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Payment, or not? The operation of Division 7A
Division 7A is part of the Income Tax Assessment Act 1936 and is intended to prevent profits or assets being provided to shareholders or their associates tax free. The operation of Division 7A
A payment or other benefit provided by a private company to a shareholder (or their associate) can be treated by the ATO as a dividend for income tax purposes, and therefore render this amount assessable. This can apply under Division 7A, even if the participants treat it as some other form of transaction such as a loan, advance, gift or writing off a debt.
Division 7A can also apply when a private company provides a payment or benefit to a shareholder or associate through another entity, or if a trust has allocated income to a private company but has not actually paid it, and the trust has provided a payment or benefit to the company’s shareholder or their associate.
A Division 7A deemed dividend is generally unfranked. Given this, the most effective way to provide a payment or other benefit to a shareholder or their associate is to pay it as a normal dividend (with a franking credit if available) and for the shareholder to include it in their assessable income.
Division 7A doesn’t apply to amounts that are assessable to the shareholder or their associate under other parts of the income tax law, such as normal dividends or director’s fees.
Division 7A does not apply to shareholder or associate payments in their capacity as employees. In such situations fringe benefits tax (FBT) may apply instead of Division 7A. Division 7A does apply to loans and debt forgiveness provided to shareholders or their associates even where such benefits are provided in their capacity as an employee or as an associate of an employee. To avoid double taxation, such benefits are not subject to FBT.
Note that payments and other benefits treated as Division 7A dividends are generally not subject to dividend withholding tax or PAYG withholding.
Payments and other benefits taken to be Division 7A dividends are generally unfrankable distributions unless they are provided under a family law obligation. The Commissioner has a general discretion to allow a Division 7A dividend to be frankable if it arises because of an honest mistake or inadvertent omission.
Payments and other benefits provided by a private company to shareholders or their associates as a result of divorce or other relationship breakdowns may be treated as Division 7A dividends and are assessable income of the recipient.
However, such payments or other benefits are treated as frankable dividends if provided under a family law obligation, such as a court order under the Family Law Act 1975, a maintenance agreement approved by a court under that Act or court orders relating to a de facto marriage breakdown.
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