Division 7A is a tax provision designed to prevent private companies from providing tax-free loans, payments or benefits to their shareholders by treating these amounts as dividends. In essence, if money or assets leave a private company for personal use without following strict guidelines, the Australian Taxation Office (ATO) can treat that benefit as a dividend – and you could end up with an unexpected tax bill.

Here, we set the record straight about some common myths related to Division 7A:

Myth: All Business Structures Have the Same Tax Consequences

The Myth: Whether you operate as a sole trader, partnership, trust, or private company, the tax implications are identical.

The Reality: Each business structure comes with its own set of rules. For instance, if you run your business as a private company, you might be subject to Division 7A. That means if your company provides money or benefits to you or your close associates, special tax rules could apply.

Myth: I Can Use My Company’s Money as I Please

The Myth: As a company owner, you’re free to spend company funds however you like.

The Reality: Remember, your company is a separate legal entity. Its money isn’t automatically your money. When you take money out as a salary, director’s fee, or dividend, it’s counted as income. Also, if you take out loans or use company assets for personal reasons without following the correct process, Division 7A rules may kick in and cause additional tax liabilities.

Myth: Division 7A Only Affects Shareholders

The Myth: Division 7A matters only for shareholders.

The Reality: Division 7A covers not only shareholders but also their associates. “Associates” can include family members, such as spouses, children, or even companies and trusts that you control. So, if you’re a shareholder, be aware that the rules might also affect those close to you.

Myth: I Don’t Need to Keep Detailled Records

The Myth: It’s not a big deal if I don’t meticulously record every transaction like payments, loans, or benefits provided by my company.

The Reality: Good record-keeping isn’t just smart business practice – it’s a legal requirement. Keeping clear, up-to-date records helps ensure you correctly account for every payment, loan or benefits. This can help you avoid inadvertently breaching Division 7A rules and facing unintended tax consequences.

Myth: A Post-Year-End Journal Entry Can Offset My Loan Repayments

The Myth: I Can simply record a dividend in my books after the income year ends to offset my loan repayment obligations.

The Reality: For a dividend to legitimately offset your minimum yearly repayment on a loan, the dividend and repayment obligations must exist simultaneously. Both the company and you (as the borrower) must agree to the offset by the end of the income year (usually 30 June). A backdated journal entry without proper supporting documentation won’t meet these requirements.

Myth: Using Company Funds for Other Ventures Has No Tax Impact

The Myth: I can use my company’s money to invest in another business or income-earning activity without any tax consequences.

The Reality: Even if the funds are used for another business venture, Division 7A may still apply if your company provides a loan – directly or indirectly – to you or your associates. The tax implications are in place regardless of what the money is used for, so it’s important to be cautious.

Myth: Routing Payments Through Other Entities Avoids Division 7A

The Myth: I can avoid Division 7A by making payments or loans through another entity instead of directly from my private company.

The Reality: Not so fast! Even if you use an “interposed entity” (which could be another individual, company, partnership, or trust) to channel payments or loans, Division 7A may still apply if the ultimate benefit goes to you or someone close to you.

Myth: Trusts Are Exempt from Division 7A

The Myth: If my company makes payments or loans to a trust, Division 7A doesn’t come into play.

The Reality: Division 7A can apply to transactions involving trusts as well. This means that if your private company provides funds to a trust – or if trust entitlements involve private company beneficiaries – the rules may still affect you.

Myth: The Interest Rate for Loan Repayments Is Fixed

The Myth: The interest rate I use to calculate my minimum yearly repayment on a Division 7A loan stays the same every year.

The Reality: Each year, you must use the current benchmark interest rate to calculate your minimum repayment. Since the benchmark rate can change annually, your repayment calculations may need to be adjusted accordingly.

Myth: Temporary Repayments or Using Company Money Can Bypass Division 7A

The Myth: I can avoid Division 7A by making a temporary repayment before my company’s lodgement day, or by using company funds to make the repayment.

The Reality: This strategy won’t work if you end up reborrowing a similar or larger amount, or if the repayment is made using money that was itself borrowed from the company. In such cases, the ATO may not recognise the repayment as meeting your obligations under Division 7A.