Announcements
Looking for information on the JobKeeper extension? Watch the video in our latest news article.

ATO Community

Re: Division 7A - Deemed Dividends

Highlighted

Initiate

Views 1181

Replies 3

Hello all,

 

A general and practical question regarding Division 7A.

 

Here is the setting:

Company A -  Individual Bob and Individual Peter has debit loans, completely private in nature and in their individual names.

Company A - Bob & Peter are both Directors of Company A

Trust Bob - is Shareholder of Company A (Individual Bob is the director of the Trustee of Trust Bob)

Trust Peter - is Shareholder of Company A (Individual Peter is the director of the Trustee of Trust Peter)

Assume company A has sufficient retained earnings and is not in a loss position for the current year.

There are complying loan agreements between Company A, with Individual Bob, and Individual Peter respectively.

 

Issue:

Individual Bob has not made enough repayments in 2019 to comply with his Division 7A loan agreement.

Individual Peter has made his repayments and is fine.

Both individuals have agreed that Company A would not pay a dividend for 2019.

 

In my understanding of this situation:

There is a deemed dividend to Bob. (let's assume he needs $5,000 to meet his minimum repayment and interest ($4,500 repayment & $500 interest))

Deemed dividends are different to normal dividends, they are not treated as 'dividends' but more as 'Income that is assessable to Bob'

 

Question:

1. Is my understanding above correct?

2. How does Company A account for this $5,000 deemed dividend to Bob in their financials

        (ie: Dr. Dividend(?) , Cr. Bob loan, Cr. Interest income)

3. Where should this deemed Dividend be reported on the Company Income Tax return? (Item X?)

4. Where does Bob report this $5,000 in his tax return? (Item X?)

5. I understand that this might also fall under the FBT regime as the loans are to the directors. So which takes precedence? Div7a or FBT? Bob & Peter are also associates of the shareholders...

 

Your help is appreciated for this curious one, many thanks.

 

Miss Chan

1 ACCEPTED SOLUTION

Accepted Solutions
Highlighted

Most helpful response

Devotee

Replies 2

1. Is my understanding above correct?

Looks reasonable to me.

 

2. How does Company A account for this $5,000 deemed dividend to Bob in their financials

        (ie: Dr. Dividend(?) , Cr. Bob loan, Cr. Interest income)

Looks right.

 

3. Where should this deemed Dividend be reported on the Company Income Tax return? (Item X?)

Deemed dividends are unfranked dividends - Dividend & Interest Schedule

 

4. Where does Bob report this $5,000 in his tax return? (Item X?)

Unfranked dividends.

 

5. I understand that this might also fall under the FBT regime as the loans are to the directors. So which takes precedence? Div7a or FBT? Bob & Peter are also associates of the shareholders...

Div 7A.

Division 7A applies in preference to FBT to loans made by a private company to a shareholder or their associate. 

see here

3 REPLIES 3
Highlighted

Most helpful response

Devotee

Replies 2

1. Is my understanding above correct?

Looks reasonable to me.

 

2. How does Company A account for this $5,000 deemed dividend to Bob in their financials

        (ie: Dr. Dividend(?) , Cr. Bob loan, Cr. Interest income)

Looks right.

 

3. Where should this deemed Dividend be reported on the Company Income Tax return? (Item X?)

Deemed dividends are unfranked dividends - Dividend & Interest Schedule

 

4. Where does Bob report this $5,000 in his tax return? (Item X?)

Unfranked dividends.

 

5. I understand that this might also fall under the FBT regime as the loans are to the directors. So which takes precedence? Div7a or FBT? Bob & Peter are also associates of the shareholders...

Div 7A.

Division 7A applies in preference to FBT to loans made by a private company to a shareholder or their associate. 

see here

Highlighted

Initiate

Replies 1

Hello TaxedoMask, thank you for your response.

 

I might have a gap in my understanding that I hope you could help with.

 

"Deemed dividends are unfranked dividends"

Does this mean that the company is 'issuing' unfranked dividends to Bob? I always thought that companies can only issue dividends (franked & unfranked) to their shareholders.. is this not the case?

 

In the example I have given, the company would enough retained earnings to facilitate unfranked dividends, what would happen if there is not enough retained earnings to issue unfranked dividends? Or does it not matter because although it is unfranked dividends, it is not treated as the general dividend rules?

 

Highlighted

Devotee

Replies 0

Yes - in some ways you can say that to the extent the company has a distributable surplus, then it is forced to pay an unfranked dividend to Bob which treats the amount as income. If no action is taken then you can think of this outcome as the default outcome when there is a Div7A loan.

 

Bob is an associate of the shareholder. The trust is treated as an interposed entity - thus is effecitively ignored 109T ITAA1936

 

Div 7A looks at a concept called Distributable Surpluswhich is like a modified retained earnings. If there is a distributable surplus, then the company in this case is deemed to have paid an unfranked dividend.

 

The purpose of Div7A is to avoid taxpayers being able to spend pre-tax money for private purposes. Think of it as more of a punishment tool rather than someone which people try to utilise. (there are some edge cases, but somewhat outside of what we are discussing).

 

On a practical level, most private companies elect to pay a franked dividend (so at least the franking credits are being utilised). Or place the amount under a complying loan agreement

 

Can also go down the 109RB route (Commissioner's discretion make it franked) but I would not recommend it.