Division 7A Rules: Complying Loans, Repayments, Deemed Dividends

The Division 7A rules in the Income Tax Assessment Act 1936 stop a private company from quietly moving profits out to its shareholders or their family without anyone paying income tax. If the company pays money to a shareholder, lends to them, or forgives a debt they owe, the amount is treated as an unfranked dividend in that person’s hands unless the transaction is repaid or documented on a complying loan agreement before the company’s lodgment day. Unfranked means no franking credits attach, so the recipient pays their full marginal rate, which can reach 47 percent including the Medicare levy.¹

What the Rules Catch

Three kinds of transaction between a private company and its shareholders or associates fall inside Division 7A: payments, loans, and forgiven debts.² A direct cash transfer is the obvious one. The definition of a loan, though, is deliberately wide. It covers any advance of money, any provision of credit, any transaction that functions as a loan in substance regardless of what the parties call it, and any payment made on someone’s behalf where there is an obligation to repay.³ Paying for a shareholder’s holiday with an expectation of repayment is a loan for Division 7A purposes even with no paperwork.

Debt forgiveness is the other big one. If the company decides not to collect a genuine debt owed by a shareholder or associate, the forgiven amount can be treated as a deemed dividend. Letting a shareholder use a company asset for personal purposes at less than market value can also be caught. The rules apply only to private companies, not to listed ones.

Who Counts as a Shareholder or Associate

The reach goes well past the people on the share register. Section 318 of the ITAA 1936 defines “associates” of a shareholder to include relatives (spouses, parents, siblings, children, and their spouses), business partners, and trustees of any trust in which the shareholder has a beneficial interest.⁴ A loan from the company to a shareholder’s spouse is caught just as if the shareholder took it directly.

Section 109C extends the same treatment to former shareholders and former associates where the payment, loan, or forgiveness relates to the earlier relationship.² Transferring shares before the company forgives a debt does not clean things up.

Section 109T then catches indirect arrangements. If money moves from the company to a third party and on to a shareholder or associate, the Commissioner can treat the company as having dealt with the ultimate recipient directly, provided a reasonable person would conclude the interposed step was mainly there to benefit that person.⁵ Timing of the payments, the closeness of the relationships, and the commercial logic of the arrangement all feed into that view.

The Distributable Surplus Cap

The maximum amount that can be treated as a deemed dividend in a year is capped at the company’s distributable surplus, calculated under Section 109Y from net assets at market value, prior Division 7A amounts, paid-up share capital, and non-commercial loan adjustments.⁶ The idea is simple: if there are no accumulated profits available to distribute, there is nothing to tax as a dividend. Where the surplus is zero or negative, no deemed dividend arises.

The calculation runs on market-value figures at year end, not book values. Understated assets and overstated liabilities are both common sources of trouble under ATO review.

How to Stop a Loan Becoming a Deemed Dividend

The cleanest fix is full repayment before the company’s lodgment day for the year the loan was made. The lodgment day is the earlier of the return’s due date or the date the return is actually lodged.⁷ Borrow $50,000 during the 2025–26 income year, repay it in full before lodgment day, and Division 7A never bites.

If full repayment is not on the cards, the loan has to sit on a complying loan agreement under Section 109N. A handful of narrow exclusions also apply: loans made on ordinary commercial terms in the ordinary course of a company’s lending business, payments that discharge a genuine arm’s-length obligation, and amounts already assessable under another provision.

What Makes a Loan Agreement Complying

A complying loan agreement has to satisfy three requirements together. Miss any one and the whole loan becomes a deemed dividend from the outset.⁷

The agreement must be in writing, signed before the company’s lodgment day for the year the loan was made, and identify the lender, the borrower, and the loan amount.
The term cannot exceed seven years for an unsecured loan. A loan secured by a registered mortgage over real property can run up to 25 years, but the whole loan must be secured and the property’s market value net of higher-priority debts must be at least 110 percent of the loan when the mortgage is registered.
The interest rate must meet or exceed the Division 7A benchmark rate for each income year. For the 2025–26 year ending 30 June 2026, that benchmark is 8.37 percent. The rate is set from the Reserve Bank of Australia’s variable housing loan indicator rate just before each income year starts, so it moves annually.⁸

The benchmark is not locked in at the start of the loan. Each year’s minimum repayment uses that year’s rate, so obligations rise when rates rise.

Minimum Yearly Repayments

Once the agreement is in place, the borrower has to make a minimum yearly repayment covering principal and interest. The ATO’s formula treats the balance like a standard amortising loan using the current benchmark rate and the remaining term, and the ATO publishes calculators for the arithmetic.⁷

Any shortfall in a given year is treated as an unfranked deemed dividend, subject to the distributable surplus cap. The deemed amount equals the gap. If the minimum was $15,000 and you paid $10,000, $5,000 is assessable income at your marginal rate.

The repayment has to be made by 30 June of the relevant income year, and it has to be real money moving to the company. A journal entry does not count. This is where compliant loans most often fall over: the agreement was set up properly, then a year’s payment slipped.

Trust Distributions and Unpaid Present Entitlements

One of the most common Division 7A situations today involves a trust that distributes income to a private company beneficiary but keeps the cash. The unpaid amount is an unpaid present entitlement, or UPE. The ATO treats the company’s decision not to call for payment as financial accommodation from the company to the trust, which can bring the UPE within Division 7A as a loan.⁹

For entitlements arising from 1 July 2022 onward, the trustee must either pay the company its entitlement (in cash or assets of equal value) or enter into a Division 7A complying loan agreement with the company before the company’s lodgment day. Where a complying loan is used, the trustee then has to meet minimum yearly repayments like any other Division 7A borrower.

Tax Determination TD 2022/11 confirms the financial accommodation arises once the company knows what it can demand and chooses not to, which typically happens shortly after the end of the income year in which the distribution was made.¹⁰ If a family trust distributes to a corporate beneficiary, this needs to be dealt with well before the lodgment deadline.

What a Deemed Dividend Actually Costs

When Division 7A applies, the amount is included in the recipient’s assessable income for that year as an unfranked dividend.¹ The unfranked part is what hurts. A regular dividend from after-tax profits carries franking credits that offset the shareholder’s personal tax. A Division 7A dividend is specifically denied franking credits, and the company’s franking account is not touched.

The result is double taxation. Corporate tax was already paid on the profits at 25 or 30 percent, and the shareholder then pays their full marginal rate on the deemed amount with no credit. In the top bracket that rate is 45 percent plus the 2 percent Medicare levy, so 47 percent all in.¹¹ On a $100,000 deemed dividend, that is up to $47,000 of personal tax with no offset, and combined with the company’s earlier tax the total take on the original profit can top 60 percent.

If the deemed dividend lands in a trust and has not been distributed to a specific beneficiary, the trustee may be assessed on the whole amount at the top marginal rate.¹² Once an assessment issues, repaying the money afterwards does not unwind the tax.

When the Commissioner Will Let a Mistake Go

Section 109RB gives the Commissioner discretion to disregard a deemed dividend, or allow it to be franked, where the breach was an honest mistake or inadvertent omission. This is not a general safety valve. The ATO’s guidance is explicit that ignorance of the law, lack of due diligence, and failure to take reasonable care do not qualify.¹³

The Commissioner works through two stages. First, was there an honest mistake or inadvertent omission (of fact, law, or both), judged against the knowledge and expertise of the person involved, with the taxpayer carrying the burden of proof. Second, even if it qualifies, do the circumstances warrant using the discretion, including how quickly the taxpayer corrected the error once found. Advice from a tax agent can support the claim, but only if Division 7A was actually discussed with the agent and the relevant facts disclosed. Repeat breaches are treated much less generously.

A separate discretion under Section 109RD covers missed minimum yearly repayments. The Commissioner can extend the repayment deadline where the shortfall was due to circumstances beyond the borrower’s control and treating it as a dividend would cause undue hardship. The borrower has to show they could repay when the loan was made, that something changed to reduce that capacity, that all reasonable steps were taken to meet the repayment, and that the shortfall was made up as soon as possible after year end.⁷

1
Australian Taxation Office. Tax Treatment of Division 7A Dividends
2
Australian Taxation Office. Private Company Benefits Division 7A Dividends
3
Australian Taxation Office. ATO ID 2011/8
4
Australian Legal Information Institute. Income Tax Assessment Act 1936 – Section 318
5
Australian Taxation Office. TD 2018/13 – Division 7A Interposed Entity Arrangements
6
Australian Taxation Office. Division 7A Distributable Surplus
7
Australian Taxation Office. Division 7A Loans
8
Australian Taxation Office. Division 7A Benchmark Interest Rate
9
Australian Taxation Office. Division 7A Trust Entitlements
10
Australian Taxation Office. TD 2022/11 – Division 7A Unpaid Present Entitlements and Financial Accommodation
11
Australian Taxation Office. Tax Rates – Australian Resident
12
Australian Taxation Office. Division 7A Rules
13
Australian Taxation Office. PS LA 2011/29 – Commissioner’s Discretion Under Section 109RB