Division 7A in Plain English: How to Avoid Accidental Deemed Dividends

Written on Feb 24, 2026. Posted in News.

For directors and shareholders of private companies in Melbourne, navigating the complexities of Australian tax law is a significant challenge. Among the most intricate and potentially costly areas is Division 7A of the Income Tax Assessment Act 1936. This legislation is designed to prevent shareholders or their associates from accessing company profits in the form of tax-free loans, payments, or forgiven debts.

Failure to comply with Division 7A can result in these transactions being treated as “deemed dividends,” which are unfranked and assessable as income at the recipient’s marginal tax rate. This can lead to substantial and unexpected tax liabilities. This article provides a plain English guide to understanding and managing your Division 7A obligations, with a focus on practical advice for Melbourne-based businesses.

What is a Deemed Dividend?

At its core, Division 7A is an anti-avoidance measure. It ensures that all distributions of company profits to shareholders are subject to taxation. When a private company provides a “financial accommodation” to a shareholder or their associate, the Australian Taxation Office (ATO) may deem this to be a dividend. This can occur in several ways:

Direct Payments: A straightforward payment from the company to a shareholder that is not a salary or repayment of a genuine debt.
Loans: Loans made to shareholders that do not meet specific criteria for interest rate and loan term.
Debt Forgiveness: When a company forgives a debt owed by a shareholder.
Use of Company Assets: When a shareholder uses a company asset (such as a vehicle or property) for free or at a reduced rate.

The consequence of a deemed dividend is that the entire amount of the payment, loan, or forgiven debt is included in the shareholder’s assessable income for that financial year. As these dividends are unfranked, no tax has been paid at the company level, meaning the shareholder bears the full tax burden at their individual marginal rate, which can be as high as 47% (including the Medicare levy).

Example:

Consider a Melbourne-based family business, “Rooibos Tea Pty Ltd,” with two directors and shareholders, John and Jane. The company has profits of $200,000. John needs $100,000 to fund a personal investment. He withdraws the money from the company’s bank account and records it as a “loan” in the company’s books. If this loan is not managed correctly under Division 7A, the ATO could deem the entire $100,000 to be an unfranked dividend paid to John. At a marginal tax rate of 47%, this could result in a personal tax liability of $47,000 for John.

The Complication of Unpaid Present Entitlements (UPEs)

Unpaid Present Entitlements (UPEs) are a common area where Division 7A issues arise, particularly for businesses that use trust structures. A UPE is created when a trust appoints income to a corporate beneficiary, but the cash has not yet been paid.

From the ATO’s perspective, if a corporate beneficiary with a UPE has knowledge of the funds and does not demand payment, it is effectively “loaning” the money to the trust. If a shareholder of the corporate beneficiary is also a beneficiary of the trust, Division 7A can apply.

The ATO’s position on UPEs has evolved, and since 1 July 2022, where a corporate beneficiary is made entitled to trust income and that UPE remains unpaid, it can be treated as a loan from the corporate beneficiary to the trust. If the trust has, in turn, made a loan or payment to a shareholder of the corporate beneficiary, these complex arrangements can trigger a deemed dividend.

Managing UPEs requires careful planning. The options for dealing with a UPE to avoid a deemed dividend include:

Paying out the UPE in cash to the corporate beneficiary before the corporate beneficiary’s lodgment day.
Entering into a complying Division 7A loan agreement between the corporate beneficiary and the trust.
Investing the UPE funds into a specific income-producing asset for the sole benefit of the corporate beneficiary, under a sub-trust arrangement.

Given the intricate nature of these rules, seeking professional advice is crucial for businesses in Melbourne dealing with UPEs to trusts with corporate beneficiaries.

Complying with Division 7A: The Section 109N Loan Agreement

The primary mechanism for managing loans from a company to a shareholder is a complying Division 7A loan agreement, as specified under Section 109N of the Act. To be effective, this written agreement must be in place before the company’s lodgment day for the income year in which the loan was made.

The key requirements for a complying loan agreement are:

Minimum Interest Rate: The loan must charge interest at a rate at least equal to the “benchmark interest rate” for the year. This rate is published by the ATO annually and is based on the Reserve Bank of Australia’s housing variable lending rate. For the 2024-25 income year, this rate is 8.27%.
Maximum Loan Term: The loan must have a maximum term, which depends on whether the loan is secured or unsecured:
- Unsecured Loans: The maximum term is 7 years.
- Secured Loans: The maximum term is 25 years. The loan must be secured by a registered mortgage over real property, with the value of the property (less any existing mortgages) being at least 110% of the loan amount.

Making Minimum Yearly Repayments:

Once a complying loan agreement is in place, the shareholder must make minimum yearly repayments of both principal and interest. The calculation for the minimum yearly repayment is based on a formula provided by the ATO. Failure to make the minimum yearly repayment by 30 June of a given year will result in a deemed dividend equal to the shortfall.

Example:

Following on from the previous example, to avoid a deemed dividend, Rooibos Tea Pty Ltd and John could enter into a 7-year unsecured loan agreement before the company lodges its tax return. The loan agreement would specify an interest rate of at least the benchmark rate. John would then be required to make minimum yearly repayments for the next 7 years.

The Importance of Pre-30 June Planning

For businesses in Melbourne, proactive planning before the end of the financial year on 30 June is essential to manage Division 7A risks. Leaving this until the last minute can lead to costly mistakes. Key pre-30 June actions include:

Reviewing the Company’s Financial Statements: Identify all payments, loans, and other benefits provided to shareholders or their associates during the year. This includes reviewing the director’s loan account for any debit balances.
Making Minimum Yearly Repayments: Ensure that all required minimum yearly repayments on existing Division 7A loans are made by 30 June.
Putting Loan Agreements in Place: For any new loans made during the financial year, ensure that a complying Division 7A loan agreement is drafted and signed before the company’s lodgment day.
Addressing UPEs: If your structure involves trusts and corporate beneficiaries, decide on a strategy to deal with any UPEs before they trigger Division 7A.
Paying a Dividend: In some cases, it may be more tax-effective to pay a franked dividend to the shareholder, which they can then use to repay the loan. This can “clear out” a loan account and avoid future Division 7A obligations.

Conclusion: Your Trusted Melbourne Advisor

Division 7A is a complex area of tax law with significant financial consequences for non-compliance. For private companies in Melbourne, it is a critical area that demands careful management and expert advice. The key to avoiding accidental deemed dividends is to be proactive, maintain meticulous records, and seek professional guidance well before the 30 June deadline.

Our firm specialises in providing tailored wealth management and legal advice to businesses across Victoria. We can assist you with:

Reviewing your company’s Division 7A exposure.
Drafting and implementing compliant loan agreements.
Advising on the management of UPEs and trust structures.
Developing a comprehensive pre-30 June tax planning strategy.

By taking a proactive approach, you can ensure that you meet your obligations under Division 7A and protect your business and personal wealth from the risk of a deemed dividend.