Don’t touch your company’s money - the Div 7A mistakes which can cost you tax

In 2024, the ATO focused on educating advisors and the public in respect of Division 7A. Following on from the education program, on 13 January 2025, the ATO published its most recent Division 7A information sheet, pointing out common myths which trigger Division 7A to apply.

From our ATO audit experience, and our discussions with ATO officers, Division 7A is one of the most inadvertently triggered taxation provisions due to the lack of awareness of its reach and application.

What is Division 7A?

Division 7A of the Income Tax Assessment Act 1936 aims to prevent private companies from benefiting shareholders or their associates from profits made in, and retained in, a company.

Consequences of Non-Compliance

Where Division 7A applies, unless the “benefit” provided to a shareholder or their associate results in a complying arrangement, then Division 7A can have serious taxation consequences.

If Division 7A applies, a payment, loan or debt forgiveness will be treated as an unfranked dividend paid to the shareholder (or their associate).

The shareholder (or their associate) is liable to pay tax on the Division 7A unfranked dividend at their individual tax rates. Interest and penalties may apply where the shareholder (or their associate) has failed to disclose the Division 7A dividend in their relevant income tax return, irrespective of whether the omission in the income tax return was intentional or not.

Common myths and mistakes

Some of the most common mistakes triggering Division 7A that we see in practice (which are also highlighted by the ATO’s information statement) are as follows:

Mistake 1: Treating the company’s money as your own

Many business owners believe they can use their company’s funds as their own. We often see clients paying private expenses from their company’s bank account without considering the taxation consequences of such payments.

A private company is a separate legal entity distinct from its shareholders and directors. Where a shareholder (or their associate) receives the benefit of company funds (other than through salary, wages, director’s fees, or dividends), Division 7A can apply to such amounts.

Mistake 2: Assuming benefits to non-shareholders are excluded from Division 7A

It’s important to note that Division 7A applies not only to shareholders but also to their associates.

An associate is defined broadly for taxation purposes and may include relatives (such as a spouse or children), companies controlled by the shareholder or their associates, or trustees of a trust where the shareholder or their associate is a beneficiary (irrespective of whether they in fact receive a benefit).

Where an associate of a shareholder receives the benefit of company funds, then Division 7A can also apply to such amounts received.

Mistake 3: Using journal entries to offset repayment obligations

This mistake in our experience is extremely common.

Division 7A will not apply to loans made by a company which are subject to complying Division 7A loan agreements. In order to comply with the requirements of a Division 7A loan agreement, and not trigger Division 7A in subsequent income years, the shareholder (or their associate) who receive the loan needs to make minimum yearly repayments to the company.

We often see these minimum yearly repayment obligations being undertaken for shareholders by the company declaring dividends in favour of the shareholder in later income years, with the dividends being offset against the shareholder’s minimum yearly repayment obligation.

A common mistake made with this repayment arrangement is the reliance solely on journal entries as an effective offset of the minimum yearly repayment obligation.

For such offset to be legally effective:

1. The obligation to make the dividend payment to the shareholder and the shareholder’s minimum yearly repayment obligation need to both exist at the time of offset (i.e. there must be mutual debts to offset);

2. The shareholder and the company must agree to offset the mutual debt obligations. There is no general legal right to offset mutual debts without the agreement of the parties. For taxpayers to ensure they comply, written confirmation of the agreement should exist for each debt offset; and

3. The dividend offset needs to occur prior to the end of the income year in which the minimum yearly repayment is required to be made.

Mistake 4: Assuming Division 7A does not apply if payments/loans are made to other entities before the shareholder receives the funds

Division 7A can still apply to transactions where a private company’s shareholder (or their associate) ultimately benefits, even if the transaction goes through an interposed entity (e.g. another individual, company, partnership, or trust).

Mistake 5: Assuming Division 7A only applies if funds are used for private purposes

If you use your company’s money to fund another business or income-generating activity, Division 7A can still apply. The tax implications of any loan made from your private company to its shareholders (or their associates) are not influenced by the purpose of the loan (i.e. Division 7A can apply whether the recipient uses the funds for taxable or private purposes).

Mistake 6: Division 7A only applies to amounts paid by a company

In addition to ordinary loans made by a company, Division 7A can also apply where a company is entitled to income from a trust which remains unpaid (i.e. unpaid trust entitlements).

Mistake 7: Round robin loans and repayments

Some taxpayers believe they can temporarily repay a loan before the company’s lodgment day to avoid Division 7A implications.

However, if you reborrow similar or larger amounts from the company after making the repayment, or if you use borrowed funds to make the repayment, this may not be considered a valid repayment.

Mistake 8: Failure to keep records recognising loans

Failing to keep adequate records could lead to unintended Division 7A consequences. Where a company’s bank account is used to pay a shareholder’s (or their associate) private expenses, Division 7A is often inadvertently triggered by a failure to keep accurate records of the amounts owed by the shareholder (or their associate) to the company.

Mistake 9: Assuming the Commissioner will exercise their discretion in your favour

There are various directions available to the Commissioner in respect of the application of Division 7A to your circumstances (including allowing a Division 7A dividend to be disregarded or franked).

The ATO’s recent Division 7A information sheet makes it clear that a taxpayer should not assume that the Commissioner will exercise these discretions in their favour.

Next steps

If you require advice in respect of how Division 7A may apply to you, or have become aware of an inadvertent breach of Division 7A, please contact the writers for assistance.

Author: Stephanie Flegg

Contributing partner: Chris Tsovolos