One of the riskiest areas of tax law and one that the Australian Taxation Office (ATO) monitors heavily is that of Division 7A loans.
Division 7A of the Income Tax Assessment Act 1936 (Cth) outlines the legal framework which deals with loans and advances made by private companies to shareholders or associates. It aims to prevent tax avoidance by treating certain transactions as deemed dividends if the company fails to comply with Division 7A. Therefore, if the ATO determines that a company has failed to comply under Division 7A, the parties may be subject to significant tax implications and other penalties.
Here are some common errors that are made under Division 7A that you need to watch out for:
- Not repaying a company loan or not entering into a compliant Division 7A loan agreement by the date the company lodges its tax return for the financial year in which the loan was advanced. A compliant Division 7A Loan Agreement has the following features:
- It must be in writing.
- It sets out the essential terms of the loan including the amount of the loan, the requirement to repay the loan, the interest rate payable (must be at least the benchmark interest rate set out by the ATO), and the term of the loan. Note the two types of compliant Division 7A Loan Agreements as follows: –
- an unsecured loan with a maximum term of 7 years; and
- a secured loan with a maximum term of 25 years, secured by way of a mortgage over real property (where the market value of the property is at least 110% of the loan amount).
- It must be signed and dated before the lodgment of the company’s income tax return for the financial year in which the loan was advanced.
- Executing a 25-year compliant Division 7A Loan Agreement before the company lodges its tax return for the financial year in which the loan was made but failing or forgetting to register a mortgage over the relevant real property.
- Poor account record keeping where outstanding company loans are not discovered until after the financial year in which the loan was made ends.
- The borrower failing to make the minimum repayments required under a compliant Division 7A Loan Agreement.
The above are only some of the errors made in relation to Division 7A loans but are important to be kept in mind.
If you are looking to enter into a Division 7A Loan Agreement and require assistance, contact Mullane & Lindsay today and speak with one of our lawyers.
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