Division 7A loan agreements

Loans to Shareholders:  Division 7A loan agreements

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. Care must be taken so that the ATO does not deem these loans to be dividends, and tax them accordingly.

Division 7A of the Income Tax Assessment Act 1936 requires such loans to be ‘arm’s length’ or deems them to be dividends, and taxes them accordingly. The rules are stringent and require a special type of loan agreement know as a Division 7A loan agreement.

Division 7A of the Income Tax Assessment Act 1936 is aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates) in the form of loans.  Unless the loan comes within specified exclusions in Division 7A it is treated as an assessable dividend and taxed as a dividend.

The ATO has confirmed in final determination TD 2008/8 the formal requirements for

a complying loan agreement for the purposes of Div. 7A.  Such loan agreements must be in writing and be agreed by the company and its borrower. It is now essential that each Div. 7Aloan agreement accurately records the loan terms in accordance with the ATO determination.  It is not acceptable to rely on parts of the company’s constitution that may provide rules for such loans.

TD 2008/8 requires that the entire agreement between the parties must be in writing

including:

• the names of the parties;
• the loan terms:
  1. the amount of the loan and the date the loan amount is drawn,
  2. the requirement to repay the loan amount,
  3. the period of the loan and,
  4. the interest
  5. that the parties named have agreed to the terms; and
  6. when the written agreement was made, ( the date it was signed )

For the purposes of the Act, an agreement that is partly oral and partly in writing is not an agreement in writing.  The author recommends that, in all cases, a formal loan agreement be prepared and signed by the company and the borrower to ensure that each Div. 7A loan complies with the  ATO’s requirements.

Term

Loans under division 7A can be either secured or unsecured.  If unsecured, the maximum term can be

Loans can have a maximum term of 25 years provided they are:

1. Secured by registered mortgage
2. The property value is at least 110% of the property value.

Both these criteria must be satisfied.

This commentary is not legal advice by Precedents Online or its Authors.

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