Division 7A: When Personal Use of Company Money Creates Tax Problems

The ATO regularly highlights compliance risks that affect small businesses.

One issue that continues to arise is where shareholders of private companies use company money or assets for personal purposes. If these situations are not managed properly, they can trigger Division 7A tax consequences.

Understanding Division 7A

Division 7A is designed to prevent shareholders of private companies from accessing company profits tax-free.

The rules ensure that when a company provides financial benefits to its shareholders or their associates, those benefits are taxed appropriately.

How Division 7A Problems Can Arise

Issues often occur where shareholders treat company funds as though they were personal funds.

For example, this might include:

• Using a company credit card for private expenses

• Transferring company funds to cover personal costs

• Using company assets for private purposes without proper arrangements

If these amounts are not addressed correctly, the ATO may treat them as unfranked dividends, which become taxable in the shareholder’s personal tax return.

Understanding the Separate Entity Rule

A company is a separate legal entity from its shareholders.

This means the company’s funds and assets belong to the company itself. Shareholders should not simply withdraw or use those funds for personal purposes unless the amounts are properly structured or repaid within the relevant timeframes.

Maintaining separate bank accounts and credit cards for business and personal expenses can help prevent these issues.

Using a Division 7A Loan Agreement

If company funds have been used by a shareholder, one way to manage the situation is to formalise the arrangement through a Division 7A complying loan agreement.

These agreements must generally include:

• Identity of borrower and lender

• Loan amount

• Repayment obligations

• Interest rate (at least the Division 7A benchmark rate)

• Loan term (usually up to 7 years unless secured by property)

Importantly, the agreement must be signed before the company’s lodgment day for the relevant income year.

Don’t Get Caught Out

Division 7A rules are complex, and even small errors can create unexpected tax liabilities.

If you are unsure whether company funds have been used correctly, it is important to review the situation early and put the appropriate arrangements in place.

Contact Lockwood & Ward on (02) 9299 7044, visit www.lockwood.com.au, or stop by Level 9, 50 Clarence Street, Sydney NSW 2000.