The loan you didn't know your company had made

A private company lends a shareholder $20,000, repayable whenever they can. Everyone involved would describe that as a loan. Fewer would describe the company paying a director’s personal credit card, or the director using the company’s ute for two years, or a trust leaving a distribution owing to a corporate beneficiary — but Division 7A treats all of them the same way.

The consequence of getting it wrong is that the amount is treated as an unfranked dividend, taxed at the recipient’s marginal rate with no franking credits to offset it. The company has usually already paid tax on the profit that funded the payment, so the same money is taxed twice.

What counts as a loan

The legislation extends “loan” well past the ordinary meaning. It includes:

• an advance of money;
• a provision of credit, or any other form of financial accommodation;
• a payment made for a shareholder or their associate — on their account, on their behalf, or at their request — where they are obliged to repay it;
• any transaction that, whatever its form, is the same as a loan of money.

The ATO’s own examples include a promissory note provided to a shareholder, and a private company beneficiary providing financial accommodation to the trustee of a trust in respect of an unpaid present entitlement. A company that pays a shareholder’s private expense and records it as a loan to the shareholder account has made a loan. A company that pays it and records nothing has still made a loan, and has also lost the evidence.

The deadline that decides the outcome

A loan is deemed to be a dividend if it is made to a shareholder or an associate, and is not fully repaid before the company’s lodgment day for the income year in which it was made — unless it is excluded by another provision or converted to a complying loan.

The lodgment day is the earlier of the due date for lodging the company’s return, or the date it is actually lodged. Lodging early does not buy extra time; it shortens the window.

What a complying loan requires

Three things, all of them mandatory:

A minimum interest rate. The rate for each year of the loan must be at least the Division 7A benchmark interest rate, which is published and updated annually.

A maximum term. Seven years for an unsecured loan. Twenty-five years where the loan is secured by a registered mortgage over real property — with the whole loan secured, and the property’s market value (less prior secured liabilities) at least 110% of the loan at the time it is made.

A written agreement in place before the lodgment day. There is no prescribed form, but at a minimum it should identify the parties and set out the essential terms: the amount, the interest rate, the term, and the repayment schedule.

Then, every year, a minimum yearly repayment of principal and interest is required — calculated to repay the loan over its remaining maximum term. Missing a payment in one year produces a dividend for the shortfall in that year, even if the loan itself was properly documented.

Where it usually surfaces

In our experience the problem is rarely a deliberate loan. It is one of these:

• A director’s loan account that has drifted, with private expenses mixed into company payments and no reconciliation since the bookkeeper left.
• A company asset — a vehicle, a property, equipment — used privately by a shareholder without a charge.
• An unpaid present entitlement to a corporate beneficiary, left sitting in the accounts as a “loan to trust” with no sub-trust arrangement or complying agreement.
• A loan that was documented once, at the start, and never had a repayment schedule attached to it.
• A loan repaid by journal entry near year end, with no money moving and no explanation.

None of these are fatal. All of them are cheaper to fix before the return is lodged than after the ATO asks.

What to do before lodgment

1. Reconcile every director and shareholder loan account for the year, and separate private payments from business ones.
2. List any company asset used privately and value the benefit properly.
3. Check trust entitlements — an unpaid entitlement to a corporate beneficiary is a Division 7A exposure that most groups do not realise they have.
4. Either repay, or put a complying agreement in place before lodgment day, with a repayment schedule the shareholder can actually meet.
5. Diarise the minimum yearly repayment for each loan, every year. This is the step that fails in year two, when everyone has moved on.

Sources: Australian Taxation Office, Loans by private companies; ATO, Division 7A benchmark interest rate. The ATO notes it is reviewing its Division 7A guidance following the High Court's decision in Bendel; positions in this area should be re-checked against current guidance. General information only — not advice for your circumstances.