In FY2025 the ATO is cracking down on widespread mistakes regarding Division 7A of the Income Tax Assessment Act. Many business owners fail to adhere to basic principles, such as recognising that private companies are separate legal entities. This can lead to using company funds for personal expenses without considering the income tax consequences, resulting in significant compliance issues, such as Fringe Benefits Tax and assessable income from private company benefits.

To avoid these pitfalls, it's crucial to maintain proper record-keeping, ensure separate bank accounts for different entities, and have compliant loan agreements. Regularly reviewing your practices, including your minimum yearly repayments and following the benchmark interest rate for unsecured loans, can help avoid costly mistakes and penalties. For more information, visit our Division 7A Services Page.

Don't wait until it's too late.

Schedule a consultation with one of our tax experts today to ensure your compliance with Division 7A and avoid ATO scrutiny. We can help you navigate the complexities of income tax, loan repayments, and making tax-effective decisions for your business.

Common Division 7A mistakes business owners make

Division 7A of the Income Tax Assessment Act is designed to prevent private companies from making tax-free distributions of profits to shareholders or their associates. Despite its importance, many business owners make common mistakes that can lead to significant tax liabilities.

Here are some frequent errors and how to avoid them:

Non-compliance with loan agreements

Business owners often fail to ensure that loans from private companies to shareholders or their associates are under a complying Division 7A loan agreement. This means the loan must have a written agreement with a minimum interest rate at least equal to the Division 7A benchmark rate and a maximum term of 7 years (or 25 years if secured by a registered mortgage over real property). Failing to meet these requirements can result in the loan being treated as a deemed dividend, which is then included in assessable income.

Errors in minimum yearly repayments

It's common for mistakes to occur in making the minimum yearly repayment on 7A loans. If the borrower doesn't make the required repayments, this can trigger a deemed dividend (subject to the private company's distributable surplus) for the shortfall, leading to additional tax liabilities for the shareholder or their associate.

Misunderstanding use of private company assets

Many business owners don't realise the use of private company assets by shareholders or their associates can be treated as a payment for Division 7A purposes. If market rates aren't paid for the use of these assets, it can trigger a deemed dividend. This often occurs when private company benefits aren't correctly identified and accounted for, which can lead to unexpected tax outcomes.

Low compliance and awareness

We find that there's generally a low level of compliance with Division 7A rules among business owners. This includes making unsecured loans without proper loan agreements, failing to account for interest payable at the benchmark rate, and misunderstanding the implications of using company assets.

To avoid these common mistakes, business owners should ensure proper loan agreements are in place, make accurate yearly repayments, and understand the implications of using company assets. Regular reviews and consultations with tax professionals can also help in managing Division 7A compliance effectively.

How to avoid Division 7A mistakes and corrective action

Avoiding issues in the first place

Division 7A dividends can arise from not keeping private expenses separate from company expenses.

To avoid this you should consider the following:

Don't pay private expenses from a company account

Ensure all private expenses are paid from personal accounts to avoid complications with Division 7A.

Maintain proper records

Keep detailed records for your company that explain all transactions, including payments to and receipts from associated trusts, shareholders, and their associates. This is crucial for compliance with tax laws.

Use complying loan agreements

If you lend money to shareholders or their associates, make sure it's based on a written loan agreement with terms that qualify it as a complying Division 7A loan. This includes meeting the minimum interest rate and the maximum term, and securing the loan with a registered mortgage if needed. This will ensure the loan amount isn't treated as a Division 7A dividend.

By following these steps, you can avoid Division 7A issues and ensure your business stays compliant, preventing unexpected tax liabilities and maximising tax benefits for shareholders.

Effectively distributing retained profits

To distribute retained profits to shareholders under Division 7A, the best approach is to pay the amount as a dividend, including a franking credit if available. The shareholder should report this dividend as assessable income.

Repay or convert by lodgment day

To avoid Division 7A issues, any payment or benefit that might be subject to Division 7A needs to be repaid or turned into a complying loan by the company's lodgment day for that income year. The lodgment day is the day the company lodges its income tax return or the due date for lodging, whichever comes first. This means you can fix the issue after the income year ends but before you lodge your tax return. Make sure the repayment or conversion happens by the lodgment day to avoid having the amount treated as a Division 7A dividend.

Are you aware of ATO relief options?

The law provides the Commissioner with the ability to overlook a deemed Division 7A dividend or permit the dividend to be franked under specific conditions.

If you have made an error or if circumstances beyond your control have occurred, you can apply for relief to avoid the impacts of Division 7A on a payment or loan. This can help prevent the payment from being treated as an unfranked dividend, providing some flexibility in managing your tax obligations.

How to prevent deemed dividends on private company loans

The ATO highlights key requirements under Division 7A of the Income Tax Assessment Act for loans from private companies to shareholders or their associates to prevent them from being treated as deemed dividends for income tax purposes. A deemed dividend is considered by the ATO unfranked for tax purposes.

Here are the essential points:

Written agreement requirements

A minimum interest rate at least equal to the Division 7A benchmark rate.

A maximum loan term of 7 years, or up to 25 years if secured by a registered mortgage over real property.

Loan repayments

Complying Division 7A loan agreements typically prevent the loan amount from being treated as a deemed dividend. However, failing to make the minimum yearly repayment can trigger a deemed dividend for the shortfall in loan repayments.

Use of Private Company Assets

The use of private company assets by shareholders or their associates can be considered a payment under Division 7A. If market rates are not paid for the use of these assets, it can trigger a deemed dividend, impacting the company's distributable surplus and resulting in additional tax liabilities.

The ATO has identified that errors in making minimum repayments and not recognising the use of private company benefits can lead to unintended deemed dividends, impacting the assessable income of shareholders or their associates. Ensuring compliance with Division 7A can help maintain tax-effective strategies and prevent additional income tax liabilities.

For professional assistance and to ensure your Division 7A loan agreements are compliant, visit our Division 7A Loan Agreement Services page.

Next steps

Maintaining compliance with Division 7A is essential for avoiding ATO scrutiny and harsh tax outcomes. At Caubrooks, we offer expert guidance to help you navigate these complex regulations and ensure your business practices align with legal requirements. Contact us today to schedule a consultation and secure your compliance with Division 7A.

For detailed assistance with Division 7A, visit our Division 7A Services Page or contact our team to schedule a consultation. Let us help you make tax-effective decisions and avoid costly mistakes.