It may seem like an easy decision to borrow from your private company but there are certain requirements that you need to be aware of to make sure that you don’t end up paying more tax.
If you or an associate take a loan from your private company, it's important to understand the requirements of repaying the loan correctly for income tax purposes. Otherwise, you could find the loan treated as a Division 7A deemed dividend and included in your or your associates' assessable income. Division 7A is intended to prevent profits or assets being provided to shareholders or their associates tax free.
You can avoid a deemed dividend by making sure your loan is a Division 7A complying loan before your company's lodgment day and making minimum yearly repayments.
All of the following conditions must be satisfied for a loan to be a complying loan and therefore excluded from being a Division 7A dividend:
A written loan agreement must be in place before the company's lodgment day for the income year in which the loan amount was paid to the shareholder or associate.
The loan interest rate for each year of the loan must at least equal the Division 7A – benchmark interest rate.
The term of the loan must not exceed 25 years if 100% of the loan is secured by a registered mortgage over real property and, when the loan is made, the market value of the property, less the amounts of any other liabilities secured over the property in priority to the loan, is at least 110% of the amount of the loan
7 years for any other loan.
There is no prescribed format for a written loan agreement. However, as a minimum, the agreement should:
identify the lender and borrower
set out the essential conditions of the loan (the amount of the loan, the date on which it's drawn down, the requirement to make minimum yearly repayments, the interest rate payable, and the term of the loan), and
be signed and dated by the lender.
However, you can’t borrow further money or assets from the same company, directly or indirectly, to make minimum yearly repayments or repay the loan. If you do, these payments may not be taken into account as repayments for Division 7A purposes, potentially resulting in an assessable deemed dividend.
Want to know more about whether your loan complies? Check out the ATO compliance tool here >>