ATO identifies common mistakes with Division 7A (May 2024 Tax Update)

Relevant For:

Business owners dealing with private company loans, who need to ensure compliance with tax laws to avoid costly mistakes.

Key Points:

  • Division 7A treats loans from private companies to shareholders/associates as dividends unless conditions are met.
  • Loans must be repaid by the lodgement day or meet specific conditions to avoid dividend classification.
  • Complying loan terms include a written agreement, meeting the ATO’s benchmark interest rate (8.27% for 2023–24), and full repayment within 7 or 25 years.
  • Common errors include improper loan repayments, non-compliance with loan agreements, incorrect interest rates, and undocumented transactions.
  • The ATO may overlook Division 7A penalties for honest mistakes upon prompt correction.

Full Article:

Where a private company makes a loan to a shareholder/associate of the company during an income year, Division 7A will deem the loan to be an unfranked dividend paid to the shareholder/associate for that income year unless:

  • the loan is fully repaid before the company’s lodgement day for the income year in which the loan was made (‘lodgement day’ is the earlier of the due date for lodgement of the company’s tax return for the income year in which the loan was made and the date of lodgement of the company’s tax return for that income year); or
  • the loan is placed on complying loan terms.

‘Complying loan terms’ means that the loan must be:

  • made under a written agreement;
  • subject to interest charged at a rate that equals or exceeds the Division 7A benchmark interest rate (8.27% for the 2023–24 income year); and
  • fully repaid within seven years, or 25 years if secured by a mortgage over real property (conditions apply).

During the recent launch of a year-long education campaign, the ATO identified that tax agents continue to make the same mistakes with Division 7A including:

  • repaying a loan before year’s end and re-borrowing that amount shortly thereafter;
  • not entering into a complying loan agreement within the relevant time;
  • choosing an interest rate outside the ATO benchmark interest rate (currently 8.27% p.a.);
  • a private company making a loan to a trust ‘for investment purposes’ on non-complying terms; and
  • 30 June ‘repayments’ done solely by way of journal entry without other appropriate documentation.

The ATO has a discretion under section 109RB to disregard the operation of Division 7A, or allow a deemed dividend to be franked for an ‘honest mistake or inadvertent omission’. Therefore, it’s important to act quickly to rectify matters when an honest mistake has been made.

Fortunately for Munro’s clients, mistakes with Division 7A are seldom experienced, with it generally only occurring when a new client engages Munro’s to help resolve previous issues.

You can learn more about Division 7A here and also in the Division 7A Mess Up Series here.

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