The Australian Taxation Office defines “loan” under Division 7A as a form of credit or advanced payment that the receiver must repay under terms agreed with the lender.
Whether you’re part of a publicly traded company, a shareholder, or a lending party, getting your head around Div7A can take some time–not to mention the major changes to repayments the ATO declared in 2023.
Read on as we outline what Div7A loans are, convey key changes you should know about, share advice on mitigating risk, and offer tailored support.
What are Division 7A Loans?
Division 7A applies to loans granted by private companies or trustees to shareholders or associates. The ATO enforces this division to prevent tax avoidance on assessable assets or finances loan recipients receive.
Secured Div7A loans, such as mortgage terms, hold a maximum repayment period of 25 years. Unsecured loans under this division have a maximum 7-year term.
In some circumstances, Div7A applies to dividends. Usually, payments sent between private companies and investing shareholders are named dividends. These dividends are usually franked, meaning they’re tax-free. Dividends paid under Div7A are typically unfranked, so income tax applies.
Have Div7A Interest Rates Changed?
As of the 1st July 2023, Division 7A interest rates will increase from 4.77% to 8.27%. Let’s put that into perspective with two scenarios.
A shareholder receives an advanced payment from a private company where the 2023 changes apply:
- Loan amount: $170,000
- Interest rate: 8.27%
- Total interest = Loan amount x interest rate = $170,000 X 0.0827 = $14,059
- Minimum yearly repayment (7-year term): $32,954.00
For comparison, shareholders repaying interest at the previous rate of 4.77% would have had an interest rate of $8,109 and a minimum annual repayment of $29,135.00. Using the calculation above, the shareholder now faces a substantial $5,950 increase in interest and yearly payments by $3,819.
(Images sources from: ATO Calculator)
What’s the Impact of These Changes?
Payments made from the 2023–2024 financial year will significantly increase, potentially hitting recipients harder. Most people will also have tax obligations on top of that amount, such as income tax.
There’s also no guarantee that rates will stagnate or drop next year. As we review trends over the recent years, interest has risen every year since 2021, where rates were 4.52%. (Source: ATO, September 2023).
How to Mitigate Risk with Div7A Loans?
If you’re managing a Div7A loan or preparing to take one, working with an accountant to recognise your financial strategy and put a reliable repayment plan in place should mitigate significant loss.
The key to managing these loans is gathering repayment funds from other income streams, like regular dividends or trust distributions. It’s important to remain realistic–accumulating finances from dividends relies on the company’s success.
We suggest reducing the payment term to around three years instead of seven so you contribute successful years’ dividends to the larger payments. This will also cover your back if the interest rates rise again.
Have You Taken a Div7A Loan? Let’s Face It Together
Our certified accountants at Advisory One specialise in financial planning and strategy building. Contact us to learn how our expertise can help you develop a plan that hits all your monetary obligations without causing major financial strain.