Even if the participants treat a payment or other benefit given by a private company to a shareholder or their associate as a loan, advance, gift, or write-off of debt, the payment or benefit may be recognized as a dividend for income tax purposes under Division 7A.
A private company may also be subject to Division 7A if it pays a shareholder or associate through a different entity, or if a trust allots income to a private company without actually paying it, and then the trust pays the shareholder or associate of the company.
The purpose of Division 7A of the Income Tax Assessment Act 1936 is to stop assets or profits from being given tax-free to shareholders or their associates.
Generally speaking, a Division 7A deemed dividend is unfranked. In light of this, paying a dividend and allowing the shareholder to include it in their assessable income as a regular dividend (with a franking credit if applicable) is the most efficient way to give a payment or other benefit to a shareholder or their associate.
Amounts such as regular dividends or director's fees that are assessable to the shareholder or their associate under other sections of the income tax law are not subject to Division 7A.
If a payment or benefit that may be subject to Division 7A is repaid or converted into a loan that complies with Division 7A by the company's lodgment day for the income year in which the payment or benefit occurs, it is not considered a dividend.
Declaring a dividend is one of the most popular ways for a private company to share its excess profits. This implies that profits will be distributed to company shareholders according to their respective shareholdings. In this scenario, the dividends would be paid to each shareholder after deducting any potential franking credits. The purpose of Division 7A of the Income Tax Assessment Act 1936 (Cth) is to stop private companies from providing their shareholders with other benefits if the shareholders are not required to pay taxes on those benefits. Unless an exception applies, Division 7A's general goal is to treat those benefits as dividends.
When a shareholder receives a dividend, they must pay tax at their marginal rate on the dividend and include the amount in their assessable income in the financial year the dividend was paid. The company may elect to tack on franking credits to the dividend in cases where it has already paid taxes on the profits it has distributed to the shareholders. By doing this, the shareholder can lower the tax obligation on those profits by the amount of taxes that the business has already paid. The goal of these franking credits is to avoid taxing the same income twice.
The anti-avoidance clause is found in Division 7A. It considers payments or other advantages given to a shareholder (or a shareholder's associate) by a private company to be dividends. This implies that the deemed dividend would be taxable to the shareholders. Division 7A is designed to get around the problem of a private company distributing profits in ways that would typically not result in a shareholder having to pay taxes on those profits.
Here is the ATO calculator and tools for reviewing and preparing your Division 7A agreements
https://www.ato.gov.au/calculators-and-tools/division-7a-calculator-and-decision-tool