Company Loans: Take Care - avoid having additional income assessed to you by ATO
Care must be taken so that the ATO does not deem these loans to be dividends, and tax them accordingly, with the total loan amount being deemed a dividend and added to the assessable income of the recipient.
Private Company Loans
Borrowing money from a private company can have serious pitfalls if not done correctly.
Directors and shareholders of private companies often borrow money from their companies for various reasons.
Care must be taken so that the ATO does not deem these loans to be dividends, and tax them accordingly, with the total loan amount being deemed a dividend and added to assessable income of the recipient, with the total principal capital loan amount being added to the recipients assessable income all in the one year that the loan principal was taken.
When the ATO deem a loan as assessable income of the recipient - the ATO deem the income an unfrankled dividend, so no benefit is available to use any frankling credits available to the company.
How do I ensure my loan is not deemed a dividend by the ATO?
A Division 7A loan agreement is typically used to prevent the ATO deeming your loan as assessable income to you.
However, we have seen many agreements which don't meet the ATO requirements - any old agreement will not do.
Very specific criteria must be met for the loan agrement to be sucessful in preventing the ATO from deeming the loan an unfranked dividend.
Some professional advisers believe that you can have one loan agreement that works for a number of years even when you draw new amounts of capital from the business - like a line of credit agreement. Ascendia Lawyers believes this is not what the law allows for, and that persons using these types of Div 7a Loan Agreements are running the risk that their agreements do not meet the requirements of Division 7a of the Income Tax Assessment Act.
I had a Division 7A Loan Agreement prepared years ago and my accountant has a copy, do I need another one?
In order to have a valid Division 7A Loan Agreement, you must have a separate loan agreement for each advance and for each financial year in which a loan occurred. This means that when your accountant is preparing your annual accounts, they should identify the amount of the loan at the end of each financial year, and you need to have a compliant Division 7A Loan Agreement prepared for each and every loan which specifies the exact amount of the loan for the relevant period.
I wrote a Loan Agreement on my computer at home, will that work for Division 7A?
If the terms of the Loan Agreement do not correspond with the specific requirements under the legislation, then the Loan Agreement is ineffective and treated as if you do not have a Division 7A Loan Agreement in place.
Does it matter if I I don’t have a Loan Agreement, will it effect my tax return?
If your accountant identifies that there is a Loan for a relevant financial year and you do not have a proper loan agreement prepared, your self assessment obligation is that you must re- prepare your returns for both the company and your personal returns in order to account for the fact that there is no valid loan. This may mean further tax for you to pay both personally and in the company, as well as additional accounting fees for the work required to re-prepare the returns.
My company is not affected by Division 7A?
All private companies are covered by this section.
I don’t have to actually repay the loan?
It is a requirement of a Division 7A loan that the principal amount is repaid over a period of seven years. Your accountant can provide a calculation of the amount payable per year.
Ascendia Lawyers can prepare your Division 7A Loan Agreements to ATO compliant standards in conjunction with your accountant.
Are there any other ways to deal with this?
There are new arrangements now called "sub-trust' arrangements which you may also be interested in. These re similar - requirign legal documentation to meet ATO requirements, however the repayment terms are different.
For more information, please do not hesitate to contact Natalie Carpenter, Legal Practice Director