From 1 July 2023 the benchmark interest rates for complying Division 7A loans has jumped from 4.77% to 8.27%. Taxpayers should be evaluating the impact of this hike now to ensure that effective tax management is in place prior to 30 June 2024.
Picture this: you’ve worked hard to turn your company into a profitable enterprise. After years of taking minimal wages to ensure you meet the bottom line, you finally have enough cash in the business’s bank account, and you would like to spend it. Perhaps you’re investing in your first home, or you need cash for some unexpected bills. Whatever the case – once money leaves the company’s bank account and enters your personal environment, Division 7A comes into play.
Outside of paying wages, the only way for business owners to access cash from a private company for personal use is via the company paying a dividend to its shareholders. When a company declares a dividend, it may have the opportunity to attach credits to the dividend (‘franked dividend’), which represents tax paid by the company on the company’s profits (generally at a tax rate of 25% or 30% depending on the size of the business). This tax credit is called a ‘franking credit’ and allows shareholders to claim a credit towards any tax payable from the dividend income received.
This therefore means that if a private company does not declare a dividend, but provides a shareholder (or their associate – broadly: spouse, relative, or entity that shareholder may control or benefit from) any of the following benefits:
the Australian Taxation Office (ATO) may step in and treat the value of benefit provided as a ‘deemed dividend’. In most cases, deemed dividends do not carry franking credits (unfranked dividends). This means the value of the benefit provided is treated as assessable income to the shareholder or associate, who will pay tax at marginal tax rates (up to 47%).
To avoid this cash – or the market value of the benefit provided – being treated as deemed dividend, a complying Division 7A loan must be created.
A complying Division 7A loan is:
The loan term depends on the security provided:
The minimum repayments for each loan term are subject to benchmark interest rates as determined by the ATO.
Division 7A loans are subject to strict repayment schedules. The ATO provides a Division 7A calculator and decision tool which assists in calculating the minimum repayment required each tax year to cover principal and interest.
Minimum repayment calculations fluctuate depending on the benchmark interest rate set by the ATO. With this rate increasing to 8.27% from 1 July 2023, taxpayers can expect these minimum repayments calculations to increase for the 2024 tax year.
Moreover, this interest calculated is assessable income to the company, with the interest paid only being deductible to the taxpayer to the extent that the loan borrowed was used for assessable income generating purposes.
The following options are available to meet minimum repayment requirements:
| Repayment option | Implications – company | Implications – shareholder |
| cash repayments to the company | N/A | – cashflow – repayments cannot be drawn out again otherwise they are not considered genuine repayments |
| declarations of dividends from the company to the shareholder, “paid” to the loan account (ie. “paid” = dividend payment due to the shareholder by the company would be ‘offset’ against the loan repayment owed by the shareholder to the company) | has the company paid income tax which can be used for franking credits on dividends paid? | dividend is assessable to the shareholder – taxpayer may be required to pay ‘top up tax’ where the taxpayer’s personal marginal tax rate is higher than the franking credits attached to the dividend (25% or 30%). |
| wages declared to the shareholder/associate and “paid” to the loan account (ie. “paid” = wage payment due to the shareholder/associated by the company would be ‘offset’ against the loan repayment owed by the shareholder/associate to the company) | company would need to consider the following: – PAYG tax withholding – Superannuation – Payroll tax – STP reporting obligations | wages are assessable to the shareholder/associate at the taxpayer’s personal marginal tax rate. |
Repayments must be paid prior to 30 June of the tax year to count towards the minimum repayment. A combination of the above options can be utilised to meet the minimum repayments, and each method has various implications and tax consequences dependent on your individual circumstances.
Failure to meet the minimum repayment required will result in the shortfall being treated as a deemed dividend. It is therefore imperative that as interest rates rise, taxpayers are aware of the implications for their tax group, and how much they are required to repay before 30 June 2024.
Division 7A is often seen as a confusing area for taxpayers. Exant Advisory is available to assist you in:
Through the implementation of effective tax planning and strategies, Exant Advisory can help you manage Division 7A loans and limit the effect of the ATO’s interest rate rises. Contact your usual Exant adviser or alternatively, one of our business advisory specialists on 07 3218 3900.