Division 7A of the Income Tax Assessment Act 1936 aims to prevent the tax-free distribution of company profits to directors, shareholders and their associates, in the form of loans which are to remain outstanding or be forgiven. Division 7A requires most loans, advances, and other forms of credit to be counted as deemed dividends in the income year in which they are outstanding, unless minimum repayments are made under a valid loan agreement. Loans from private companies to family trusts also fall under Division 7A.

Deemed dividends force the borrower to accept a payment as a completely assessable unfranked dividend, which must be declared in the individual’s tax return. Dividends reduce the earnings retained by the company, and may waste franked credits, which can double taxation. Failure to declare dividends may constitute tax evasion.

Some loans will not fall under Division 7A provisions. For example, intercompany loans are excluded from Division 7A. To discern whether or not a particular payment is considered under Division 7A, ask yourself the following:

• Has the payment been made to an affiliated entity, other than a company?

• Has the payment been made due to the influence of the shareholder/recipient?

If the answer is yes to both questions the payment is probably subject to 7A provisions. Seek further professional advice if you are still unsure.

All companies wishing to avoid tax penalty under Division 7A are strongly advised to implement loan agreements before lending to associates. Where a loan agreement is in place between the company and affiliated entity deemed dividend provisions will not apply. The following conditions must also be met:

• A written, standardised loan agreement must be in place before company tax return is due or lodged (whichever comes first);

• Minimum repayment on loan must be made before aforementioned date;

• Loan term not exceeding 7 years for any unsecured loans, and 25 years for mortgage-secured loans;

• A minimum rate of interest must be charged.