Division 7A of Part III of the Income Tax Assessment Act 1936
If a private company makes a loan to a shareholder or an associate of a shareholder, it must comply with the requirement of Division 7A of Part III of the Income Tax Assessment Act 1936. Otherwise, the loan may be treated as an unfranked dividend paid to the shareholder or associate.
You should be aware of the following Division 7A issues, which could have major consequences for your clients.
Loans made before the introduction of Division 7A
Private Company loans to shareholders that were made before the introduction of Division 7A on 4 December 1997 do not generally have to comply with the requirements of that provision. However, these loans should not be ignored.
If an 'at call' loan is not documented, acknowledged or repaid, it may become statute barred under the relevant state Limitation Act. In most states, an undocumented at call loan may become statute barred six years after the loan was made, or was last acknowledged or partly paid.
If a loan to a shareholder becomes statute barred, it will be a forgiven debt for the purposes of Division 7A and may be treated as a dividend.
Recording loans to shareholders in the company accounts
When a private company makes a loan to a shareholder or associate of a shareholder, Division 7A requires that minimum yearly repayments be made in the second and subsequent years of the loan according to a statutory formula. It has been found that some private companies are keeping only one ledger account to record all loans to a shareholder. This approach makes It very difficult to correctly calculate the minimum yearly repayment required on each loan. If the minimum yearly repayment is not made on a loan, the balance of the loan at the end of the financial year may be treated as a dividend.
For example, ABC Pty Ltd should record all loans to shareholder MD during the year ended 30 June 2001 with a maximum term of 7 years in one account, and all loans to MD in the same income year but with a maximum term of 25 years in a second account. If ABC Pty Ltd also makes a loan to MD during the year ended 30th June 2002, this loan should be recorded in a third account.
Source: The Tax Agent - Issue 21 // September 2003
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