A Division 7A loan agreement is a special type of loan agreement. It covers certain payments or loans that are made or debts that are forgiven by a private company (also known as a proprietary (pty) limited company), which in the absence of a Division 7A loan agreement would be treated as assessable income of the recipient for tax purposes.
Division 7A of the Income Tax Assessment Act 1936 (Cth) prevents private companies from making tax free distributions to shareholders or their associates. Generally, it treats as unfranked dividends any amounts paid by a company to its shareholders or their associates, amounts lent by a company to its shareholders or their associates, and debts owed to a company by its shareholders or their associates that are forgiven. Such amounts would be assessable income of those shareholders or their associates.
Where a Division 7A loan agreement is in place between a private company and a shareholder or shareholder’s associate the terms of the loan agreement will negate the operation of Division 7A and the relevant amount will be treated as a loan by the company to the shareholder. This loan will be subject to interest and repayments must be made in accordance with the terms of the Division 7A loan agreement, which must comply with the provisions of Division 7A of the Income Tax Assessment Act 1936 (Cth).
Six essential points to understand about Division 7A loan agreements are set out below:
- Division 7A of the Income Tax Assessment Act 1936 (Cth) only applies to private (proprietary limited) companies, not public companies.
- Both payments and loans made, and debts forgiven, can be caught by Division 7A.
- Division 7A captures loans and debts involving a company and its shareholders or their associates (e.g. relatives, related companies).
- Where Division 7A applies, in the absence of a Division 7A loan agreement the recipient will have to pay tax upfront as the relevant amount of the loan or debt will be treated as assessable income of the recipient in the year in which it is received.
- A Division 7A loan agreement must comply with the provisions of Division 7A of the Income Tax Assessment Act 1936 (Cth). For example, it must provide for repayments of interest and principal at the interest rate determined by legislation.
- Division 7A generally applies to loans and payments made on or after 4 December 1997. However, if a loan or payment was made before that date and is subsequently varied or forgiven after that date then Division 7A may apply from the date of variation or forgiveness.
More information on Division 7A of the Income Tax Assessment Act 1936 (Cth) is available from the Australian Taxation Office (ATO). To find a lawyer, contact LegalVision on 1300 544 755.