Payments by private companies
A private company may be taken to pay a dividend to an entity at the end of the company's income year if it pays an amount to the entity during the year:
- when the entity is a shareholder or an associate of a shareholder of the company, or
- a reasonable person would conclude that the payment was made because the entity was a shareholder or an associate of a shareholder at some time.
The total of all dividends a private company is taken to pay under Division 7A is limited to its distributable surplus for that income year.
However, Division 7A does not apply to shareholder or associate payments in their capacity as employees. In such situations fringe benefits tax (FBT) may apply instead of Division 7A.
In this fact sheet, a reference to a shareholder or their associate also refers to:
- an entity that has been a shareholder
- an entity that has been an associate of a shareholder.
Division 7A also applies to certain payments made by trustees to a shareholder (or an associate of a shareholder) of a private company.
Division 7A also applies to certain payments and loans made by private companies to a shareholder or an associate of a shareholder through interposed entities.
Payments for Division 7A purposes
Watch this video to understand what a payment is for Division 7A purposes.
Payments by other entities
Closely-held corporate limited partnerships
In general, income tax law treats corporate limited partnerships as companies. For example, a reference to a share includes a reference to an interest in a corporate limited partnership. A reference to a shareholder includes a reference to a partner in a corporate limited partnership. As of 1 July 2009, Division 7A applies to a closely-held corporate limited partnership in the same way it applies to a private company.
Division 7A applies to certain payments made by trustees to a shareholder or an associate of a shareholder of a private company where the company is presently entitled to an amount from the net income of the trust estate and the whole of that amount has not been paid by a specified date.
However, the rules do not apply in all cases where there is an unpaid present entitlement.
Division 7A applies to certain payments made by private companies to a shareholder or their associate through interposed entities.
A payment is not treated as a dividend:
- if it is made to another company (and they are not acting in the capacity of trustee)
- if the payment would be included in the shareholder's or their associate's assessable income under a provision of the tax law (other than Division 7A)
- if the payment would be excluded from the shareholder's or their associate's income under a provision of the tax law
- if it is made to the shareholder or their associate in their capacity as an employee or an associate of an employee (fringe benefits tax may apply, see also: Division 7A and Fringe Benefits Tax)
- if it discharges a private company's obligation to pay money to the shareholder or their associate and the payment does not exceed the amount required to discharge the obligation if the shareholder or their associate and the company were dealing at arm's-length
- if it is a distribution made in the course of a liquidator winding-up a company
- if it was made on or after 23 June 2009 to a capital gains tax concession stakeholder under subsection 152-325(1) of the Income Tax Assessment Act 1997 (a retirement exemption payment)
- if it was for provision of asset payments (other than transfer of property), minor use of company assets, certain payments that would otherwise be allowable as once-only deductions and the use of certain residences.
Example 1 – payment on behalf of a shareholder
Cody is a shareholder of Barbarian Pty Ltd. Cody is neither an employee nor an associate of an employee of Barbarian Pty Ltd. Barbarian Pty Ltd pays Cody's gym membership fees. Barbarian Pty Ltd is taken to pay a dividend to Cody because the payment of the fees is made on behalf of a shareholder. The amount of the dividend is subject to Barbarian Pty Ltd's distributable surplus.
If Cody was an employee or an associate of an employee, Fringe benefits tax (FBT) would apply instead of Division 7A.
Example 2 – payment to shareholder's associate
On 1 February 2016, Tom Pty Ltd pays $3,000 towards an overseas trip for Mary. Mary is a daughter of Jerry, who is a shareholder of Tom Pty Ltd. Neither Jerry nor Mary is an employee or an associate of an employee of Tom Pty Ltd.
The payment is to a shareholder's associate. On 30 June 2015, Tom Pty Ltd is taken to pay a dividend of $3,000 to Mary, subject to Tom Pty Ltd's distributable surplus.
Example 3 – discharging an obligation
Helen, a shareholder of Riley Pty Ltd, lends the company $1,000. Riley Pty Ltd repays the loan by making a payment of $1,000 to Helen. The payment will not be treated as a dividend because the payment discharges an obligation of Riley Pty Ltd to pay money to Helen and the payment is not more than the arm's-length value of that obligation.
End of example
Transfer or rights to use property
The definition of 'payment' in Division 7A includes the transfer of property. Property includes land, buildings, vehicles, tools, equipment and shares.
A 'right to use' property can be a payment for Division 7A purposes where that right involves a transfer of property.
For example, a right to use property that is made by way of a lease of real property involves a transfer of property to the lessee and is considered a payment for Division 7A purposes.
Before 1 July 2009, the meaning of 'payment' did not include the use of assets under a licence or other right to use (other than the transfer of property). Such use of an asset was not subject to Division 7A.
Use of assets (other than a transfer of property)
From 1 July 2009, a payment includes:
- the provision of an asset for use by a shareholder or their associate (other than a transfer of property)
- when a company asset is available for use by a shareholder or their associate to the exclusion of the company. It does not matter when the right to use the asset is granted.
- a right to use assets under a licence or lease, but which does not involve a transfer of property.
Marriage or relationship breakdown
Transfers of property and other payments related to a marriage or relationship breakdown are caught by Division 7A. Even though they may be non-voluntary, a deemed dividend may arise.
Generally, payments that fall under Division 7A will be unfranked deemed dividends. For the 2007 and later income years, dividends arising from family law obligations may be frankable by the private company taken to pay the dividend.
Circumstances where deemed dividends may be franked include:
- a court order under the Family Law Act 1975 or a corresponding foreign law
- a maintenance agreement approved by a court under section 87 of the Act, or a corresponding agreement approved by a court under a corresponding foreign law
- a court order under state, territory or foreign law relating to de facto marriage breakdowns.
Example 4 – property transfer on marriage or relationship breakdown
Jack and Stephanie divorce. Stephanie owns and controls private company BCD Pty Ltd. The Family Court orders Stephanie to transfer the private company's motor vehicle to Jack as part of the property settlement.
The dividend may be franked irrespective of whether it was made to a shareholder or associate of the shareholder. The recipient is treated as a member of the private company.
End of example
Amount of the dividend
The amount of the dividend is the amount paid or credited to the shareholder or their associate by the private company, subject to the private company's distributable surplus.
Amounts treated as dividends under Division 7A are generally unfranked, even though they are taken to be paid out of the private company's profits.
If the payment is a transfer of property, the amount of the dividend is the amount that would have been paid for the transfer by parties dealing at arm's length, less any consideration given by the shareholder or their associate for the transfer. The amount of a payment is nil if the consideration given by the shareholder or their associate is equal to, or greater than, the amount that would have been paid for the transfer at arm's length.
'Dealing at arm's length' means that the parties to the transaction are dealing with each other in a manner as independent parties would normally do, so that the outcome of their dealing is a matter of real bargaining. An important element of an arm's length transaction is that the parties have acted severally and independently in forming their bargain so that there is no question of a conflict of interest.
Where a deemed dividend arises because of an honest mistake or inadvertent omission, the shareholder or their associate may request the exercise of the Commissioner's discretion to disregard the deemed dividend (subject to certain conditions) or allow the private company to frank the dividend.
Example 5 – property transfer with amount paid by shareholder
On 3 January 2015, Goldfinger Pty Ltd gives office furniture to Renee, a shareholder who is not an employee or an associate of an employee of the company. The arm's length market value of the furnishings on that date is $5,000. When the property was transferred, Renee paid Goldfinger Pty Ltd $100 for the transfer costs.
On 30 June 2015, Goldfinger Pty Ltd is taken to pay a dividend to Renee. The amount of the payment is equal to $5,000 for the furnishings, less $100 paid by Renee for the transfer. Goldfinger is taken to pay a dividend of $4,900 to Renee, subject to Goldfinger Pty Ltd's distributable surplus.
End of example
Converting payments to a loan
A payment that is converted to a loan before the private company's lodgment day is treated as a complying loan.
A private company's 'lodgment day' is the earlier of the due date for lodgment or the date of lodgment of the company's tax return for the income year in which the loan is made.
Example 6 – convert payment to a complying loan
In the 2015 income year, XYZ Pty Ltd pays the petrol expenses of a vehicle owned by a shareholder Sally. Sally is not an employee of the company and is under no express or implied obligation to repay the amount. Sally and XYZ Pty Ltd have until before the lodgment day of the company's 2015 income tax return to convert the payment into a loan and repay it, or enter into a written agreement that meets the maximum term and minimum interest rate criteria for a loan to be a complying loan,
XYZ Pty Ltd may need to undertake a journal entry in its accounting records to reflect the loan and reverse what may have been recorded as an expense in the financial statements for the 2015 income year. If these have been finalised, an adjustment to retained earnings may be required.
End of example
Payments by private companies to shareholders and shareholders' associates treated as dividends under Division 7A of Part III of the Income Tax Assessment Act 1936.