Your accountant has just said the words Division 7A and it's at this point you glaze over and don't hear another word, but there's lots of blah blah tax and blah blah I told you, and you're like what the hey! So fear not, we're here to throw you a lifebuoy and navigate these choppy waters together.
What in the world is Division 7A anyway?
In simple terms, it's like borrowing money from your company – you've taken some cash out, but haven't paid any tax on it yet. Now, before you start protesting with a "but it's my money!" – hold your horses! Your company isn't your personal piggy bank; it's a separate legal entity, and borrowing from it comes with some tax strings attached.
But why does anyone care if you've borrowed from your own company?
Well, because the taxman-ian devil (AKA the ATO) wants their cut eventually. Instead of making you pay up front like with employee wages, Division 7A lets you delay paying tax for a while – 7 years if it's unsecured, and a whopping 25 years if it's secured. So you get to kick that can down the road for a bit. And YES it's legitimate, but it is the technical definition of tax deferral.
Sounds too good to be true, right?
Well, here's the kicker – you'll have to charge yourself interest on the loan and make annual repayments, starting by the end of the first income year after you borrowed the cash.
Now, about that interest rate – from 1 July 2023, it's a hefty 8.27%. And if you've used the money for personal stuff, that interest isn't tax deductible. Ouch.
Annual repayments also need to be made in cold hard cash or in dividends, which means reporting it as income to the shareholders (that's where we come in handy😉). If the company has paid tax and has a franking account balance, then the dividend can usually be franked (ie, be distributed to shareholders with the company tax being attached, ie, 25% of tax has already been paid).
Word of warning here - an end of year journal entry where no cash changes hands is NOT an effective repayment.
So what if you don't play by the rules?
Get ready for some serious pain. The full loan amount can be slapped on you as unfranked dividends. Translation: you'll be paying tax at your regular rates, possibly hitting that top marginal tax rate of 47% (incl medicare levy). Yikes!
Our advice
Don't mess with Division 7A. It's like trying to dodge a bulldozer on a motorbike – not gonna end well. So chat with us or your accountant to make sure you're sailing smoothly through these tax waters.
Still scratching your head? No worries – our team of oh so cool not nerdy at all experts is here to help. Drop us a line, and we'll guide you through this tax maze like pros.
Disclaimer: The information provided is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice