Division 7A treats the following amounts as dividend deemed to be paid by a private companies:
- Amount paid by the company to a shareholder or shareholder's associate under section 109C of the ITAA 1936. Payments include transfer of property for less than the amount that would have been paid in an arm's-length dealing.
- Amounts lent by the company to a shareholder or shareholder's associates.
- Amounts of debt forgiven that were owed by a shareholder or shareholder's associate to the company.
If Division 7A applies, payments, loans and forgiven amounts taken to be dividends are included in the assessable income of the shareholder or an associate as an unfranked dividend (although the Commissioner can allow the dividend to be franked in special circumstances). The unfranked dividend is not subject to withholding tax if deemed to be paid to a non-resident.
Loans that are fully repaid by the earlier of lodgement or the due date for the lodgement of the company's income tax return in which the loan was made are not caught by these measures nor are loans that are put on commercial terms. A common question that is often asked is can the Division 7A payments be done by journal entries. The short answer is yes , however there are few tricks and traps that you need to be mindful.
It is pretty commonly accepted, particularly in common law, so in case law that a journal entry of itself will not constitute a payment or be sufficient evidence of a payment, when no other documentation exists. So, the journal entry is really telling the story of what has already happened. And the biggest problems with using journal repayments in this particular fashioned, if they are ever queried by the ATO, often the taxpayer do not have any documentation to demonstrate the actual transaction, which has occurred. And this could potentially trigger division 7A because they were not able to produce this additional documentation. And that concept of journal entries alone are not evidence of a payment came from a well-known case Temples Wholesale Flower Supplies Pty Ltd v FCT [1991] FCA 162.
What are the examples of documentations required to evidence the minimum yearly repayment is set-off against the Division 7A loan?
- Evidence the shareholder’s obligation to make a payment to the company (e.g. Division 7A loan agreement)
- Company resolution declaring the relevant dividend and appropriately dated as 30 June; This is where the company has the relevant obligation to pay the dividend to the relevant shareholder
- A Division 7A set-off agreement in place where the shareholder is trying to set-off one liability against the other by way of journal entries.
- An acknowledgment from the company accepting this request, and more.
Often it gets overlooked, if the company has a shareholder that has a Div7A issue and pay a dividend, the company will often be required to pay dividend to other shareholders that do not have a division 7A issue.
Disclaimer: The material and contents provided in this blog are general guide and informative in nature only. They are not intended to be seen as legal and tax advice. If expert assistance is required, you should seek your own advice for any legal, tax or investment issues raised in your affairs.