Division 7A and Deemed Dividend
Division 7A of the Income Tax Assessment Act 1936 (“Div 7A”) deems certain payments and loans from private companies to their shareholders (or associates of those shareholders)1 and forgiveness of certain debts owed by the shareholder (or associates)2 as dividends paid by the private company to a shareholder, out of the profits of the company.3
An exception to the above deemed dividend rule is available where a loan from a private company is not fully repaid before the company’s lodgement day for the income year in which the loan was made and a loan agreement that complies with the requirements set out in Division 7A has been entered into before that day (“Div 7A Loans”).4
Div 7A Loans
Despite an increase in minimum repayment requirements reflecting the heightened interest rates of late, Div 7A Loans continue to provide a safe harbour and effective tax planning tool for payments out of companies, which would otherwise be taxable as dividend income in the hands of the shareholder.
While the repayments of Div 7A Loans might be manageable during the lifetime of the borrower from other sources of income or dividend offsets, it could prove challenging for the executor to meet the minimum repayments or make a full repayment of such loans that remain owing post-death. Also, repayment requirements may affect the executor’s ability to fund the distribution of the estate in accordance with the borrower’s will and Div 7A Loans, particularly secured loans with 25-year terms, could delay completion of the administration of the estate.
Identifying and specifically planning for any loans, including Div 7A Loans, as part of the estate planning process during the lifetime of the borrower is therefore critical to address funding issues that may arise during the administration of the estate and mitigate unintended tax consequences to the estate.
Dealing with Division 7A Loans
If loans are owing by a deceased estate to a private company, the executors may consider the following actions during the administration of the estate:
- Ascertain whether the loans comply with Div 7A
Assessing whether a purported Div 7A Loan is indeed compliant with Div 7A can be complex, but if the relevant loan was not made under a written agreement or the minimum repayments have not been met, the loan is likely to be non-compliant. If the loan is non-compliant and the borrower is a shareholder or an associate of a shareholder of the company, the loan could instead be taken as a deemed dividend under Div 7A in the year the payment was made or a minimum repayment was not met.
If it is determined that the Div 7A Loan is non-compliant, specific tax advice or a private ruling from the Commissioner should be sought as to the tax treatment of such non-compliance and potential tax implications to the estate, particularly if the non-compliance arose within the statutory amendment period.
- Repay the loan
If the loans comply with Div 7A, the executor can decide to continue to make minimum repayments or otherwise make the loan repayment in full. This decision will depend on the funding requirements, beneficiaries under the will, and the terms of the loan agreement.
Where an estate’s capital and income entitlements are divided between different classes of beneficiaries, the administration of Div 7A Loans in an estate can be further complicated. An income beneficiary’s interests could be defeated by minimum yearly repayments out of income, or a capital beneficiary’s interests could be reduced if the estate’s capital is used to repay the loan in full. Therefore, consideration should also be given as to which class of beneficiaries should pay the different costs associated with repayment of Div 7A Loans.
- Seek forgiveness of the loan from the company
If funding is an issue, the executor could request that the company forgives the loan. Company directors are not required to comply with such a request and may be unable to do so. Where there are multiple shareholders, the directors will owe a duty to the other shareholders to consider how writing off a debt will affect them.
Where a company resolves to forgive a loan owed to it by a deceased estate, it is likely that a deemed dividend will arise to the estate at the time of forgiveness of the loan.
How we can help
The circumstances of each estate are unique and must be carefully considered to determine an executor’s best course of action, so that the interests of the beneficiaries are best protected and adverse tax consequences are minimised.
The Wills, Estate Planning and Structuring team at Moores is one of the largest in Australia with expertise in succession planning, estate administration and taxation. We can assist you with managing the loans forming part of the estate, including loans owing from private companies, in the estate administration process in the most tax effective manner.
Contact us
Please contact us for more detailed and tailored help.
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Disclaimer: This article provides general information only and is not intended to constitute legal advice. You should seek legal advice regarding the application of the law to you or your organisation.
1Sections 109C, 109D and 109E of Income Tax Assessment Act 1936 (“ITAA36”)
2Section 109F of ITAA36
3Section 109Z of ITAA36
4Section 109N of ITAA36