Company Money Crackdown – Division 7A

The ATO is cracking down on business owners who take money or use company resources for themselves. 

It’s common for business owners to utilise company resources for their personal use. Business owners usually blur the line between company and their personal life. They also don’t consider the tax implications.  

Although tax laws prevent individuals from accessing company profits or assets tax-free, people still make mistakes, and the Australian Taxation Office (ATO) has had enough.

The ATO has launched a new education campaign. This is to raise awareness of these common problems and the serious tax consequences that can arise. 

What the tax law requires – Division 7A.

Division 7A is an area of the tax law aimed at situations where a private company provides benefits to shareholders or their associates in the form of a loan, payment or by forgiving a debt. It can also apply where a trust has allocated income to a private company but has not actually paid it, and the trust has provided a payment or benefit to the company’s shareholder or their associate. 

Division 7A aims to stop shareholders from accessing company profits or assets without paying the proper tax. If triggered, it treats the benefit as a deemed unfranked dividend, which the recipient must pay tax on at their marginal rate. You can avoid this unfavourable tax outcome by:

• Paying back the amount before the company tax return is due; or 
• Putting in place a complying loan agreement between the borrower and the company with minimum annual repayments at the benchmark interest rate. 

The problem areas.

Division 7A is not a new area of the tax law; it has been in place since 1997. Despite this, common problems are occurring. These include: 

• Incorrect accounting for the use of company assets by shareholders and their associates. Often, the amounts are not recognised; 
• Loans made without complying loan agreements; 
• Reborrowing from the private company to make repayments on Division 7A loans; 
• The wrong interest rate applied to Division 7A loans (there is a set rate that must be used). 

Like life, managing the tax consequences of benefits provided to shareholders and their associates can get messy quickly. Avoiding problems can often come down to a few simple steps: 

• Don’t pay private expenses from a company account; 
• Keep proper records for your company that record and explain all transactions. This includes payments to and receipts from associated trusts and shareholders and their associates; and 
• If the company lends money to shareholders or their associates, make sure it’s on the basis of a written agreement with terms. These terms should ensure it’s treated as a complying loan – so the full loan amount isn’t treated as an unfranked dividend. 

There are strict deadlines for managing Division 7A problems.

An example from the Administrate Appeals Tribunal

A case before the Administrate Appeals Tribunal (AAT) was a loss for a taxpayer who blurred the lines between his private expenses and those of his company.

The taxpayer was a shareholder and director of a private company that operated a business. Over a number of years, he made withdrawals and paid personal private expenses out of the company bank account, but the amounts were not recognised as assessable income.

Following an audit, the ATO assessed the withdrawals and payments as either:

• Ordinary income assessable to the taxpayer, or
• Deemed dividends under Division 7A.

The taxpayer tried to convince the AAT that the withdrawals were repayments of loans originally advanced by him to the company. Therefore should not be assessable as ordinary income. Alternatively, he argued that the payments were a loan to him and there was no deemed dividend under Division 7A. The company did not have any ‘distributable surplus’ (a technical concept which limits the deemed dividend under Division 7A).

The AAT found issues with the quality of the taxpayer’s evidence, concluding that he failed to prove that the ATO’s assessment was excessive. This was based on a number of factors, including:

• The taxpayer produced a number of different iterations of his financial affairs and tax return.
• He could not satisfactorily explain how he was able to fund the original loans to the company, especially given he had declared tax losses in multiple years around the time when the loans were made.

The taxpayer claimed he funded some of his loans to the company with money borrowed from his brother, but the AAT rejected this explanation as implausible, noting the brother’s tax return showed only modest income.

So, how should a company owner treat a contribution made to get a business up and running?

It really depends on the situation, but for small start-ups, the common avenues are:

• Structure the contribution you make as a loan to the company, or
• Arrange for the company to issue shares, with the amounts paid being treated as share capital.

In making a decision on which is the best approach, it is necessary to consider a range of factors, including:

• Commercial issues,
• The ease of withdrawing funds from the company later, and
• Regulatory requirements.

The way you put money into the company also impacts on the options that are available to subsequently withdraw funds from the company. However, you should remember that if you take funds out of a company then there will probably be some tax implications that need to be carefully managed.

To discuss the matter further, please contact your Aintree Group adviser.

This is general advice only and has not been prepared with your situation and needs in mind. For individual and personalised advice, we highly recommend that you seek out proper professional advice from your adviser.