Division 7A

As set out in section 109C, a private company is taken to pay a dividend at the end of the income year it pays an amount to a shareholder or an associate of the shareholder. That includes former shareholders and their associates, if a reasonable person would conclude (having regard to all the circumstances) that the payment is made because of that former relationship.

What is a payment?

A payment can include any of the following:

• a payment to the extent that it is to shareholder or their associate, on behalf of them, or for their benefit;
• a equivalent credit;
• a transfer of property to the shareholder or their associate;
• the provision of an asset to the entity, unless an exception applies.

A loan is not considered to be a payment. However, a payment can be converted to a loan but only before the private company’s lodgement date or due date – whichever is sooner. Section 109D deals with Division 7A consequences arising from loans (see relevant heading below).

The provision of an asset

As mentioned, a payment can include the provision of an asset. That includes the provision of a lease or licence. Section 109CA provides the following example:

Yacht builder Mainbrace Enterprises Pty Ltd owns a yacht for the purpose of sales demonstrations. With the private company’s permission, one of its shareholders uses the yacht on weekends. [Here], the company has made a payment to the shareholder, unless one of the exceptions applies.

Section 109CA has scope to apply even where an asset is never used if the provider does not have the right to either use the asset or to provide the asset for use to another entity.

The provision of an asset will not be a dividend where:

• the shareholder or their associate is an employee, and the asset provided qualifies as a minor benefit that is exempt from fringe benefits tax;
• the shareholder or associate would have been allowed an immediate deduction, had they paid for the expenditure.
• One of the three exemptions apply which relate to the right to use a dwelling and/or adjacent land.

Unpaid present entitlements

In TD 2015/20, the ATO take the view that a private company makes a payment where it releases all or part of an unpaid present entitlement to the benefit of the entity to whom the UPE is released. The definition of a payment includes the credit of an amount, and the release is taken to meet that definition as it would properly result in a credit entry against the UPE account on the private company’s balance sheet.

Exclusions

In addition to the general Division 7A exclusions listed in the above heading ‘The Scope of Division 7A’, a payment will not be a deemed dividend under section 109C where any of the following apply:

• the private company pays a shareholder or their associate because money is owed to them. For instance, if a shareholder performs 1-hour of work for a private company and charges their usual $500/hr rate. The company’s payment of that invoice will not be caught under section 109C and treated as a dividend.
• in respect of the transfer of an asset (or the provision of an asset for use), consideration was given to acquire the asset (or use it) that was at least equal to the arm’s length value.
• it represents a distribution from a liquidator winding up the company.
• It is subject to fringe benefits tax.

Tax consequences

If section 109C applies, the shareholder (or their associate) in receipt of payment will be deemed to have been paid an unfranked dividend that is assessable to them.

The payment occurs when it is made but the dividend arises at the end of the income year in which the payment is made.

If the payment involves the provision of an asset, the payment is made at the relevant time outlined below:

• If the shareholder uses the asset with the permission of the provider of the asset – when the asset is first used. For example, if a shareholder were driving a company car with the company’s permission – when the company car is first used; or
• If the shareholder has a right to use the asset – when the shareholder first obtains that right. For example, if a shareholder had the car parked at his or her house or at another place of his or her choosing – when the shareholder is given the right to do so.

If the use (or right of use) spans across 2 or more income years, there will be a separate payment in each of those income years.

The amount of the dividend is the lower of:

• the amount of the payment; and
• distributable surplus

The amount of the payment for the transfer of property or use (or use right) of company assets is determined by reference to market value under arm’s length conditions less consideration.

Example

Take the example of Peter. He is a shareholder of a private company. On 1 January 2025, $50,000 is transferred to Peter from the private company. He uses the funds to pay down a personal debt. Here, Peter will be deemed to have received an unfranked dividend at 30 June 2025. The distributable surplus at 30 June 2025 is $80,000 which means the dividend amount is $50,000 (which is the lower of the amount of payment and distributable surplus). Peter includes that dividend amount in his assessable income in his 2024/25 tax return.

As set out in section 109D, a private company is taken to have paid a dividend at the end of an income year it makes a loan to a shareholder or an associate of the shareholder. That includes former shareholders and their associates, if a reasonable person would conclude (having regard to all the circumstances) that the loan is made because of that former relationship.

However, a loan will not be taxed as a deemed dividend where:

• the loan is repaid before the company tax return lodgement date or due date – whichever is sooner.
• the loan complies with the requirements of section 109N.

What is a Division 7A loan?

A loan includes:

• an advance of money; and
• a provision of credit or any other form of financial accommodation; and
• a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and
• a transaction (whatever its terms or form) which in substance effects a loan of money.

Note a payment can be converted to a loan before the company tax return lodgement date or due date – whichever is earlier.

Tax consequences

If section 109D applies, the shareholder or their associate in receipt of loan will be deemed to have been paid an unfranked dividend that is assessable to them.

The dividend arises at the end of the income year that the loan is made.

The amount of the dividend is the lower of:

• the amount of the loan that has not been repaid before the lodgement date (or lodgement due date, if earlier) for the current income year; and
• distributable surplus.

Let’s reconsider the earlier example of Peter. Instead of making a payment, Peter receives $50,000 from the private company on 1 January 2024. Peter does not repay any amount of the loan before the company lodges its tax return for the 2023/24 income year. Peter is deemed to have received an unfranked dividend at 30 June 2024. Remember that the distributable surplus ($80,000) exceeds the loan amount not repaid. Accordingly, the unfranked dividend amount is $50,000. Peter includes this dividend amount in his assessable income in the 2024/25 income year.

Exclusions

In addition to the general Division 7A exclusions listed in the above heading ‘The Scope of Division 7A’ and the other exclusions flagged earlier under this section about loans, a loan will not be a deemed dividend under section 109D where any of the following apply:

• the loan is made in the ordinary course of business on usual arm’s length terms;
• it is a loan made by a liquidator of the private company;
• the loan is made to fund the purchase of an ESS interest under an employee share scheme.

As mentioned, a loan which complies with section 109N (and by extension, section 109E) will not be treated as a dividend.

The key requirements of that section include:

• the loan is made under a written agreement before the company tax return lodgement date (or actual lodgement date, if earlier);
• interest repayments are agreed to be payable which equal or exceed the relevant annual benchmark interest rate;
• the term of the loan does not exceed the maximum allowable term of 7 years, or 25 years if 100% of the value of the loan is secured by a registered mortgage over real property and the market value of the real property, when the loan is made, is at least 110% of the amount of the loan.

In certain circumstances, a loan can be converted from a 7 year maximum term loan to 25 year maximum term loan, or vice versa. However, the maximum term of the new loan is reduced by the time between the date of the original loan is made and the conversion date. Take the example of a 7 year loan which is made in the 2019/20 income year. In the 2021/22 income year, the original loan is converted to a 25 year loan. The maximum term of the new loan becomes approximately 23 years (that is, the 25 year maximum term less the time elapsed between the date the original loan is made and the date the loan is converted).

The complying loan must be repaid by way of minimum repayments each year. The minimum repayment for a particular income year is calculated using the below formula contained in subsection 109E(6):

Amount of the loan not repaid by the end of the previous year of income x Current year’s benchmark interest rate
1 – (                                1                                    )  Remaining Term
1 + Current year’s benchmark interest rate

As you might notice, the minimum repayment comprises a repayment on the principal lending and interest.

The minimum repayment obligation only commences in the income year after the loan is made. In addition, interest only starts accruing from the start of the income year after the loan is made. The minimum repayment must be met each year. That means there may be limited ability for the borrower to make higher repayments in an income year to entirely avoid the need to make repayments in a future income year.

If there is failure to enter into a complying loan agreement (in the first place), section 109D applies and deems a dividend. If a complying loan agreement is entered into but there is a failure to meet minimum annual repayments, section 109E applies and deems a dividend in respect of the repayment shortfall.

Note – if multiple loans are advanced during an income year, those loans will be amalgamated and viewed as a single loan for the purposes of calculating the minimum annual repayment. However, loans made in different income years are not amalgamated. So, for example, if a private company provides 7-year loans to a shareholder on a yearly basis, up to 7 separate complying loans could be on foot with that shareholder.

Disregarded repayments

As set out in section 109R, a loan repayment may be disregarded/not taken into account in determining how much of a loan has been repaid:

• a reasonable person would conclude (having regard to all the circumstances) that, when the payment was made, the shareholder or their associate intended to obtain a loan or loans from the private company of a total amount similar to, or larger than, the payment. Take the example of a private company that lends $10,000 to a shareholder in the 2022/23 income year. On 10 May 2024 (the date the 2022/23 company tax return is lodged), the shareholder repays the $10,000. One day later on 11 May 2024, the shareholder again borrows $10,000. The shareholder’s $10,000 repayment will probably need to be disregarded when assessing the amount of the loan repaid.
• The shareholder or their associate obtained, before the payment was made, a loan or loans from the private company of a total amount similar to, or larger than, the amount of the payment. And a reasonable person would conclude (having regard to all the circumstances) that the entity obtained the loan or loans in order to make the payment. Let’s again take the example of a private company that lends the shareholder $10,000 in the 2022/23 income year. Just before 10 May 2024 (the date the 2022/23 company tax return is lodged), the shareholder borrows another $10,000. The shareholder then repays the company $10,000. Again, the shareholder’s $10,000 repayment will probably need to be disregarded when assessing the amount of the loan repaid.

In essence, these rules are designed to prevent avoidance arrangements where a shareholder or their associate makes a further borrowing from a company to repay a loan, or repays a loan but shortly thereafter redraws a similar or greater amount.

If allowable, these types of arrangements would clearly somewhat thwart the purpose of Division 7A.

A loan repayment will not be disregarded merely where the repayment obligation is offset by any of the following:

• a dividend payable by the private company to the shareholder or their associate;
• a salary or wage to the shareholder or their associate;
• a transfer or property to the private company by the shareholder or their associate.

In TD 2025/D2, the ATO provides draft views on the application of section 109R.

The principle of mutual set off

In some circumstances, the obligation to make repayments on a loan can be met by the borrower setting off the repayment obligation against certain other entitlements owed toward them by the lender. That includes entitlements to things such as dividend payments, salary and wages, and property.

Take the basic example of David who is the sole shareholder of ABC Pty Ltd. David borrowed funds from ABC Pty Ltd and the parties entered into a complying Division 7A loan facility agreement. The first minimum annual repayment is calculated to be $10,000. Before the first minimum annual repayment is due, ABC Pty Ltd declares a $10,000 dividend to David. Instead of two separate cash payments being made i.e. one for the loan repayment and the other for the dividend, David and ABC Pty Ltd agree to set off the minimum annual repayment obligation against the dividend payable. The two mutually opposing obligations cancel out one another. As a result, David does not need to make a cash repayment to avoid a repayment shortfall (resulting in a deemed dividend). His minimum annual repayment requirement is met by set-off against his dividend entitlement.

Importantly, for an amount to be effectively set off against the minimum annual repayment, the relevant obligation must exist at the time set-off is sought to be applied. For instance, in terms of a dividend set off, the dividend must be validly declared by the date the minimum annual repayment is due (generally 30 June).

Note – there may be challenges in establishing mutually opposing obligations where a private company makes a loan to the associate of a shareholder. For instance, the associate will not typically have rights to a dividend payable as they are not a shareholder. It may be necessary for the associate to make cash repayments on loaned monies or for the parties to enter into further arrangements with a third-party in order to achieve an effective set-off.

In section 109D, the definition of a loan (set out earlier) includes the provision of financial accommodation.

Since 2009, as expressed in TR 2010/3, the ATO has taken the view that an unpaid present entitlement from a trust to a private company can be a form of financial accommodation (and thus a loan and deemed dividend) where the private company beneficiary is aware of the entitlement and there is a consensual agreement between the controlling minds of the private company and the trust for the UPE to not be called for. The consensual agreement is most likely in a family group situation.

The view that a UPE meets the extended definition of loan under section 109D has recently been rejected by the Federal Court in the Bendel decision. It is a significant decision as it may bring many forms of UPEs to corporate beneficiaries outside the scope of section 109D. At the time of writing, the ATO has applied for special leave to appeal the decision to the High Court of Australia. In the meantime, the ATO has indicated it will continue to administer the law without regard to the Federal Court decision.

UPEs and Subdivision EA

In addition to section 109C to 109F triggering a deemed dividend, section 109XB provides alternative triggers for certain payments, loans or forgiveness transactions after 11 December 2022 to be treated as unfranked dividends.

Broadly, section 109XB operates in situations where the payment, loan or forgiveness:

is made to a shareholder or an associate of a private company that is not itself a private company; and

where there is a payment, the payment amount discharges the present entitlement of the shareholder or their associate; and

the present entitlement is wholly or partly referrable to an unrealised gain; and

at or after the time of the relevant transaction, the private company itself has or obtains an unpaid present entitlement which subsists at the trust’s tax return lodgement date (or due date, if earlier) for the income year of the relevant transaction.

You might notice that section 109XB has far more limited application than section 109C through to 109F. There are also some unique aspects in the way 109XB operates in terms of things such as the timing recognition of a dividend. The nuisances of section 109XB are complex and may be addressed in a future article.

As set out in section 109F, a private company is taken to have paid a dividend at the end of an income year it forgives a debt to a shareholder or an associate of the shareholder. That includes former shareholders and their associates if a reasonable person would conclude (having regard to all the circumstances) that the forgiveness occurs because of that former relationship.

What is a debt?

A debt takes its ordinary meaning.

Note – a UPE is not usually considered a debt but instead an equitable right. Thus, it falls outside the scope of section 109F. Notwithstanding, in TD 2015/20, the ATO takes the view that a private company releasing a UPE might constitute a payment under section 109C. In short, that is because a payment can include situations where an amount is credited for the benefit of another. When a UPE is released, the books of the presently entitled corporate beneficiary would likely record a credit entry against the UPE asset account. That credit entry is seen as a credit for the benefit of the trust under the section 109C definition of a payment.

When is a debt forgiven?

A debt may be forgiven in any of the following circumstances:

• The amount would be forgiven under section 245-35 or 245-37 of the commercial debt forgiveness rules contained in Division 245 of the ITAA 1997. That includes, for instance, a release, waiver, extinguishment, or the passing of a statutory deadline for recovery.
• The company assigns the right to receive payment to an associate of the debtor (or a party to an arrangement with the debtor about the assignment) and it is reasonable to conclude that entity will not exercise the assigned right by insisting on repayment.
• A reasonable person would conclude having regard to all circumstances that the private company will not insist on the entity paying the amount or rely of the entity’s obligation to pay the amount.

Exclusions

In addition to the general Division 7A exclusions listed in the above heading ‘The Scope of Division 7A’, a forgiveness will not be deemed dividend under section 109F where any of the following apply:

• the forgiveness results from the debtor becoming bankrupt; or
• the forgiveness is in respect of an amount of debt from a loan that resulted in a deemed dividend under section 109D or section 109E; or
• the ATO exercises discretion not to treat the forgiveness as a deemed dividend on the basis that doing so would cause undue hardship.

Tax consequences

If section 109F applies, the shareholder or their associate that is provided with the forgiveness will be deemed to have been paid an unfranked dividend that is assessable to them.

The dividend for the forgiveness arises at the end of the income year that the debt is forgiven.

The amount of the dividend is the lower of:

• the amount of debt forgiven; and
• distributable surplus.

Let’s return to the example of Peter and his private company. On 1 January 2025, Peter borrows $50,000 from a private company to which he is a shareholder. Later in the 2024/25 income year, the private company formally forgives the debt. On 30 June 2025, the private company’s distributable surplus is $80,000 and the amount of forgiveness is $50,000 as no repayments were ever made. Here, Peter is deemed to have received an unfranked dividend of $50,000 which is the lower of the amount forgiven and distributable surplus. He must include that amount in his assessable income when he lodges his personal 2024/25 tax return.

A payment, loan or debt forgiveness to a shareholder (or an associate of the shareholder) who is also an employee of the private company (or an associate of the employee) may constitute a taxable fringe benefit and fall within the scope of the FBT regime. Remember that the FBT regime applies if a non-monetary benefit is provided to someone in respect of their employment.

To prevent amounts being potentially taxed under both Division 7A and the FBT regime, there are various tie-breaker rules to consider.

Broadly:

• for payments (including the transfer of property), FBT takes precedence
• for loans, Division 7A takes precedence
• for forgiven debts, Division 7A takes precedence.

To the extent Division 7A does not apply to a loan or forgiveness, the FBT regime may apply. For instance, a loan which does not meet the requirements of section 109D might instead be taxable under the FBT regime as a loan benefit.

As flagged throughout this article, where there is a payment, loan or forgiveness, the dividend amount is capped at company’s distributable surplus.

Distributable surplus is calculated as follows:

Net assets + Division 7A amounts – Non-commercial loans – Non-commercial loan repayments – Paid-up share value

The key parts of this equation are net assets and paid-up share value. The other three inputs are there to address issues with the counting of Division 7A amounts (or the former equivalent regime in former section 108 of the ITAA1936).

As a result, distributable surplus is a similar concept to retained earnings and the two will often align. Although, not always.

For reference:

• net assets broadly refers to company assets less present liabilities (including provisions for depreciation, annual leave, long service leave, and amortisation of intellectual property and trademarks) as reflected in the company’s books. The ATO may revalue assets and liabilities to market value if it considers there is significant undervaluing or overvaluing.
• Division 7A amounts broadly refers to deemed dividend amounts under section 109C or 109F during the present income year.
• Paid-up share value broadly refers to the total value of share capital paid to the private company for the acquisition of shares as at year end.
• Non-commercial loans broadly refers to amounts under former section 108, or present section 109D, 109E or 109XB that were taken to be dividends in earlier income years and which show as assets on the company’s books at year end.
• Repayment of non-commercial loans broadly refers to total repayments against non-commercial loans. That includes repayments that occur through allowable set-offs.

As we have addressed, a dividend under Division 7A is unfranked.

That said, there are circumstances where the ATO is given discretion to allow a dividend to be franked.

This includes where the dividend arises from an honest mistake or inadvertent omission by:

• the recipient, or
• private company, or
• another entity whose actions contributed to the result.

In PS LA 2011/29, the ATO provide guidance on factors which might be considered in exercising discretion favourably or not.

For instance:

• was there are misunderstanding of the law regarding Division 7A?
• was there a mistake in relation to a fact that inadvertently caused the Division 7A to apply?

A dividend may also be franked where it arises because of compliance with a family law obligation. A family law obligation is limited to those obligations described in section 126-5 of the ITAA97. That includes formal orders, agreements, awards etc.

If the dividend is allowed to be franked, it will usually be franked in accordance with the benchmark franking percentage, or, if no benchmark: 100%.