LOANS MADE BY PRIVATE COMPANIES

Quick Companies company’s constitution contains provisions which allow it to loan money to its members under certain conditions. This Memorandum will explain how this should be conducted, and provide example documentation required to effect such a loan.

Division 7A

Effective from 4 December 1997, Division 7A was inserted into the ITAA to deem as an assessable unfranked dividend, any advances, loans, or credits by private companies to its shareholders and/or associates, unless the loan was determined to be an excluded loan.

Division 7A also applies to the forgiveness of debts incurred prior to the introduction date above, and to a variation of the significant terms of a loan (such as an additional advance) after the introduction date.

Excluded Loans

Loans will not be treated as unfranked dividends if the loan is:

(a)     made to another company (other than in its capacity as a trustee) and the recipient company does not on-lend the amount to a shareholder or associate of the lender company; or

(b)     made at arms length in the ordinary course of business ie. on commercial terms, benchmark interest rate etc (these terms are provided for in your company’s constitution); or

(c)     a repayment of debt owed by the company to a shareholder or associate provided that the payment is not excessive (determined by what the debt would have been had the parties dealt at arm’s length); or

(d)     made by the company to a shareholder or associate, and is repaid by the end of the financial year in which it was made; or

(e)     made by the company to a shareholder or associate which forms part of the assessable income of the shareholder or associate by virtue of another provision of the ITAA; or

(f)      deemed to have met the criteria of an excluded loan under the ITAA, which is that:

(i)      the loan is made under a written agreement;

(ii)     the rate of interest payable on the loan is equal to or exceeds the benchmark interest rate (the RBA’s variable housing loan rate);

(iii)     the maximum term of a secured loan does not exceed 25 years. A secured loan must be effected by a registered mortgage, the loan amount not exceeding 90% of the value of secured property. For all other loans, the maximum term shall not exceed 7 years;

(iv)    the loan repayments must be equal to or greater than the minimum yearly repayment (Section 109);

(v)     the loan was made to the company from one of its members. The requirement that it be on commercial terms remains, however minimum yearly repayments are not necessarily required, it is sufficient that a lump sum be paid at the end of the loan term, accounting for the interest payable on the loan for the loan period.

Calculating Repayments

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Pursuant to Section 109E(6) the formula to calculate minimum yearly repayments is as follows:

Loan balance outstanding at prior year end   x   Benchmark interest rate of current year

  1 – [ 1 / 1 + Benchmark interest rate of current year ] ^{Remaining term}

$500,000  x  0.07
1 – [ 1 / 1 + 0.07 ] ¹⁰    =   $ 71,189

The above example presumes the commencement of the loan. For the following and subsequent years, the loan amount will be reduced by the portion of payments made in the prior years representing the reduction of loan principal. Therefore, the amount of $71,189 must be apportioned between interest paid, and reduction in loan principal. This is done as follows:

$ 71,189 x Benchmark Interest Rate for that year (7%) = $ 4,983

Therefore, the loan balance outstanding for the following year’s calculation will be:

$433,794 [ being $500,000 – ($71,189 - $4,983) ].
 

Failure to Meet Repayments

If a shareholder or associate fails to meet the minimum yearly repayments under the terms of the loan, the balance of the loan will be assessable to the shareholder or associate as an unfranked dividend in the income year in which the default is made (Section 109E(1) & (2)).

If a company makes numerous loans on similar terms to the same shareholder or associate during a given income year, any outstanding balances at year end will be treated as an amalgamated loan requiring a minimum yearly repayment as above (Section 109E(4)).

The Commissioner has a discretion to disregard a shareholder or associate’s failure to meet the minimum yearly repayments on a loan if the circumstances were beyond it’s control and the inclusion of an unfranked dividend would be undue hardship. The Commissioner will consider the shareholder’s capacity to meet the repayment and/or any factors which reduced that capacity, whether the shareholder made a genuine attempt to make the repayment, and its prior history in making repayments (Section 109Q).

Payments made to the company by a third party on behalf of the shareholder or associate will only be treated as a loan repayment if the amount is owed by the third party to the shareholder or associate and would be included in its assessable income.

Further, loan repayments will be disregarded if a reasonable person would conclude in the relevant circumstances, that the shareholder intended to re-borrow a similar or larger sum from the same private company.

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MORE INFORMATION OR TO ORDER

Should you wish to know more about Quick Companies services and products or need assistance, or if you would like to order one of our products, please contact us on 1300 66 86 09 or send us an email to info@quickcompanies.com

WARNING
 

This memorandum has been prepared by Gadens Lawyers as a general guideline, and is not intended to be an exhaustive or complete statement concerning the operation of a trust.  There are many particular legal and accounting matters which have not been dealt with in this memorandum and clients are urged to discuss any aspect of the operation of the trust not discussed herein with their professional advisers.

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