Division 7A - Loan not repaid at the end of the year

Are the balances of opening debit balance loan accounts, not repaid at years end, deemed to be unfranked dividends under the legislation contained in Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The balance of shareholders loan accounts, at the end of the year, are deemed to be unfranked dividends under Division 7A of the ITAA 1936 to the extent of the company's distributable surplus.

As part of a business restructure, a partnership transferred its assets and liabilities to a private company on 1 July 1999. In this transfer, the overdrawn capital accounts of the partners were taken over by the company as loans to shareholders. During the year, entries were transacted in the respective loan accounts of the shareholders.

At the end of the financial year, these loan accounts were not repaid and recorded a debit balance. The company had a distributable surplus.

Generally, Division 7A of the ITAA 1936 has the effect that loans made by private companies to shareholders or their associates on or after 4 December 1997 will be treated as dividends and assessable to the recipient under section 44 of the ITAA 1936. A loan is defined in subsection 109D(3) of the ITAA 1936 to include: • an advance of money; • a provision of credit or any other form of financial accommodation; • a payment of an amount for another person if there is an obligation to repay the amount; and • a transaction that is in substance a loan.

A loan is taken to have been made in the year of income in which the private company pays or credits an amount to the shareholder or associate by way of loan.

A loan will be treated as a dividend where: (a) a private company makes a loan to a shareholder or associate in a year of income; and (b) the loan is not fully repaid by the end of that income year; and (c) Subdivision D does not prevent the private company from being taken to pay a dividend; and (d) the recipient of the loan is either a shareholder in the private company or an associate of such a shareholder when the loan is made, or a reasonable person would conclude that the loan is made because the recipient has been such a shareholder or associate at some time.

The amount that is treated as a dividend is the amount of the loan that has not been repaid at the end of the year in which it is made, subject to there being a distributable surplus in the company. A loan in existence at 4 December 1997 is not affected, unless the loan is varied to extend the term or to increase the amount.

Here, the private company lent funds to shareholders on 1 July 1999. The loans were not fully repaid at 30 June 2000. The private company had a distributable surplus at 30 June 2000.

The loans do not meet the exclusions contained in Subdivision C and D of Division 7A.

Therefore, the balance of the loans to shareholders at 30 June 2000 will be treated as a dividend under Division 7A and assessable to the recipients under section 44 of the ITAA 1936 to the extent of the private company's distributable surplus.

The dividend will be unfranked as it is excluded from the definition of 'frankable dividend' provided in section 160APA of the ITAA 1936.