Division 7A of the Income Tax Assessment Act 1936 prevents private companies from distributing pre-tax profits to shareholders or their associates free of tax by dressing the distribution as a loan, payment, or debt forgiveness. Where the rules are triggered, the amount is treated as an unfranked deemed dividend, taxable in the recipient's hands.
Complying loan agreements
Loans can avoid deemed-dividend treatment if they are placed on a complying loan agreement before lodgement of the company's tax return for the year the loan was made. A complying loan must charge at least the ATO's Division 7A benchmark interest rate and be repaid within a maximum term: 7 years for an unsecured loan, 25 years for a loan secured by a registered mortgage over real property.
Minimum yearly repayments
Each year the loan is outstanding, a minimum yearly repayment (MYR) must be made. The ATO publishes a benchmark interest rate each April that applies for the full year. If the MYR is not paid by the lodgement date of the private company's return for the year, the shortfall becomes a deemed dividend in that year.
Common scenario
A company lends $50,000 to its sole director-shareholder on 30 June. The accountant puts a complying 7-year unsecured loan agreement in place before the company's tax return is lodged. Each year, the director must pay at least the ATO's benchmark interest rate on the outstanding balance plus a minimum principal component. At year 7, the full amount must be repaid.
Division 7A is a frequent source of year-end adjustments for accountants; most firms maintain a Division 7A loan register per client and a benchmark interest rate workbook to calculate minimum repayments.