A common misconception that many individuals have is that their company’s funds are ‘their personal funds’ and can be drawn from the company as required.
Does this sound like you? You run a successful family-owned business through a private company. Over the years, your company has accumulated profits that could help fund personal investments or assist family members. Like many SME owners, you see no harm in accessing these profits informally. After all, it’s your business, right?
What you might not have heard of is Division 7A of the Income Tax Assessment Act 1936 (Cth).
Division 7A is one of Australia’s most feared anti-avoidance provisions – “you have a Division 7A problem” – are not words you want to hear your accountant say. The purpose of Division 7A is to stop private companies from distributing profits to shareholders (or their associates) tax-free, without declaring formal dividends. How does it work?
A bit of history…
Let’s start with the doctrine of the ‘corporate veil’, a concept first essayed in the landmark case of Salomon v A Salomon & Co Ltd [1897] AC 22. In that case we meet Mr. Salomon, a boot and shoe manufacturer, who operated his business through a company in which he was a majority shareholder. When the company became insolvent, creditors tried to hold him personally liable, arguing Mr Salomon was essentially ‘the company’. The House of Lords upheld the company’s separate legal personality, insulating Mr. Salomon from personal liability.
This ruling firmly established the ‘corporate veil’ which shields shareholders from liability for the company’s debts, except in cases of fraud or statutory exceptions. This is great for asset protection (as liability of a shareholder is limited to the extent of contributed capital) but complicates things from a tax perspective.
Two taxpayers…
We now have two entities with separate legal personalities – the company and the shareholder – that is, two taxpayers. The government will therefore tax both, the company on its profit and the shareholder on the dividends.
To prevent the evil of double taxation, the Australian tax system uses a mechanism known as the dividend imputation system which allows companies to ‘frank’ dividends with franking credits, representing the tax already paid by a company. A franking credit on a dividend reduces the tax paid by the shareholder by the amount of tax paid by the company.
However, many business owners are still subject to the ‘top-up’ tax, being the difference between the tax paid by the company and the shareholder’s marginal tax rate. If the company has issued a fully franked dividend, then the company has paid full tax, usually 25% for a small or medium sized business, or 30% for larger businesses. If the business owner is on the top marginal tax rate (45% + 2% Medicare levy), there is still an additional 22% tax to be paid (47% less 25%).
This clearly creates an incentive for business owners to access profits at the company level without issuing a dividend, hoping they will only pay tax at the company level and avoid the additional top-up tax at the shareholder level.
This is where Division 7A flexes its muscles – stepping in to treat the transfer of money into a shareholder’s personal account, the forgiveness of loans to shareholders, gifts to shareholders, or shareholder use of company assets, without the shareholder declaring wages, director’s fees or dividends, as unfranked dividends.
At the top marginal tax rate, this will result in a total tax ~62.9% payable by the shareholder on the company dividends. Other adverse consequences include:
- The ATO may charge penalties and interest where there has been a deemed dividend;
- Franking credits cannot attach to the deemed dividend; and
- Non-compliance triggers ATO attention. Regular breaches could lead to audits or legal action.
This is where strategic tax advice comes in – not to avoid Division 7A, but to navigate it legally.
If you want to read more about how to pay yourself from your company, you may find this article helpful. For tailored tax advice on your business, call us on 1300 654 590 or email us to speak to an experienced legal adviser.
What specifically do I have to worry about?
Broadly, the legislation is intended to capture three types of transactions, being payments, loans and forgiven debts. They are defined widely:
- Payments: The actual payment of cash, the transfer of property to the shareholder and the free use of a company asset (please note, the company is not allowed to buy your holiday home and just let you use it for free);
- Loans: Loans and other advances of money – even if you ultimately intend to repay the loan; and
- Forgiven debts: The company can’t just forgive a loan that is owed to it by a shareholder, nor can it ‘park the debt’, being the assignment of the debt to someone who is unlikely to ever call on it.
As you will appreciate, this covers a broad spectrum of transactions – essentially all attempts to access company resources, other than by means of a dividend.
What can I do about this?
If you find yourself with a Division 7A issue, you can avoid a deemed dividend if a payment or loan is put on strict ‘Division 7A compliant’ criteria before the company’s lodgement day (generally the due date for lodging the company’s tax return): either repay the loan before the company’s tax return lodgement date, or set up a complying loan agreement (see below);
If you’ve already breached the rules, voluntarily disclose the issue to the ATO —this may help the Commissioner use his discretion to minimise penalties or interest. And of course, keep records. Maintain clear documentation—loan agreements, repayments, interest calculations—to support your compliance.
A Complying Loan Agreement
The requirements for a complying loan agreement are:
- The loan must be in writing: The agreement must be executed before the lodgement day and clearly set out the loan terms. An informal agreement or verbal understanding is not sufficient.2
- The interest rate charged is at least equal to the Division 7A benchmark interest rate (set by the RBA — currently 8.77% at June 2025): This rate is published annually and interest rate charged under the loan must consistently reflect this updated rate.
- The maximum loan term is:
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- 7 years for unsecured loans; or
- 25 years if the loan is secured by a registered mortgage over real property that is worth at least 110% of the loan amount at inception.
You will need tax advice and legal assistance in entering and drawing up a complying Division 7A loan. As a form of distribution of money from a company, loans are only used in very specific situations.
How we can help
Get in touch with our team to review your business structure for Division 7A exposure. We can ensure your inter-entity arrangements are documented and compliant. If you want to read more about Division 7A, you may like this article.
The cost of doing nothing is high. The better approach is to act early, structure transactions properly, and stay in control of your tax position. If you are concerned that Division 7A issues may be lurking in your business structure, then call us on 1300 654 590 or email us to speak to an experienced legal adviser.
