For busy medical professionals and GP owners, the financial well-being of your practice is just as critical as the health of your patients. One area that frequently trips up practice owners is Division 7A – a complex part of tax law closely watched by the ATO.
Unfortunately, entirely avoidable errors can lead to significant and unexpected tax liabilities. Knowing the common pitfalls is the first step to staying compliant and protecting your practice’s finances.
What is Division 7A?
Division 7A is an ‘anti-avoidance’ measure designed to prevent private companies from making tax-free distributions of profits to shareholders (or their associates) through disguised payments, loans or forgiven debts. Importantly, the definition of a ‘loan’ under Division 7A has a broader meaning than most people expect.
A loan includes:
- An advance of money
- Any form of credit or financial accommodation (providing money or a financial benefit)
- Payments made on behalf of a shareholder or associate with an obligation to repay
- Any transaction that in substance is the same as a loan
This means informal arrangements that seem harmless can easily trigger Division 7A issues if not handled correctly.
Common Division 7A errors for practice owners
- No complying loan agreement
If you borrow funds from your practice and the loan is not fully repaid by the time the practice’s tax return is lodged, it must be placed under a ‘complying loan agreement’. This agreement must be in writing; charge at least the ATO’s benchmark rate; have a maximum term of 7 years (unsecured) or 25 years (secured over real property).
Without this agreement, the ATO can classify the entire loan as an unfranked dividend for that year and that means a personal tax bill.
- Repayments don’t qualify as genuine
Complying loans require minimum yearly repayments. However, not all repayments count.
A common error is ‘round-tripping’ – transferring funds to the practice account just before year-end and then withdrawing them again shortly after. The ATO won’t accept this as genuine. A repayment must be a real transfer of funds that reduces the loan balance.
- Personal expenses paid from the practice
It can be tempting to use the practice bank account to pay for significant personal expenses. However, these are treated as loans under Division 7A.
To avoid compliance issues, these amounts must be repaid in full before the company’s tax return is lodged. Be cautious, lodging the return early reduces the repayment window.
The consequences of getting it wrong
We sometimes encounter clients where Division 7A issues have been overlooked by their former accountant or dealt with inadequately. When these rules are breached, the loan or payment is treated as a ‘deemed dividend’. This amount is added to the shareholder’s assessable income as an unfranked dividend, which can result in a significant personal tax liability. These dividends are generally not frankable.
Where an honest mistake or inadvertent omission has been made, it may be possible to apply to the ATO for relief.
Protect your practice’s financial health
Withdrawing funds from your practice is a common and necessary activity, but it can lead to unintended Division 7A consequences. For busy medical professionals focused on patient care, having an accountant who understands and proactively manages Division 7A is essential. By addressing these risks early, you can protect both your practice’s financial stability and your personal financial well-being.
Contact your William Buck advisor to safeguard your practice and avoid unnecessary ATO attention.
