A common occurrence, particularly in family companies, is the provision of benefits to shareholders of a company in which those same shareholders are also directors of the company. The question will then arise; is that payment caught by Division 7A or FBT?
As a general rule, a fringe benefit arises if the company provides a benefit to a director of the company (directors are also employees) in connection with the performance of his or her duties (that is, the benefit is provided in respect of the employee’s employment).
At the same time, the benefit provided may also be subject to Division 7A – which deems the provision of a benefit to a shareholder (or associate) to be an unfranked dividend which is required to be assessed in the hands of recipient.
Broadly, Division 7A is an integrity measure that applies to loans, payments and debt forgiveness made by a private company to a shareholder (or an associate of the shareholder). The extended definition of “payment” under Division 7A includes the provision of an asset for use by the entity (see s109CA).
A typical example where a fringe benefit and payment for Division 7A purposes can happen is the use of a holiday house by a shareholder/director. There is a residual fringe benefit provided by the company as well as a payment for Division 7A purposes.
Division 7A and the FBT regime contain tie-breaker tests. These tests determine whether the FBT regime or Division 7A prevails where a benefit is provided by a private company to an employee in respect of their employment and also in their capacity as a shareholder.
The benefit type and the tax outcomes are laid out in the table below.
|Division 7A benefit type||Outcome||Reasoning|
|Loan from private company to shareholder/employee (or associate)||Division 7A will apply in favour of FBT for loans to shareholder/employees (s109ZB(1) ITAA36).||Specifically, Division 7A will apply to a loan to a shareholder or an associate even if the loan is made to that entity in its capacity as an employee or associate (as defined under FBT law), or in respect of the employment of an employee. Prima facie, the loan is a deemed dividend to the recipient.The provision of the loan does not constitute a loan fringe benefit as it is excluded from the definition of fringe benefit (see s136(1) – para (r) FBTAA).
Note also that the loan is still precluded from being a loan fringe benefit where the loan is taken to be a dividend, but the amount is reduced to nil due to a “nil” distributable surplus (see ATO ID 2011/33).
Further, if the loan is placed on a complying loan agreement in accordance with s109N ITAA36 from 1 April 2007, the loan will not be treated as a fringe benefit (s136(1)- para (s) FBTAA). A complying loan satisfies the minimum interest rate and maximum term criteria. This ensures that FBT is not payable for the period in the income year that no interest was required under the loan agreement to be paid on the loan.
|Debt forgiveness by private company to shareholder/employee (or associate) in respect of loan owed such entities||Division 7A will apply in favour of FBT for debt forgiveness in respect of a loan owed by a shareholder/employees (s109ZB(2) ITAA36).||Specifically, Division 7A will apply to a debt forgiveness by a company in respect of a loan owed by a shareholder or an associate even if the loan is made to that entity in its capacity as an employee or associate (as defined under FBT law), or in respect of the employment of an employee. Prima facie, the loan is a deemed dividend to the recipient.The forgiveness of the debt owed does not constitute a fringe benefit as it is excluded from that definition (s136(1) FBTAA). As such, a debt waiver fringe benefit has not been provided.|
|Payment* by private company to shareholder/employee (or associate)||FBT will apply in favour of Division 7A for payments to shareholders/employees (s109ZB(3) ITAA36).||Division 7A does not apply to a payment made to a shareholder, or an associate of a shareholder, in their capacity as an employee or an associate of such an employee.The payment can be either an expense payment, property fringe benefit or a residual fringe benefit.
The company is prima facie subject to FBT (unless an exemption or reduction to taxable value applies).
*A payment for Division 7A purposes (s109C ITAA36) includes:
– a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity, and
– a credit of an amount to the extent that it is to (i) the entity; (ii) on behalf of the entity; or (iii) for the benefit of the entity, and
– a transfer of property to the entity.
It also includes the provision of an asset by the company for use by the entity (s109CA ITAA36).
Bob is the sole director and shareholder of ABC Pty Ltd.
The company provides him use of a yacht his own for services rendered as an employee. The provision of the asset for Bob’s use is also a payment for Division 7A purposes.
The company also provided a loan to Bob on interest-free terms in his capacity as an employee. The provision of the loan is also taken to be a loan for Division 7A purposes. It has not been placed on a complying s109N loan agreement.
As the benefits were provided to Bob “in respect of his employment”, the FBT implications to ABC Pty Ltd are as follows:
The provision of the yacht for Bob’s personal use is a residual fringe benefit and is not a deemed dividend pursuant to Division 7A due to the operation of the tie-breaker in s109ZB(3) ITAA36. The benefit is not specifically excluded under the meaning of fringe benefit in s136(1)). Therefore, ABC Pty Ltd will, prima facie, be subject to FBT on the provision of the benefit.
The interest-free loan made by the company to Bob is not a fringe benefit to the extent that it is a deemed dividend pursuant to Division 7A due to the operation of the tie-breaker s109ZB(1) ITAA36. The benefit is specifically excluded under the meaning of fringe benefit in s136(1) para. (r) ITAA36. The company, prima facie, is treated has having paid a deemed dividend to Bob.