Repaying a Division 7A loan correctly is crucial to avoid the loan being treated as an unfranked dividend, which can result in unexpected tax liabilities. Here are the primary ways to repay a Division 7A loan:
1. Minimum Yearly Repayments
Interest and Principal: The borrower must make minimum yearly repayments, which include both interest and principal, starting from the income year after the loan is made.
Benchmark Interest Rate: The interest rate for each year of the loan must be at least equal to the Division 7A benchmark interest rate. For the income year ending 30 June 2024, the benchmark interest rate is 8.27%. This increases to 8.77% for the year ending 30 June 2025.
Due Date: The required payments must be made by the end of the income year (usually 30 June).
2. Full Repayment
The borrower can repay the entire loan amount in a lump sum before the company’s tax return lodgment date to avoid the loan being treated as a dividend.
3. Offsetting Against Dividends
The borrower can use dividends declared by the company to offset the loan balance. This involves declaring a dividend and applying it against the outstanding loan amount. If the company has sufficient franking credits, the dividend can be franked to reduce additional tax liabilities.
4. Refinancing the Loan
The borrower can refinance the existing Division 7A loan with a new complying loan agreement. The new loan must meet all Division 7A requirements, including being in writing, having a benchmark interest rate, and adhering to the maximum loan term (7 years for unsecured loans or 25 years for certain secured loans).
5. Using Other Funds
The borrower can use personal funds or other available resources to repay the loan. This can include savings, proceeds from the sale of assets, or other income sources.
Important Considerations
Record Keeping: Maintain detailed records of all repayments, including dates, amounts, and sources of funds.
Compliance: Ensure that all repayments comply with Division 7A requirements to avoid the loan being treated as a dividend.
Professional Advice: Consult with a tax professional to ensure that repayments are managed correctly and to explore the most tax-efficient repayment strategies.
By understanding and utilizing these repayment methods, borrowers can effectively manage Division 7A loans and avoid unexpected tax consequences.
