• Amounts that will not be treated as dividends

    Attention

    Warning:

    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

    End of attention

    The following transactions will not be treated as a dividend:

    • a repayment of a debt owed by a private company to a shareholder or associate, provided the payment is not more than would have been required to discharge the obligation if the company and shareholder or associate had been dealing with each other at arm's length
    • a payment or loan made to another company except where the payment or loan is made to the company in its capacity as trustee
    • a loan made in the ordinary course of a private company's business and on the usual terms for similar loans made to parties at arm's length
    • a payment or loan which forms part of the assessable income of the shareholder or associate by virtue of some other provision of the tax law
    • a loan made during the course of winding up a company where the loan is either repaid or offset by distributions by the end of the income year following the year in which the loan is made
    • a payment or loan which has been specifically excluded from the assessable income of the shareholder or associate by virtue of an exempting provision of the tax law
    • a loan made solely for the purpose of enabling the shareholder or associate to acquire shares or rights to shares under an employee share scheme to which Division 83A of the ITAA 1997 applies, and
    • the forgiveness or release of a debt of a shareholder or associate under the Bankruptcy Act 1966.

    Excluded loans

    A loan is not treated as a dividend in the year the loan is made if before the 'lodgment day':

    • the loan is put under a written agreement
    • the rate of interest payable on the loan equals or exceeds the bank variable housing loan interest rate last published by the Reserve Bank of Australia before the start of the income year in which the loan was made, and
    • the term of the loan does not exceed
      • 25 years if the loan is secured by a registered mortgage over real property and the market value of the property at the time the loan is made is at least 110% of the loan amount, or
      • seven years for all other loans.
       

    Before the 2004-05 income year, the relevant provisions required that the written agreement be in place before any amount was advanced to the shareholder or associate. However, Practice Statement Law Administration PS LA 2005/3 (GA) - Division 7A - extended timeframe for repayment of a loan or execution of a written loan agreement for the 2003/04 income year sets out an administrative concession for the 2003-04 year only, allowing the written agreement to be in place by the 'lodgment day'.

    All loans made during a year which are not treated as dividends at the end of the year and which have the same maximum term are, for tax purposes, amalgamated to form a single loan. Shareholders or their associates must make a minimum yearly repayment in respect of that amalgamated loan. The minimum repayment is calculated by using the formula set out in the legislation. An amount treated as a dividend will arise equal to the amount of the shortfall in the event of a failure to make the minimum yearly repayment.

    Example 15: Loan repayments

    A private company made an unsecured loan to a shareholder on 1 July 2008 of $110,000. Prior to the private company's lodgment day a repayment of $10,000 was made.

    The loan was made under a written agreement which specified that the rate of interest payable for all future years must equal or exceed the benchmark interest rate for the year. For 2009-10 the benchmark interest rate was 5.75% per annum.

    The term of the loan is five years. For the year ended 30 June 2009, as it met the criteria for minimum interest rate and maximum term, the loan is not treated as a dividend.

    If the amount of the loan not repaid at 30 June 2009 was $100,000, the minimum yearly repayment required for the 2009-10 income year is calculated as follows:

    Formula for the minimum yearly repayment

     

    Example 15 formula calculation showing minimum yearly repayment required for the 2009-10 income year

    *Minimum yearly repayment required for the 2009-10 income year

    If repayments made in the 2009-10 income year equal or exceed the minimum yearly repayment, no amount will be treated as a dividend for this year.

    Amounts treated as dividends cannot exceed distributable surplus

    The private company's distributable surplus is the maximum amount that can be treated as a dividend. The company that made the payment or loan or forgave the debt will have to determine how much of the payment or forgiven debt is to be treated as having come from their distributable surplus. The distributable surplus is worked out at the end of the company's income year using the following formula:

    Net assets

    -

    Non-commercial loans*

    -

    Paid-up share value

    -

    Repayments of non-commercial loans

    *Non-commercial loans are loans which have previously been treated as dividends.

    Prevention of double taxation

    As a general rule, if a subsequent dividend paid by the private company is used to offset an amount that has already been subject to tax as a result of being treated as a dividend, that amount will not be included as assessable income.

    Example 16: Prevention of double taxation

    Simone is a shareholder in a private company, Martley Pty Ltd. She borrowed, on a non-commercial basis, $500 from the company in September 2008. The loan was not repaid before the lodgment day of the company's 2008-09 income year. Simone included an amount of $500 as assessable income - as a dividend - on her 2009 tax return.

    In June 2010, after the company's 2008-09 lodgment day, Simone became entitled to receive an unfranked dividend of $1,100 from Martley Pty Ltd.

    However, Simone agreed that Martley Pty Ltd would offset $500 of her entitlement against the outstanding loan and pay the balance of $600 to her. Therefore, Simone is only required to include an amount of $600 in her assessable income for the 2009-10 year. This is because she had previously included the other $500 - the loan which had been treated as a dividend - on her 2009 tax return.

    Discretions

    Division 7A provides the Commissioner of Taxation with three discretions:

    • a general discretion to disregard an amount treated as a dividend or allow the dividend to be franked where the failure to comply with the rules has arisen because of an honest mistake or inadvertent omission. This discretion applies where a deemed dividend under Division 7A arises in 2001-02 or a later income year.
    • a discretion to disregard an amount treated as a dividend where the Commissioner is satisfied that the failure to pay the minimum yearly repayment on an amalgamated loan was due to circumstances beyond the control of the shareholder or the shareholder's associate and undue hardship will otherwise be suffered, and
    • for the 2006-07 income year and subsequent years, a discretion to disregard an amount treated as a dividend and extend the period to pay the minimum yearly repayment on an amalgamated loan where the failure to make the minimum yearly repayment was due to circumstances beyond the control of the shareholder or the shareholder's associate.

    Note: For income years up to and including the 2005-06 income year, the Commissioner of Taxation did not have the discretion to extend the period for making repayments of an amalgamated loan, and the outstanding amount of the loan (not the shortfall amount) was the amount taken to be the dividend.

    Attention

    Honest and inadvertent omission

    Law Administration Practice Statement PS LA 2007/20 Division 7A - Exercise of the Commissioner's discretion under section 109RB of Division 7A of Part III of the Income Tax Act 1936 to disregard a deemed dividend in respect of the 2001-02 to 2006-07 income years sets out a transitional arrangement which allowed taxpayers to get on a compliant footing by taking the necessary 'corrective action' on or before 30 June 2008.

    The transitional arrangement ended on 30 June 2008. A request for exercise of the discretion must now be made in writing to the Commissioner.

    For more information, see Division 7A essentials.

    End of attention
    Last modified: 29 Jun 2010QC 27989