When your company’s money is not your money (yet)
Six things you need to know
- Have you taken money from your company to help cover personal costs? If so, you need to show this as taxable income in your own name, or it might come under the Div 7A rules.
- Private companies cannot distribute profits to shareholders (or their associates) as loans, payments or forgiven debts to avoid income tax liability.
- This attracts scrutiny from the ATO who will treat the distributions as unfranked “deemed dividends” under Division 7A unless three key compliance requirements are in place.
- Shareholders and their associates will be taxed on unfranked deemed dividend amounts at marginal rates.
- Div 7A encompasses loans, payments, benefits or forgiven debts and will be applied even when transactions occur through trusts, partnerships or other interposed entities where the ultimate beneficiary is a shareholder or their associate.
- The law remains uncertain around trust distributions owed to corporate beneficiaries, that is unpaid present entitlements (UPE), until the High Court considers a Federal Court decision in March 2025 that has been appealed by the ATO.
Background
Many business owners pay themselves via wages throughout the year, but what happens when you either don’t pay yourself a wage via payroll, or you take extra funds out of your business via drawings or loans?
Well, if your business operates via a company, this may trigger Division 7A rules to apply.
As a bit of background, a company is a separate legal entity, distinct from its shareholders and associates. As such, profits generated within the company belong to the company, and are generally not able to be drawn out by its shareholders or associates without some form of tax or administrative consequences.
The attitude of ‘the company’s money is my money’ will not fly with the ATO, and they have intentionally legislated Division 7A of the Income Tax Assessment Act 1936 (Div7A) to ensure taxpayers are not unfairly benefiting from their company’s income tax rate of 25% or 30%, rather than paying their individual effectively marginal tax rate, which is currently as high as 47% when factoring in the Medicare Levy.
For example, if an individual earned a $300,000 salary, the income tax associated with this type of earnings would be $107,138 including Medicare Levy, for the 2025 Financial Year. This equates to an effective marginal tax rate of about 35.7%. Alternatively, if a small business company earned a net profit of $300,000, this would be taxed at a flat 25%, resulting in $75,000 income tax being associated with these earnings. If the shareholder of the company was able to draw these funds out indefinitely without consequence, they will have effectively avoided $32,138 in income tax (being the $107,138 if assessed individually minus the $75,000 assessment for the company). The higher the individual salary or equivalent company profit, the higher the disparity.
Where payments have been made from a company to its shareholders and/or associates, these are effectively treated as a loan from the company to the shareholder or associate for that particular Financial Year.
Any amounts owed to the company for a particular Financial Year will need to either be cleared (via loan repayment, wages or dividends) prior to the lodgement date or due date of lodgement of that Financial Year’s tax return (whichever is earlier), or converted to a complying Division 7A loan agreement.
Failure to properly deal with loaned amounts may result in a deemed dividend being allocated the shareholder or associate, which may result in significant income tax consequences, as deemed dividends do not have any tax credits attached to them.
For example, Fred’s Food Pty Ltd is a company that operates a food truck business. Fred owns this company and during the 2025 Financial Year has drawn out a $50,000 wage, properly processed via payroll, and a further $25,000 of funds to personally use.
Fred’s Food Pty Ltd lodges its 2025 tax return on 31 October 2025.
While preparing the year end tax work, Fred’s accountant noticed that $25,000 was loaned from the company to Fred and outstanding at 30 June 2025. Fred’s accountant contacted Fred and confirmed this amount was funds drawn from the company, and advised Fred that he will need to account for this money in one or more of the following ways to avoid a Div7A deemed dividend:
- Repay the $25,000 back to the company;
- Pay the $25,000 out as a net wage or dividend from the company; or
- Convert the loan to a complying Division 7A Loan agreement.
Or a combination of the above.
Fred only has $5,000 to pay back to the company, so he physically repays this back to the company on 15 September 2025. Fred then asks to receive $10,000 as a net wage, and convert the rest of the loan to a Division 7A loan agreement.
By the time the income tax return is lodged (31 October 2025), Fred has accounted for his $25,000 outstanding at 30 June 2025 in a compliant manner, through a partial repayment of $5,000, a net wage of $10,000 (which increases his personal taxable income), and a compliant Division 7A loan prepared and signed prior to his tax return lodgement for the remaining $10,000.
If Fred was behind on his taxes and only provided his tax information to his accountant on 30 June 2026, technically Fred will have failed to account for his 2025 loan of $25,000, as Fred’s Food Pty Ltd’s lodgement due date will have already passed (typically 15 May 2026). In this case, a $25,000 deemed dividend would be required to be allocated to Fred, which would result in a further $25,000 taxable income being allocated to Fred, personally, which, in this case, results in Fred being required to pay an additional amount of $8,250 in income tax.
For the remainder of this article, we will specifically focus of Division 7A loans.
One thing you should do
Ensure any distribution of profits to shareholders (or their associates) as loans, payments or forgiven debts is documented and on commercial terms.
How Herron can help
- Review payments made to shareholders or their associates that may be identified as Div7A loans
- Consider your circumstances and advise if there is an alternative treatment to these payments (such as wages or dividends) that would provide an overall better result
- In cases where Div7A applies, assist you to properly document payments to ensure these are on commercial terms
The details
It should be no surprise to anyone that the Australian Tax Office (ATO) does not like it when private companies make payments to shareholders (or their associates) purporting to be loans, payments or forgiven debts as a way of “sidestepping” income tax liability.
The ATO relies on Division 7A (Div 7A) of the Income Tax Assessment Act 1936 (ITAA 1936) to treat these payments as typically unfranked “deemed dividends”, and tax the amounts at the shareholder’s marginal rate rather than being paid tax-free as disguised loans.
When is Div 7A triggered?
Div 7A encompasses:
- Loans, including advanced money, credit, promissory notes, or other financial accommodation.
- Payments or benefits on behalf of shareholders or associates (for example, company paying personal expenses).
- Forgiven debtsby the company.
The ATO will apply Div 7A even when transactions occur through trusts, partnerships or other interposed entities where the ultimate beneficiary is a shareholder or their associate.
What Counts as a Div 7A Deemed Dividend?
If a private company does not repay or convert the loan or benefit into a complying Div 7A loan by lodgement day (that is, the earlier of the due date or actual lodgement date of its tax return), the ATO deems the unpaid amount to be an unfranked dividend up to the company’s distributable surplus.
Multiple loans in the same year are amalgamated and treated as one, with repayment requirements calculated on the aggregate.
When is a Loan Compliant?
To avoid a deemed dividend, a loan must meet three key compliance requirements:
- A written agreement signed before the lodgement day.
- Minimum interest rate payable at or above the ATO’s benchmark rate for that income year.
- Maximum term, which is generally 7 years for unsecured loans, or up to 25 years if secured by real property.
These loans must also include annual minimum repayments, generally by each 30 June, with any shortfall treated as a deemed dividend.
Loans that are repaid or converted into complying loans by the lodgement day escape the deemed dividend treatment.
Indecision still for Unpaid Present Entitlements
Unpaid Present Entitlements (UPEs) are trust distributions owed to beneficiaries but not paid. Historically, the ATO treated UPEs to company beneficiaries as Division 7A loans, pointing to tax avoidance.
In March 2025, a landmark Federal Court ruling affirmed UPEs to corporate beneficiaries are not loans under Div 7A, overturning earlier views. This decision, and the earlier Administrative Appeals Tribunal finding, offers some relief but remains uncertain as the ATO has been granted special leave to appeal this decision to the High Court of Australia.
If the High Court affirms the Federal Court ruling, in the future this may permit greater flexibility in trust-to-company distributions without triggering Div 7A exposure, subject to legislative change.
Compliance Risks and ATO Scrutiny
We have seen an increased focus by the ATO on Div 7A compliance with close examination of:
- Proper documentation.
- Accurate interest application.
- Genuine terms.
Common issues include:
- Using loans for personal expenses
- Inadequate records
- Improper interest rates
- Re-borrowing to “repay,” and refinancing without consequences
Penalties may apply, including interest charges, tax shortfalls, and deeming of unfranked dividends without franking credits.
What you can do:
To minimise risks and stay compliant, we help our clients to:
- Identify all related-party loans, UPEs, and financial arrangements each year.
- Formalise loans in writing, with the correct benchmark interest and term.
- Use the ATO’s Div 7A calculator and decision tool to compute minimum repayments and closing balances.
- Ensure annual repayments meet the prescribed minimum requirements and avoid repayment through additional borrowing.
- Review UPE status, especially given the recent Federal Court ruling and impending High Court decision.
- Maintain detailed records of agreements, repayments, interest calculations, and lodgement dates.
- Review annually, before 30 June, to identify deficiencies or refine compliance strategies.
- Seek professional advice for complex structures, trust arrangements, or multi-entity groups.
Final Thoughts
Division 7A remains a cornerstone of Australia’s tax regulation to curb disguised payments from private companies. While its rules are clear, complexity arises in practice—particularly with loans through trusts or involving UPEs. The 2025 Federal Court ruling on UPEs offers relief but remains subject to potential appellate decisions and possibly legislative changes.
Click here to make an appointment and talk to us about shareholder loans and how to minimise the impact on your business.
Michael Rashid
Accountant
Mark Herron
Principal