Heads of Agreement & MOU

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Heads of Agreement & MOU

Memorandum of Understanding & Heads of Agreement

Heads of agreement & MOU are pre-contract documents used prior to entering into a more ‘formal’ contract. Non-disclosure agreements are also used as pre-contractual documents and are covered in a separate collection dealing with confidentiality (see Confidentiality Agreements).

‘Heads of agreement’ (HOA) and ‘memorandum of understanding’ (MOU) are terms used interchangeably to cover any agreement that is entered into prior to entering into a contract. This may be desirable where the parties are in the early stages of negotiation and wish to confirm the basic points of their agreement.  HOA’s and MOU’s are most commonly used in the following circumstances:

  1. Commercial Leasing
  2. Sale of business
  3. Joint ventures
  4. Sale of shares
  5. Distribution Agreements / supply agreements / manufacturing agreements

The Heads of Agreement, although not a fully fledged contract, can still contain binding commitments.

Heads of Agreement: General

A Heads of Agreement precedent for general use. Includes provisions relating to:

  • Subject to contract
  • Payment of costs
  • Terms to be included in contract
  • Form of contract included as Annexure  A

4 pages long.

Heads of Agreement & MOU

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Borrowing money from a private company can have serious pitfalls if not done correctly. Directors and shareholders 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’. The rules are stringent and require a special type of loan agreement known 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 7A loan 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:  

1)    the names of the parties;  
2)    the loan terms:

a)    the amount of the loan and the date the loan amount is drawn; 
b)    the requirement to repay the loan amount; 
c)     the period of the loan;
d)     the interest; 
e)     that the parties named have agreed to the terms; and  
f)     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.

 

 

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