You may have heard your accountant mention the words ‘division 7A’ to you. It is an area where people struggle to fully understand and can get themselves in a bad situation with a lot of tax, interest or loan repayments.
It is a law that prevents private companies from drawing additional funds that are not wages or declared as a dividend used for personal reasons by either the shareholders or associates of the private company.
A common example we come across all the time is the client is the sole shareholder in a private company. The client takes out additional funds on top of his wage (this could be for mortgage repayments, new personal car, school fees or holiday home). The private company and the client are two separate entities. These funds used for personal purposes are funds owned by the company, which is an asset of the company.
The first option to deal with this situation is to put the loan into a complying Division 7A agreement which will require the following terms:
- To be repaid over 7 years
- That minimum annual repayments be made each year; and
- That interest is payable a commercial rate prescribed by the ATO
The interest will be assessable income to the private company and taxed at company tax rates.
The second option is to pay tax on the funds withdrawn from the company at your personal marginal tax rate now. This can be done by paying a fully franked dividend or a bonus in wages.
The last option is to fully pay back the loan by the company tax returns due date or lodgement date relating to the year the loan was taken out.
If you would like to know anything further about Division 7A or any other taxation matters please call Melbourne Tax Advisory on 1300 942 230.