Warning On It Tax Treatment Of Loans
The Age
Tuesday November 16, 1999
OWNERS of small IT businesses who take loans from their companies to cover personal expenses without making those borrowings comply with tax law could face hefty bills, a tax expert said last week.
Clive Bird, a tax partner with William Buck Chartered Accountants, said IT business owners should ensure such ``private company loans" comply with division 7A of the Tax Act. Otherwise, instead of simply repaying the loan, the business-owner borrower could be forced to pay tax on the loan amount at their personal tax rate of up to 48.5 per cent.
So instead of paying back the $1000 loan you have taken from your company to cover Christmas gift-giving bills, you could have up to $485 of it taxed and still have the debt to your company outstanding.
This is because, if the loan failed to comply with Division 7A, and was made and then repaid over more than one financial year, it would be taxable as normal income from an unfranked company dividend.
Further, the company's franking account would also be debited, Bird said.
Division 7A applies to loans that private companies such as IT start-ups make to their shareholders or associates after 4 December 1997, or loans whose terms have been varied after that date. ``Associates," Bird said, could include company shareholders' relatives, their trusts or other related private companies under shareholder control.
The law had aimed to clamp down on payments that private companies made in the guise of ``loans" to their owners to shelter the money at the 36 per cent company tax rate and avoid any top-up tax otherwise payable on a dividend.
To avoid falling foul of the law, Bird said, written loan agreements should be prepared before monies are loaned, stipulating the minimum annual repayments, a commercial interest rate, a maximum repayment term and set underlying security.
Bird said that to comply, interest rates of such loans may not fall below the Reserve Bank's indicator lending rate for variable housing loans, which stands at about 6.5 per cent.
Unsecured loans from private companies must have interest and principal repaid within seven years, while secured loans may be repaid within 25 years. But security for such loans must be real property worth at least 110 per cent of the loan amount.
Bird noted this stipulation was harsher than loan terms many banks would enforce, and he said the demand for such security would ``push many small-business shareholders to take unsecured loans, and the term on those will make loan repayments quite onerous".
``Minimum repayments" are the amounts required to repay the loan within the set timeframe, but Bird said this annual amount could rise and fall with variable interest rates.
If a private company loan does not comply with Division 7A and is regarded as an unfranked dividend, this dividend is capped at the amount of the company's ``distributable surplus", which is calculated using a complex formula loosely based on company assets minus liabilities.
But Bird said various liabilities could be excluded when calculating a company's distributable surplus, and the tax commissioner had discretion to revalue company assets in some circumstances, leaving the exact nature of the surplus ``pretty unclear."
Legislators have also pre-empted IT business directors trying to loan themselves company profits through third-party trusts or other companies. Division 7A may catch this action, as well.
© 1999 The Age