Unstructured Loans May Carry Tax Burden
The Age
Monday January 3, 2000
Small-business owners who do not properly structure loans they take from their business accounts could end up paying 79 per cent tax, according to a tax expert.
Clive Bird, a tax partner with William Buck Chartered Accountants, said the Australian Taxation Office was targeting company proprietors and their associates who took profits from their companies as ``loans" to defer paying top-up tax on company dividends.
Directors also did this to keep money sheltered at the 36 per cent corporate tax rate, Mr Bird said.
But Division 7A of the Tax Act stipulated such ``private company loans" must satisfy criteria, or else be treated as profit distributions taxable as income in borrowers' hands at their own tax rate.
If loans made after 4 December 1997 to business owners or their associates failed Division 7A tests, the company's franking account would also be debited, he said.
Loans made before this date, and whose terms were altered after 4December 1997, would also be subject to Division 7A, and Mr Bird said it was vital to confine post-1997 loans in separate ledgers.
Loans made and repaid within the same income year were safe from Division 7A, Mr Bird said.
To avoid any problems, private-company loans spanning more than one financial year should be preceded by a written loan agreement, carry a set commercial interest rate, have minimum annual repayment amounts and be repaid within seven years for unsecured loans, or within 25 years for secured loans. Underlying security must be real property worth at least 110 per cent of the loan amount, Mr Bird said.
So, which business pays tax at 79 per cent?
Assume Company A has $100 profit, on which it pays 36 per cent corporate tax. It then lends to its director the post-tax $64. This loan fails Division 7A and is deemed to be an unfranked dividend, so the director pays 48.5 per cent tax on the $64, or $31 tax. This leaves $33.
If the company then declares a $64 franked dividend to help the director repay the original debt, that director pays dividend top-up tax on the $64 dividend of about $12. Subtract this from $33 and you're left with $21, or a 79 per cent tax rate.
Mr Bird said provisions in Division 7A also captured non-complying private-company loans made through third parties.
For company loans, the amount of any taxable non-complying loan is capped at the level of that company's distributable surplus. This is broadly defined as the company's assets less certain liabilities, but Mr Bird said the ATO could revalue assets it thought ``significantly undervalued".
But tax law could also catch business owners receiving repayments on money they had lent in the opposite direction, into their companies, after 1 July 2001.
This would occur if a company had undistributed profits and made loan repayments to the lender before distributing those profits.
Mr Bird said the Review of Business Taxation suggested that repayments of loans that failed set criteria be treated as profit distributions taxable in the lender's hands.
For non-complying loans, if the company had paid the 30 per cent corporate tax rate under tax reform on distributions it thought were loan repayments, the lender could be forced to pay ``top-up tax" on what were in fact seen as profit distributions.
This tax would be the difference between 36 per cent and the lender's marginal tax rate. To avoid this impost, Mr Ralph said, the loan should be repaid within the same periods as those for private-company loans.
© 2000 The Age