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How do deemed dividends arise?
In the previous article, we delved into the concept of dividends and their tax implications. For further clarification on the imputation system and deemed dividends, please refer to the definitions provided in Dividends vs Deemed Dividends .
This article will focus on exploring the regulations surrounding deemed dividends and their limits.
Notable regulations regarding deemed dividends provided by ITAA36 are as follows:
- Section 109- Excessive Payments
- Division 7A - Loan to Shareholders
- Bonus share issues
Section 109- Excessive Payments
If a private company makes an excessive payment to someone associated with the company as remuneration, termination or retirement allowance, that payment will be treated as an unfranked deemed dividend.
Division 7A- Loan to shareholders
Loans to shareholders may be considered deemed dividends in certain circ*mstances. Here are three primary situations.
Situation 1
A company makes a non-arms-length loan to its shareholders.
1. If the shareholder pay back the loan before the end of the financial year, Loan = loan
2. If the shareholder did not pay back the loan by the due date of Company A’ tax return, Loan = deemed dividend
Situation 2
A company makes a loan to an entity and that entity handed the loan to company A’s shareholder who makes repayments to company A.
1. A deemed loan arises between companies A and B as a result of an interposed entity loan.
2. The deemed loan has to be either repaid or converted to a Div7A compliant loan before the tax return due date or it will become a deemed dividend.
Situation 3
If a company is a beneficiary of a trust and the unpaid present entitlement of the company beneficiary (UPE) has been distributed by trust A to company A’s shareholder for use.
1. Deemed loan arises due to UPE in Trust A being distributed to Company A’s shareholders instead of the company itself.
2. The deemed loan has to be either repaid or converted to a Div7A compliant loan before the tax return due date or it will become a deemed dividend.
Note that loans or any remuneration made by a company to its shareholders’ associates (family) can be subject to potentially become deemed dividends.
Bonus share issues
When shareholders opt for additional shares instead of cash dividends from a company, these extra shares are considered deemed dividends for tax purposes. However, if shareholders receive bonus shares without the option to choose, they are not treated as deemed dividends.
What is the limit on deemed dividends?
Deemed dividends are limited to the amount of a company’s distributable surplus, which is calculated as below:
Net assets + Division 7A amounts - Non-commercial loans - paid-up share value - repayments of non-commercial loans
Hence, when the estimated deemed dividends exceed the distributable surplus, amounts over the threshold would not be considered as part of the deemed dividend.
Overall, deemed dividends have to be included in the shareholder or their associates’ assessable income for tax purposes and franking credits will not apply if those deemed dividends are treated as unfranked dividends. Moreover, the deemed dividends of a company are constrained by its distributable surplus. Any excess amount beyond this surplus, in the form of loans extended to shareholders and their associates, will not incur tax consequences.
CTK Accounting is a full-scope accounting firm based in Wollongong, servicing clients nationally.
For advice on Tax, BAS, GST, Bookkeeping, and Payroll visit us at ctkaccounting.com.au
