 1/3 after year 4
    • see example 2

Example 2

Company car used solely by the spouse - purchased for $50,000 + GST
Lets assuming statutory method is used
Private use adjustment = 20% x $50,000 = $10,000 + GST
$10,000 is added to the company's income
$1,000 GST is payable to the ATO
$11,000 is added to the shareholder loan - this will need to be paid back to the company

Plan ahead - refer to our Company Tax Planning acticle