Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates). In particular, advances, loans and other payments or credits to shareholders (or their associates) are, unless they come within specified exclusions, treated as assessable dividends to the extent that the private company has a distributable surplus.
The dividend is taken to be paid out of the private company's profits to the recipient as a shareholder in the private company. However, no dividend is taken to be paid for withholding tax purposes.
In Division 7A there are rules relating to payments and loans made through interposed entities and guarantees. There are also provisions dealing with the interaction with fringe benefits tax (FBT), imputation and the prevention of double taxation.
Division 7A also includes rules in Subdivision EA designed to ensure that a trustee cannot shelter trust income at the prevailing company tax rate by creating a present entitlement to an amount of net income in favour of a private company without paying it, and then distributing the underlying cash to a shareholder (or their associate) of the company.
The trust is treated as a notional company and the general Division 7A provisions are modified to determine the amount to be included in the assessable income of the shareholder (or their associate) as if it were a dividend. These rules are explained in the five fact sheets on trust amounts treated as dividends. However, Subdivision EA does not apply in all circumstances where there is an unpaid present entitlement.
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For the purposes of Division 7A, 'loan' has an extended meaning. In addition to including ordinary loans a 'loan' includes the provision of credit or any other form of financial accommodation and transactions that in substance effect a loan of money.
From 16 December 2009, if a private company beneficiary with an unpaid present entitlement provides financial accommodation to the trustee of a trust, or enters into a transaction with the trustee of a trust which in substance effects a Division 7A loan, it will be taken to make a loan to the trustee of the trust for Division 7A purposes.
The Australian Taxation Office (ATO) will not treat such an unpaid present entitlement as a present entitlement that remains unpaid for Subdivision EA purposes in situations where the trustee is a shareholder or an associate of a shareholder of the private company. As a result Subdivision EA does not apply to such an unpaid present entitlement. For more information refer to Taxation Ruling TR 2010/3.
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Division 7A has been amended on a number of occasions. The amendments which apply to payments made, loans made and debts forgiven on or after 1 July 2009 are highlighted in a table in this fact sheet. These latest amendments were made to tighten Division 7A to ensure that it operates as intended. Other earlier amendments are summarised in When does it apply?
Division 7A operates automatically and the Commissioner is not required to make a determination. However, the Commissioner can disregard the operation of Division 7A in certain circumstances.
Section 108 of the ITAA 1936 is the predecessor of Division 7A and unlike Division 7A it was not self-executing. Section 108 has been repealed and now only has potential application in the 2005-06 and earlier income years. For more information on the residual operation of section 108, refer to the fact sheet Division 7A - residual operation of section 108.
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In this fact sheet a reference to a shareholder or their associate is also a reference to:
- an entity that has been a shareholder
- an entity that has been an associate of a shareholder.
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For more on the application of Division 7A to arrangements involving payments, loans and debt forgiveness, visit Division 7A essentials.
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Last Modified: Thursday, 8 July 2010