Division 7A is a section of the Income Tax Act that contains anti-avoidance provisions which are aimed at preventing private company owners and their associates from avoiding dividend taxation by trying to access company profits in another form besides dividends.

Division 7A applies to debts forgiven and private company loans made or deemed to have been made after 3 December 1997.  However, it may also apply to loans in place before this date where the amount of the loan is increased or its term is extended and this occurs after 3 December 1997.

Division 7A applies to debts forgiven after 3 December 1997, regardless of when the debt was created.

Division 7A applies to trustee loans made after 11 December 2002.

Division 7A requirements take precedence over FBT requirements, where the benefit is paid to a shareholder/associate who is also an employee.

For more information refer below.

Example:

30/06/2017 - Trust distribution to bucket company – unpaid present entitlement

15/05/2018 – Trust lodges tax return on due date.

15/05/2018 – If no action taken, the UPE is treated as a Division 7A loan from this date - not from distribution date

Action Options to avoid distribution being treated as a deemed dividend

By 15/05/2018:

Option 1 – Payout the UPE to the company

Option 2 – Put the UPE on Sub-Trust in accordance with PSLA 2010/4

> Calculate interest from 15/05/18 to 30/06/18

> Pay the interest by 15/05/2019 – date of Trust’s 2018 tax return lodgement

> If a 7-year UPE – repay the principal by 15/05/2025

> If a 10-year UPE – repay the principal by 15/05/2028

Option 3 – If not paid out or put under a Sub-Trust arrangement by 15/05/2018, then the UPE converts to a  Division 7A loan effective from 15/05/2018 – but not a deemed dividend yet

Before it is deemed a dividend the Trust still has until 15/05/2019, (at the latest or Company’s actual lodgement date, if sooner) to either:

• Fully repay the loan
  
  

• Enter into a s109 complying loan agreement with the company
  
  The first minimum principal and interest repayment amount under the Division 7A loan agreement must be paid by 30 June 2019
  
  
  

  Note: Sub-division EA applies to new UPE’s and quarantined UPE’s (pre 16/12/2009)
  
  If a trust distributes to a company but does not pay out the distribution (UPE) and the trust makes a loan to a shareholder of that company, instead of to the company itself, then Division 7A can apply to that payment. It can be deemed in lieu of a payment to the shareholder by the company itself. Once the UPE converts to a loan Sub-Division EA no longer applies.
  
  

As defined by subsection 109N (2), for the purposes of Division 7A, the benchmark interest rate for an income year is the Indicator Lending Rates – Bank variable housing loans - owner occupied - interest rate last published by the Reserve Bank of Australia before the start of the income year.

This rate also applies to 7-year interest only unsecured UPE under a Sub-Trust arrangement – Option 1 - PSLA 2010/4

A different rate applies to a 10-year interest only unsecured UPE under a Sub-Trust arrangement – Option 2 - PSLA 2010/4 – see table below

 Refer to PSLA 2010/4 below

An Unpaid Present Entitlement (UPE) will not be considered to be a loan to which Division 7A applies if the funds representing the UPE are held on sub-trust for the sole benefit of the private company beneficiary.

The ATO will consider that the funds in the sub-trust are held for the sole benefit of the private company beneficiary if the funds are invested in the main trust using one of the following investment options:

Option 1 - invest the funds representing the UPE on an interest only 7-year loan (see paragraphs 62 to 73 of PSLA 2010/4)

Option 2 - invest the funds representing the UPE on an interest only 10-year loan (see paragraphs 74 to 85 of PSLA 2010/4)

Option 3 - invest the funds representing the UPE in a specific income producing asset or investment (see paragraphs 86 to 94 of PSLA 2010/4)

Under Option 1 - repay within 7 years

The trustee must pay an annual return on the funds equal to the Benchmark interest rate.

The Benchmark interest rate is as defined by subsection 109N (2).

The benchmark interest rate for the purposes of sections 109N and 109E is equal to the relevant Reserve Bank of Australia Indicator Lending Rates - Bank variable housing loans interest rate.

Under Option 2 -  repay within10 years

The trustee must pay an annual return on the funds equal to the Prescribed interest rate.:

The Prescribed interest rate for a particular income year is the Reserve Bank of Australia's indicator lending rate for small business variable (other) overdraft for the month of May immediately before the start of that income year. These rates can be found at Table F5 at the Reserve Bank of Australia website (http://www.rba.gov.au/statistics/tables/index.html).

PSLA 2010/4 - Para 56
For the avoidance of doubt, the annual return on investment can either be paid in cash or set off against an account owing by the private company to the main trust, but it cannot be paid by crediting it to a liability account owing to the private company from the main trust or sub trust. The payment of the principal funds invested in the main trust (that is, the funds representing the UPE) and annual return to the private company must be such that if those payments had instead been repayments of a Division 7A loan made by a private company, they would not be disregarded by section 109R.

For the purposes of a 10-Year Sub Trust Loan the Prescribed interest rate for an income year is the Reserve Bank of Australia's indicator lending rate for small business variable (other) overdraft for the month of May immediately before the start of that income year. These rates can be found at Table F5 at the Reserve Bank of Australia website (http://www.rba.gov.au/statistics/tables/index.html).