23 October 2019
If you own a private company, a common area of tax legislation that impacts shareholders and their associates is Division 7A of the Income Tax Act.
A company is considered a separate legal entity. For this reason, the highest tax rate payable by a company is lower than the comparable highest tax rate payable by an individual (e.g. 30% versus 47%).
A common practice prior to the introduction of Division 7A in 1997 was for a company to earn income and pay tax at company rates (i.e. 30%). The shareholder of the company would then “borrow” the money from the company with little or no intention of paying the money back to the company.
This means the shareholder would enjoy the use of the funds earned by the company without paying the difference between the higher individual tax rate and the company tax rate.
Division 7A was introduced in 1997 to ensure ‘ that all advances, loans and other credits by private companies to shareholders, are treated as assessable dividends. In addition, debts owed by shareholders which are forgiven by private companies are treated as dividends.’ Explanatory Memorandum to Act No 47 of 1998
Division7A can treat 3 kinds of amounts as dividends paid by a private company:
• amounts paid by the company to a shareholder or shareholder’s associate
• amounts lent by the company to a shareholder or shareholder’s associate
• amounts of debts owed by a shareholder or shareholder’s associate to the company that the company forgive)
Avoiding Unintended Tax Consequences
There are strategies and approaches that shareholders can use to avoid having amounts treated as dividends from the private company.
For example a summary of loans not treated as dividends include:
- A pre-4 December 1997 loan
- A loan fully repaid in the same year
- A loan to a company (but not a company acting as a trustee)
- A loan made in the ‘ordinary course of business on commercial terms’
- A loan made for the purpose of enabling the acquisition of shares or rights under an employee share scheme
- A loan that is otherwise assessable
- A loan that meets the definition of an ‘excluded loan’
The provisions of Division 7A are extremely complicated. The Board of Tax is currently reviewing the provisions of Division 7A to see whether it should be amended.
Company shareholders and associates should be aware of Division 7A’s potential application and seek technical advice where appropriate.
Get in touch with the team at Shakespeare on 9321 2111 if you would like to discuss how this may apply to your individual circumstances.
General Disclaimer
Our firm provides the information on this website for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation.
Tax articles on this website are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose .
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