You have a Div 7a loan, but you’re confused as to how, why, and what to do from here.
In this this article we attempt to demystify Div 7A loans and explain everything you need to know.
What is Div 7A?
Division 7A prevents private companies from making tax-free distributions of profits to shareholders or to their associates in the form of payments, loans, or debts that are forgiven.
What is a Div 7A Loan?
When funds are transferred to a shareholder, the most tax effective way in which you can deal with the funds is via a Div 7A loan. Essentially this is a loan between a shareholder and the company acknowledging the funds have been received and agreeing to a term in which those funds will be repaid (generally 7 years).
Why do you have a Div 7a loan and what are your options?
A Division 7a loan is most commonly the result of:
- Funds have left your company and transferred to a related party or shareholder, or
- Your trust has distributed to a company to take advantage of the lower company tax rate vs your personal tax rate.
As a consequence there is a loan from a company to a related party (the recipient).
They are usually an indicator of high levels of profit or retained earnings.
What does a Div 7a loan actually mean?
This means on paper (in the accounts) a loan is owed to the company.
Usually you will own or control the company, so although the loan is real, it is owed to a company that you ultimately own or control.
It does mean the loan must be repaid in accordance with the Div 7a loan term/agreement.
How is the loan paid?
The Div 7A loan terms are generally 7 years, although a secured loan can be 25 years.
The loan is usually paid by declaring a dividend equal to the required minimum repayment (each financial year) so there is no actual repayment of cash to the company.
The loans are 7 year principal and interest terms. The interest rate is the benchmark rate as set by the ATO. Your accountants will generally keep a schedule in an excel format to work out the annual required payment and the interest.
Remember you can cash out or unwind the Div 7a facility at any time. This will trigger tax payable to the ATO but the tax to pay will be no more than the tax you would have paid if the loan funds were received as income in your own name at the time the loan was made.
Div 7a loans are an effective tax minimisation/management strategy, however you do need to consider your long-term strategy. Be mindful that the amount owed from each year will require an additional loan.
Opportunities to reduce the loan
During the term of the loan there are often opportunities that arise to reduce the loan such as:
- Sale of business
- Lower income years that see lower tax rates for shareholders
- Children turn over 18 and are able to be taxed as adults
- Assets are able to be acquired by related party companies (which are not classed as Div 7a loan)
Check list of Div 7a - what you need to do
- Have good documentation – ensure complying loan agreements are in place before the lodgement date of the company
- Pay minimum dividends each financial year
- Use funds where possible for an income purpose (so the interest is tax deductible)
- Have your bucket company set up with a separate trust as the shareholder (see diagram below)
Are there other options?
There are alternative options to having Div 7a loans:
- Choose to pay tax each year at individual tax rates for all funds taken from the trust or company.
Given the options, most business owners choose to take advantage of the lower tax rate of the company than to pay tax on the income at their individual marginal rates. - Pay back into the company before lodging of the annual tax return.
- Pay a dividend or bonus to clear the loan – this will most likely create a tax obligation at the individual level.
Although they are a very popular tax minimisation and management strategy, we understand that Div 7A loans can be very confusing for business owners.
The aim of this article was to demystify Div 7A loans and provide some clarity around why you have one and what this means to you.
Should you require any further clarification or would like a discussion specific to your personal circumstances, our team of accountants is here to help. Please do not hesitate to contact us.
How can Walsh Accountants help?
Although they are a very popular tax minimisation and management strategy, we understand that Div 7A loans can be very confusing for business owners.
The aim of this article is to demystify Div 7A loans and provide some clarity around why you have one and what this means to you.
Should you require any further clarification or would like a discussion specific to your personal circumstances, our team of accountants is here to help. Please do not hesitate to contact us.
