How Shareholder Loans Can Quietly Increase Your Long-Term Tax Bill
Many business owners I talk to initially see shareholder loans, particularly those falling under Division 7A, as a smart move. They imagine it’s a neat way to get cash out of the company now, deferring personal tax and keeping more money in their pocket today.
It sounds appealing, doesn't it? Avoid an immediate personal tax hit on a dividend, and instead, take a loan from the company.
Deferring tax doesn’t always mean saving it. A Division 7A loan can increase your total tax over time once you factor in interest, repayments, and how franking credits apply. It often looks simple on paper, but the long-term outcome can be more expensive.
At Tullastone, we regularly review these arrangements for business owners and often find avoidable costs built into the structure.
The Hidden Tax Mechanics That Compound Over Time
Many business owners look at a Division 7A loan mainly as a way to defer personal tax. Even when it’s fully compliant, it can create ongoing taxable events for both you and the company for seven years or more. The real question isn’t the cashflow benefit in year one, it’s the total tax paid over the life of the loan.
The company pays tax on interest it charges you
Start with the company’s side. For a Division 7A loan to be compliant, the company has to charge interest. Even though it feels like an internal book entry, that interest is still taxable income to the company, so the company pays company tax on it.
Here’s a simple example. Say you borrow $100,000 under a Division 7A loan and the benchmark interest rate is 8.27%. That means the company charges $8,270 in interest for the year. If the company tax rate is 25%, the company then pays $2,067.50 in tax on that interest income.
So even before you look at your personal tax position, a Division 7A loan can create a real, recurring cost at the company level: the company is earning interest, and the ATO takes a cut of it every year.
You can't deduct the interest (if it's for personal use)
Now, what about that interest you're paying to your company? If you used the loan funds for personal expenses, that interest isn't tax-deductible for you personally but rather a non-deductible expense.
Contrast this with using the funds for an income-producing investment. In that specific case, the interest might be deductible, lessening the personal burden.
However, most Division 7A loans are taken for personal reasons, meaning you're paying interest out of your after-tax income with no corresponding personal tax relief.
This creates a real economic cost, where you're paying a benchmark rate of interest, but the tax system isn't giving you any break on it personally.
Repayments usually trigger dividend tax anyway
To keep a Division 7A loan compliant, you must make the minimum yearly repayment (MYR). In practice, many owners cover this by having the company declare a franked dividend, then applying that dividend straight against the loan balance. It often feels cashless, but it still has a tax outcome.
The main thing is that the loan may reduce the upfront tax hit, but it doesn’t remove tax altogether. You’re simply shifting it into smaller, ongoing personal tax bills as those dividends are declared each year across the loan term.
That can be a sensible trade-off when cash flow matters, but it’s important to understand you’re deferring the tax, not avoiding it.
When the Numbers Actually Favour Each Option
It's easy to get lost in the theoretical mechanics. Let’s bring this down to brass tacks: when does an upfront dividend actually make more sense than a Division 7A loan, and vice versa?
It really boils down to a clear comparison, where the theory meets your real-world financial situation. While Division 7A can definitely offer benefits for timing your personal cashflow, the impact of those ongoing interest charges and tax events can really shift the balance of total tax paid.
Worked comparison: dividend now vs Division 7A over time
Picture a common scenario: you need $100,000 for personal use. Your company tax rate is 25%, and your personal marginal tax rate (including Medicare levy) is 39%. If you choose a Division 7A loan, assume a benchmark interest rate of 8.27% and a typical 7-year unsecured term. Rather than running every line-item, here’s the practical difference in how the tax shows up.
If you take the money as an upfront franked dividend, the tax outcome is largely concentrated in year one. The company has already paid tax at 25% (that’s $25,000 on $100,000 of profit). You then pay the top-up personal tax on the dividend after franking credits, which in this simplified example is roughly $18,667. That puts the combined tax impact at around $43,667. The key point is it’s essentially one main personal tax event, paid upfront.
If you take the money as a Division 7A loan, the personal tax hit is spread out, but you usually create more moving parts. The company charges interest each year (which is taxable income to the company), and you typically clear the minimum yearly repayments using franked dividends over the loan term (which still creates personal tax each year). Over seven years, that layering of company tax on interest plus personal tax on dividend-funded repayments can push the combined total higher, commonly landing around $47,000 to $50,000+ in a simplified comparison like this.
The takeaway is straightforward: the loan can feel better in year one because it defers tax, but once you account for interest and the way repayments are commonly funded, the total tax paid over time can end up higher than taking the franked dividend upfront.
The discount rate question most owners skip
Net present value (NPV) is just a way to compare “tax later” versus “tax now”. Deferring tax can be valuable because you keep cash for longer, but only if you can earn a return on that cash that outweighs the extra costs of the structure.
Your discount rate should reflect your real cost of funds, or what your money could earn elsewhere. For many owners, that’s either their home loan rate or the return they can reliably generate by reinvesting in the business.
Example: if your home loan is 6% and the Division 7A loan lets you keep more cash in your offset, your “return” on the deferral is effectively 6%. At that level, the benefit of deferring tax can be modest, and it can be quickly eroded by the ongoing tax friction of Division 7A (interest income taxed in the company, non-deductible interest personally, and dividend-funded repayments). This is often the deciding calculation.
Scenarios where Division 7A still makes sense
Now, let's be clear that the Division 7A loan isn't always the wrong choice. It just needs to be applied in the right circumstances. There are indeed practical scenarios where it can be a smart move:
Genuine Cash Need Now: If you have an urgent personal expense or a deposit for something important and immediate, and your personal cashflow is genuinely tight, a Division 7A loan can provide that crucial timing flexibility.
High-Return Use for Funds: If you plan to use the loan money for an investment or business opportunity that promises a significantly higher return than the benchmark interest rate – for example, if you can earn 12% on the funds while the loan costs you 8.27% – then deferring tax makes commercial sense. You're effectively leveraging cheap capital.
Longer Loan Term Available: While unsecured loans are typically 7 years, some secured loans can extend to 25 years. A longer term further spreads the repayment burden and might make the cashflow manageable, though the total interest paid increases.
Strong Admin Discipline: If you and your business have impeccable financial discipline, meticulous record-keeping, and the commitment to manage repayments and interest accurately year after year, it reduces the risk of costly mistakes.
These are specific, calculated decisions, not the default. It's about weighing the costs and benefits with a clear-eyed view of your unique financial situation, not just grabbing seemingly "free" money.
What to Check Before You Choose
Choosing between an upfront franked dividend and a Division 7A loan isn’t a gut call. It’s a financial decision that affects cash flow, tax outcomes, and admin risk over multiple years.
This is where tax advisory for business owners matters: not just staying compliant, but modelling the options properly based on your margins, tax rates, and what you’re actually using the funds for.
The goal is a simple decision framework you can defend, backed by your numbers, not a default approach you follow because “that’s what everyone does”.
The six-question decision framework
Before you commit to either option, ask yourself these six practical questions:
What are the funds for? Is it personal use (non-deductible interest) or an income-producing investment (potentially deductible interest)?
What is your marginal tax rate now versus what you expect in the future? If you anticipate a lower personal tax rate in later years, deferring might offer a slight benefit, but this needs careful modelling.
What company tax rate applies to your business? Knowing if it’s 25% or 30% affects the tax on the interest income your company earns.
What is the current Division 7A benchmark interest rate? This rate significantly impacts the company's assessable interest income and your annual repayments.
What is your cost of funds or opportunity cost? If you’re using the funds to pay down a home loan at 6%, that 6% is your opportunity cost. If you can earn 15% in your business, that’s your opportunity cost. Compare this to the benchmark interest rate.
Have you modelled total cashflow and NPV (Net Present Value)? This isn't just about year one. Have you mapped out the total tax implications and cash movements for both scenarios over the full loan term?
These questions aren't designed to give you a single answer but to guide your thinking and ensure you consider all the angles before making a choice that impacts your long-term wealth.
Common mistakes that turn compliant into costly
Even with the best intentions, it's remarkably easy for a compliant Division 7A loan to become a costly headache. Here are some of the common missteps we see:
No Proper Loan Agreement: Relying on verbal agreements or incomplete documentation is a recipe for disaster.
Missing Minimum Yearly Repayments: Forgetting or failing to make your MYRs turns the loan into an unfranked dividend, often triggering a massive personal tax bill in one hit.
Poor Dividend Documentation: Not correctly documenting the dividends used to fund repayments can lead to compliance issues.
Not Modelling Total Tax: Focusing only on the initial cashflow benefit without projecting the total tax over the full term is a huge oversight.
Ignoring Rate Changes: The Division 7A benchmark interest rate changes annually, and failing to adjust can lead to under-repayments.
Treating Division 7A as Set-and-Forget: These loans require ongoing attention and administration.
This is where an experienced business tax accountant helps, as they can help you set the loan up correctly, keeping the paperwork tight, and making sure repayments and dividends are handled properly so small mistakes don’t turn into big tax bills later.
Business Tax Accountant Takeaways: Avoid the Quiet Tax Creep
Division 7A loans can feel like a shortcut: take company cash now and push personal tax into future years. The catch is the structure creates ongoing tax costs.
Interest is taxable to the company, the interest is often non-deductible personally if the funds are for private use, and repayments are usually made via franked dividends, which still triggers personal tax over time.
If you’re considering a shareholder loan, speak with a business tax accountant before you lock it in. At Tullastone, we can model dividend vs Division 7A outcomes using your actual tax rates, loan terms, and intended use of funds, then set the structure up properly so it stays compliant and doesn’t quietly cost more than it needed to.