Loans from Private Companies: New Rules
The Government proposes to change the current rules relating to loans from companies to their shareholders and associates. Loans from such companies are a common alternative to shareholders withdrawing profits in the form of taxable dividends.
A loan from a private company is subject to strict requirements under Division 7A of the tax law. That Division requires the loan to be documented and to have specific terms. Failure to do so causes the amount of the loan to be a taxable dividend.
The proposed changes are:
- Simplified Division 7A loan rules to make the law easier to comply with;
- A self-correction mechanism to allow breaches of Division 7A to be promptly rectified;
- Safe harbour rules to give certainty and simplify compliance for taxpayers; and
- Clarification that unpaid present entitlements (UPEs) owing by trusts to companies come within the scope of Division 7A.
These amendments are expected to apply from 1 July 2019.
1. Changes to Loan Rules
Under the new rules, Division 7A loans will have a maximum term of 10 years with a variable interest rate and payments of both principal and interest in each year. The Government says that the new ten-year model will be simpler than the current apportionment model and will be more closely aligned to commercial practice for principal and interest loans.
Currently, the rules allow Division 7A loans to have a maximum term that must not exceed:
- 7 years for an unsecured loan; or
- 25 years for a secured loan.
The current benchmark interest rate is defined as the ‘Bank variable housing loans interest rate’ published by the Reserve Bank (5.20% for 2018-19).
The new rules will be as follows:
- Maximum loan term – 10 years;
- Surprisingly, no requirement for a formal written loan agreement (however, evidence showing that the loan was entered into must exist by the lodgement day of the private company’s income tax return);
- The minimum yearly repayment amount must consist of both principal and interest;
- The minimum yearly repayment amount reduces the balance of the loan each income year;
- Interest is calculated for the full income year, regardless of when the repayment is made during the year (except in Year 1);
- The new benchmark interest rate will be the ‘Small Business; Variable; Other; Overdraft – Indicator’ rate published by the Reserve Bank (currently 8.30%); and
- Repayments of the loan made after the end of the income year but before the lodgement day for the first income year are counted as a reduction of the amount owing even if they are made prior to the loan agreement being finalised.
2. Transitional Rules
Existing 7 and 25 year loans will be transitioned to the new 10 year loan model under following rules:
- 7 year loans existing at 30 June 2019 must comply with the new proposed loan model including the new benchmark interest rate to remain complying, but they will retain their existing term.
- 25 year loans existing at 30 June 2019 will be exempt from the majority of changes until 30 June 2021. The interest rate applicable to these loans during this period must equal or exceed the new benchmark interest rate.
- On 30 June 2021, the outstanding value of the loan will give rise to a deemed dividend unless a complying loan agreement under the new loan model is put in place prior to the lodgement day of the 2020-21 company tax return.
Pre-December 1997 Loans
When Division 7A was enacted to apply to loans made by private companies from 4 December 1997, loans made prior to that date were mostly unaffected by the then new law. The grandfathering of these loans will effectively cease with the proposed new rules.
Shareholders of private companies will have until the lodgement day of the 2020-21 company tax return to either pay out the amount of those loans or put in place a complying loan agreement; if either of those events does not occur, the loan will be treated as a taxable dividend of the borrower shareholder in the 2020-21 income year. The first repayment will be due in the 2021-22 income year.
