At some point in most startups’ early life, money moves between the founder and the company without much ceremony. The company is short, so the founder covers payroll from savings. The founder is short, so they draw $30,000 from the company account and plan to “sort it out at tax time”. It is the founder’s company, after all — the instinct is that moving money between your own pockets can’t be a tax event.
Division 7A of the Income Tax Assessment Act 1936 (Cth) exists precisely to defeat that instinct. If a private company pays money to, lends money to, or forgives a debt owed by a shareholder or their associate, and the arrangement doesn’t fit within one of the statutory exceptions, the amount is deemed to be a dividend — unfranked — assessable to the recipient at their marginal tax rate. No franking credits, no deduction for the company, and in most cases no way to unwind it after the deadline has passed. For founders, it is one of the most common — and most avoidable — tax problems in early-stage companies.
What Division 7A Catches
The rules apply to private companies — which is to say, virtually every Australian startup — and they catch three families of transaction:
- Payments (section 109C) — money or property paid or transferred to a shareholder or associate, unless a statutory exception applies — such as payments discharging a genuine obligation at no more than arm’s-length value (section 109J) or amounts already assessable in the recipient’s hands, like salary (section 109L). Personal spending on the company card sits here, and so does the private use of company assets, which section 109CA treats as a payment.
- Loans (section 109D) — defined expansively to include advances, the provision of credit or “any other form of financial accommodation”. The $30,000 drawing above is a loan whether or not anyone documented it.
- Debt forgiveness (section 109F) — forgiving a founder’s loan account converts the forgiven amount into a deemed dividend in the year of forgiveness.
Two features make the net wider than founders expect. First, “associate” is defined broadly (borrowing the section 318 definition), so a loan to a founder’s spouse, or to the family trust that holds the founder’s shares, is caught just as if it were made to the founder. Second, the interposed entity rules in sections 109T–109X catch amounts routed through another entity to disguise the destination — lending to a founder’s second company, which on-lends to the founder, doesn’t work.
Direction matters, though. Division 7A is about value flowing out of a private company. A founder lending their own money to the company — the classic bootstrap loan — is not a Division 7A problem, and neither is the company repaying it (though undocumented founder credit loans create their own diligence headaches, and charging interest has tax consequences of its own). And the reach of the provisions is not infinitely elastic: in Commissioner of Taxation v Bendel [2026] HCA 18 the High Court confirmed that a trust’s unpaid present entitlement owed to a corporate beneficiary is not, of itself, a “loan” for Division 7A purposes — a reminder that the regime turns on real transfers of value and financial accommodation, which founder drawings squarely are.
The Deadline That Decides Everything: Lodgment Day
A loan made during an income year is deemed a dividend at the end of that year unless, by the company’s lodgment day — the earlier of the due date and actual lodgment of the company’s tax return for that year — the loan has been repaid or put under a complying loan agreement. That timing rule is the whole game. A founder who draws money in August has until the company’s return for that year is lodged or falls due, whichever comes first — often well into the following calendar year — to fix the position. A founder who discovers the problem after lodgment day is largely out of options.
Two traps sit inside the fix:
- Repay-and-redraw doesn’t work. Section 109R disregards repayments where the borrower intends to reborrow a similar amount — sweeping the loan account clean on 29 June and drawing it down again in July achieves nothing.
- A complying agreement defers, it doesn’t erase. Under section 109N, the loan must be in writing before lodgment day, carry interest at least equal to the ATO’s benchmark rate — 8.77% for the 2026–27 income year, up from 8.37% — and run no longer than 7 years (25 years if secured by a registered mortgage over real property with sufficient headroom in value). From the following year, section 109E requires minimum yearly repayments of principal and interest; miss one, and the shortfall is itself deemed a dividend. At current benchmark rates, a Division 7A loan is expensive money — often more expensive than simply paying salary or a franked dividend and paying the tax.
Deemed dividends are unfranked and generally cannot be franked, which is what makes the sting so sharp: the company has typically paid no tax on the amounts (startups rarely have taxable profits), yet the founder is taxed at full marginal rates with no credit. The Commissioner has a discretion in section 109RB to disregard a deemed dividend or allow it to be franked where it arose from an honest mistake or inadvertent omission — useful, but discretionary, and no substitute for getting it right.
The Startup Twist: Distributable Surplus
Here is the nuance most general commentary misses. A Division 7A deemed dividend is capped at the company’s distributable surplus under section 109Y — broadly, net assets less paid-up share capital (with adjustments). A loss-making, venture-funded startup whose balance sheet is mostly paid-up capital from its raises may have a distributable surplus of nil — in which case the deemed dividend for that year is nil.
Founders sometimes hear this and relax. Don’t. The cap is tested in the year the deemed dividend would otherwise arise, and the loan itself does not disappear — it sits on the balance sheet as a related-party receivable. Forgive it in a later, profitable year and section 109F applies against that year’s surplus. Leave it unresolved and it becomes someone else’s problem to price: founder loan accounts are a standard red flag in investment and acquisition due diligence. Investors read an undocumented founder drawing as a governance signal, subscription agreements routinely include warranties that there are no outstanding related-party loans, and completion checklists routinely require them to be repaid or formally documented before money moves. The tax analysis might land at nil; the deal friction never does.
The Bottom Line
Division 7A is not a trap for the dishonest — it is a trap for the informal. If money has moved from your company to you, your family or your trust, deal with it before the company’s lodgment day: repay it, put it under a complying written agreement at the benchmark rate, or pay it out properly as salary or dividend and account for the tax. Keep the founder loan account clean in both directions, documented, and off your due diligence issues list. The founders who get burned are almost never the ones who planned; they are the ones who meant to sort it out at tax time.
This article is general information only, not legal or tax advice — the treatment of any founder loan depends on the amounts, timing, documentation and your company’s distributable surplus, and you should take advice on your specific position. Viridian Lawyers advises Australian startups and founders on company structuring, founder arrangements and financing readiness, and works alongside your accountant on Division 7A compliance. If there is an undocumented loan on your balance sheet, get in touch.
