Can a director or shareholder take a loan from a company?

Over the years the ATO has developed and tinkered with legislation via division 7A of the tax legislation which specially sets out the rules, requirements and responsibilities of taking funds untaxed from the company.  It applies to amounts paid, lent or forgiven by a private company to a shareholder or their associate.

These laws have been developed since 1997 with pre 1997 loans protected until recently with new legislation proposed to change this situation.

If a director / shareholder takes a loan from a company or via an associated structure or individual, then that loan has to be repaid within 7 years and interest charged at the ATO rates as a minimum plus interest and principal paid back annually on all loans established since 1997. A written loan agreement between the individual and structure is also required, where the ultimate beneficiary of the loan is an individual company officer or associate. If this legislation is not followed and there is no written loan agreement in place then a deemed unfranked dividend is applied by the ATO and tax must be paid on these funds by the individual or associate (this could apply to the individual trustee or directors of a trust).

The company is a separate person in law; the company is not the individual director, associate or family member; the company is its own entity and not an extension of the person.

These rules are continually tightening and the interest rate to be charged on these loans increased annually by the ATO as a disincentive which is well above the bank interest rates on home loans.

On real property the loan period over which repayments must occur is up to 25 years and the annual nominated interest rate by the ATO must be applied annually.  Again, interest and principal must be paid annually and if not a deemed unfranked dividend is applied.

If you are concerned about a division 7A loan or funds that you have borrowed, debt forgiven or expenses paid from the company, you have a number of options:

1. Pay the funds back immediately before the 30 June in full or plus interest if past the 30 June in any financial year.
2. Get a loan agreement in place and pay the interest and principal according to the terms and over the period of the loan either 7 years or 25 years on real property.
3. Convert the loan to an unfranked dividend and pay tax at individual rates of tax.
4. Pay wages to pay off the loan and remit tax to the ATO.
5. Transfer cash to the entity to pay off the loan.
6. Face the consequences that the ATO rules apply to you and the company for non-compliance if discovered or reported to the ATO.

Please come and see your local TaxAssist Accountant for guidance if you suspect you have incurred a division 7A loan or have a division 7A loan in place and need tax advice.

 

David Cornes

CPA

Date published 5 May 2020 | Last updated 12 May 2020

This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayer’s circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.