How is dividend taxed in Australia?
Many business owners are very confused about Division 7A. I mean, yes, it is evil. And ends up with unpleasant surprises. Forget that yacht. Buy this donut instead. Because you are left with pocket change once Div 7A has had a go at your backpocket? True enough. Enough to turn your accountant into your punching bag. How does that drama all start? Let’s start with something you are familiar with.
One of the most prevalent methods for a private company to distribute surplus profits is through the declaration of dividends. Which involves distributing profits to company shareholders in proportion to their respective shareholdings. In this scenario, each shareholder is subject to taxation on the dividends they receive, with the possibility of offsetting the tax liability with any available franking credits.
Division 7A, the infamous.
Division 7A of the Income Tax Assessment Act 1936 (Cth) is designed to prevent private companies from providing additional benefits to shareholders without those shareholders incurring tax obligations on those benefits. Broadly speaking, Division 7A deems such benefits as dividends unless specific exemptions apply. This article will delve into dividends, Division 7A arrangements, and Division 7A loan agreements.
What Constitutes a Dividend and How is it Subject to Taxation?
A dividend represents the distribution of a company’s profits to its shareholders. It’s important to note that a company is not obligated to distribute dividends to its shareholders. In fact, many companies opt to retain surplus profits for reinvestment in their operations. Significantly, a company’s board of directors cannot decide to declare a dividend unless they are convinced that:
- The company’s assets surpass its liabilities immediately before the dividend declaration, and this surplus is sufficient to cover the dividend.
- The payment of the dividend is equitable and reasonable for the company’s shareholders as a whole.
- The payment of the dividend does not substantially harm the company’s ability to meet its obligations to creditors.
When a shareholder receives a dividend, they are required to include the dividend amount in their taxable income for the fiscal year in which the dividend was paid and pay taxes on it at their applicable marginal tax rate. In cases where the company has already paid taxes on the profits distributed to shareholders, it has the option to attach franking credits to the dividend. This enables the shareholder to offset their tax liability for those profits by the amount of tax the company has previously paid. These franking credits are designed to prevent the double taxation of the same income.
What Is Division 7A?
Division 7A serves as an anti-avoidance provision. It treats payments or other advantages provided by a private company to a shareholder (or a shareholder’s associate) as if they were dividends. Consequently, shareholders become liable for taxes on these deemed dividends. Division 7A is intended to address situations where a private company distributes company profits in arrangements that would typically not result in a tax obligation for the shareholder.
The definition of an “associate” is quite expansive and encompasses any relative or partner of the shareholder.
Which Benefits Does Division 7A Cover?
The following table offers a summary of circumstances in which Division 7A may come into play to classify a benefit supplied by a private company as a dividend:
When Does Division 7A Apply and What Is the Deemed Dividend Amount?
Division 7A may apply in various situations, as outlined below, with corresponding deemed dividend amounts:
- **Payments to Shareholders or Their Associates:**
– If the company makes a payment to a shareholder or a shareholder’s associate within a financial year.
– The term “payment” encompasses a broad definition, including the transfer or provision of assets.
– It applies when the payment was made to the shareholder, their associate, or when it is reasonably concluded that the payment was made because the recipient had been a shareholder or an associate at some point.
– The deemed dividend amount equals the payment’s value. In cases involving property transfers, it’s the fair market value of the property minus any payment made in return for the property.
- **Loans to Shareholders or Their Associates:**
– When the company extends a loan to a shareholder or their associate during the financial year.
– The loan has not been fully repaid before the company’s income tax return deadline for that fiscal year.
– The deemed dividend amount corresponds to the outstanding loan balance at the end of the financial year.
- **Forgiven Debts Owed to the Company by Shareholders or Their Associates:**
– If the company forgives all or part of a debt owed to it during the year.
– The deemed dividend amount equals the forgiven debt amount.
It’s important to note that this list is not exhaustive.
In all those cases, the actual dividend amount is contingent on whether the cumulative deemed dividends under Division 7A within a financial year surpass the company’s “distributable surplus” for that same year. Yes – you mostly have to have a surplus. If the deemed dividends exceed the distributable surplus, the dividend amount is proportionally reduced.
Crucially, it’s worth noting that a deemed Division 7A dividend cannot be franked. Therefore, a shareholder who receives a deemed Division 7A dividend cannot benefit from any tax the company has previously paid on that amount.
When Does a Loan Fall Under Division 7A as a Dividend?
Within the framework of Division 7A, the term “loan” holds a broad definition. For Division 7A purposes, a loan encompasses:
- An advance of money.
- The provision of credit or any other form of financial assistance.
- A payment made on behalf of an entity, at the entity’s request, with an obligation for repayment.
- A transaction, regardless of its form or terms, that essentially involves lending money.
Consequently, if a private company engages in any of the above arrangements with one of its shareholders or an associate of that shareholder, it is likely to trigger the provisions of Division 7A. Any outstanding amounts by the end of the financial year are regarded as deemed dividends and subject to taxation in the hands of the shareholder.
It’s important to note that certain payments are excluded when calculating how much of a loan has been repaid in a financial year.
Under What Circumstances Is a Loan Not a Dividend According to Division 7A?
When a private company intends to provide a loan to one of its shareholders for legitimate commercial purposes (and not as part of a tax avoidance scheme), the parties should enter into a Division 7A loan agreement. If this agreement is established before the company’s lodgment day for the relevant financial year, the loan is exempted from being classified as a dividend and is not taxed in the hands of the shareholder.
To qualify as a compliant Division 7A loan agreement, the following conditions must be met:
- The loan agreement must be documented in writing.
- The interest rate applied to the loan must be equal to or greater than the “benchmark interest rate” for the year. The benchmark interest rate is the variable housing loan interest rate published by the Reserve Bank of Australia before the start of the financial year.
- The loan’s term must not exceed the “maximum term” designated for the type of loan, which is either:
– 25 years if the loan is 100% secured by a registered mortgage over real property, and the property’s market value is at least 110% of the loan amount.
– 7 years for any other type of loan.
Additionally, minimum repayments must be made each financial year.
To meet the Division 7A requirements, a Division 7A loan agreement must be in place before the company’s lodgment day for the relevant financial year.
Here are the main points:
- **Dividend Distribution:** It’s common practice for companies to distribute their surplus profits by declaring dividends. Consequently, each shareholder receives a portion of these profits corresponding to their shareholding and is obligated to pay taxes on those earnings.
- **Exercise Caution:** Companies seeking to distribute profits to shareholders in ways that don’t typically trigger tax obligations should be cautious. Division 7A has the effect of treating specific payments and benefits as dividends. If an arrangement is categorized as a Division 7A dividend, it’s generally not possible to attach franking credits to reduce the shareholder’s tax liability.
- **Division 7A Loan Agreements:** In the context of loans from private companies to shareholders, parties can establish Division 7A loan agreements. This ensures that the payment is treated as a loan rather than a dividend.
Ever had these questions perhaps?
-**Will this apply to me?**
Everyone is under Div 7A, if that’s what you mean. But for your individual case, you need to pick up that computer you call a phone and give us a call to see whether you are about to get penalised by it. Or about to fail an audit & commit a crime & break the law. Hey, I am not being dramatic. Tax law is still law and fully enforceable when broken.
– **What is a dividend?** A dividend refers to a payment made by a company to its shareholders, distributing any surplus profits. It’s important to note that a company’s directors are only permitted to declare dividends in specific circumstances, and they are not obliged to do so.
– **What is the purpose of Division 7A, and which payments does it encompass?** Division 7A serves as an anti-avoidance provision, effectively categorizing certain payments by private companies to their shareholders as dividends.
– **Does Division 7A automatically apply to any loan from a private company to a shareholder?** No, it does not. If parties establish a Division 7A loan agreement, the payment is treated as a loan, not a dividend.
Fine – yes, this was a scary post. It was meant to be. I am not narcissistic nor am I megalomaniac. But, if you are not 100% sure here & you feel your accountant is a bit sloppy, odds are he/she may have done the wrong thing here. Many do.
If you are about to freak the freak about tax, dont!