A Division 7A loan refers to a loan arrangement between a company and its shareholder, where funds are transferred to the shareholder with the understanding that they will be repaid within a specified term, typically seven years. This method is considered one of the most tax-effective ways to handle funds transferred to shareholders, as it allows the company to manage the distribution of funds while ensuring compliance with tax regulations.
Why Do You Have a Division 7A Loan and What Are Your Options?
A Division 7A loan typically arises when:
- Funds are transferred from a company to a related party or shareholder, or
- A trust distributes funds to a company to take advantage of the company’s lower tax rate compared to the shareholder’s personal tax rate.
In both scenarios, a loan is created from the company to the related party (the recipient), often indicating high levels of profit or retained earnings within the company.
What Does a Division 7A Loan Actually Mean?
A Division 7A loan means, on paper, that a loan is owed to the company. While you may own or control the company, the loan is still considered a liability of the company, and it must be repaid in accordance with the terms of the Division 7A agreement. This repayment is usually structured as a loan to be repaid over a seven-year term, although it can extend to 25 years if the loan is secured.
How is the Loan Paid?
Typically, the Division 7A loan repayment is not made with cash but rather through the declaration of dividends equivalent to the required minimum repayment for each financial year. These loans are structured as seven-year principal and interest loans, with the interest rate set by the Australian Taxation Office (ATO). Your accountant will generally maintain an amortization schedule to calculate the required annual payment and interest.
If desired, you can “cash out” or unwind the Division 7A loan at any time, triggering a tax obligation to the ATO. However, the tax due will be no higher than the tax you would have paid if the loan funds had been treated as income in your name at the time the loan was made.
Opportunities to Reduce the Loan
During the term of the loan, there may be opportunities to reduce the outstanding balance, such as:
- Sale of the business
- Lower-income years that result in lower tax rates for shareholders
- Children turning 18, which allows them to be taxed as adults
- Acquisition of assets by related-party companies (which are not classified as Division 7A loans)
Checklist for Managing Division 7A Loans
To ensure compliance with Division 7A, consider the following steps:
- Maintain good documentation—ensure a complying loan agreement is in place before the company’s tax return lodgment date.
- Pay the minimum required dividends each financial year.
- Where possible, use the funds for income-generating purposes so that the interest is tax-deductible.
Are There Other Options?
There are alternative strategies to Division 7A loans, such as:
- Paying tax at individual tax rates for all funds taken from the trust or company. While this avoids the complexities of Division 7A, many business owners opt for the company’s lower tax rate over the higher individual tax rate.
- Repaying funds to the company before the lodgement of the annual tax return.
- Paying a dividend or bonus to clear the loan, which may create a tax obligation at the individual level.
Conclusion
While Division 7A loans are an effective tax minimization strategy, business owners must carefully consider their long-term tax planning. Proper documentation, regular repayments, and thoughtful use of company funds can help manage the loan and avoid tax issues. It is important to weigh these options against alternative strategies and remain vigilant about the tax obligations and potential risks involved in such arrangements.
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If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au or arrange a time for a meeting so we can discuss your requirements in more detail.
How can we help?
If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au or arrange a time for a meeting so we can discuss your requirements in more detail.
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Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.
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