Can I Borrow Money From My Company? Tax Rules for Company Loans to Shareholders
If you own a private company, you may have wondered: can I borrow money from my company?
It is a common question for Australian business owners. You may want to transfer money from the company to your personal account, pay a private expense from the company account or borrow company funds temporarily with the intention of paying them back later.
However, a company is a separate legal entity. Borrowing money from your company can have tax consequences, particularly where the transaction falls within the rules known as Division 7A.
Many business owners do not encounter the term Division 7A until money has already been withdrawn. Understanding how the rules operate before taking money from a private company can help avoid unexpected tax consequences.
What Is Division 7A?
Division 7A forms part of the Income Tax Assessment Act 1936 and deals with certain payments, loans and forgiven debts involving private companies and their shareholders or associates.
Broadly, the rules are designed to prevent private company profits being provided to shareholders or their associates in certain forms without the appropriate tax treatment.
In some circumstances, money or another benefit provided by a private company can be treated as an unfranked dividend for tax purposes, even though the shareholder considered the transaction to be a loan or another type of payment.
This is commonly known as a Division 7A deemed dividend.
Can I Borrow Money From My Company?
A private company can lend money to a shareholder. The existence of a loan does not automatically mean the entire amount will be treated as a dividend.
However, simply calling the transaction a “loan” is not necessarily enough.
The way the loan is documented, when it is repaid and how it is administered can affect its tax treatment.
Depending on the circumstances, the loan may need to be repaid by the relevant lodgment day or placed on complying Division 7A loan terms.
A complying loan generally needs to satisfy requirements relating to:
- a written loan agreement;
- the interest rate charged;
- the term of the loan; and
- minimum yearly repayments.
This means that simply recording money taken from the company as a shareholder loan in the company’s accounts does not necessarily resolve the Division 7A issue.
What Types of Company Payments Can Division 7A Affect?
Division 7A is not limited to a business owner formally asking their company for a loan.
Depending on the circumstances, issues can potentially arise where:
- company money is transferred into a shareholder’s personal bank account;
- a company pays personal expenses for a shareholder;
- company funds are used for private purchases;
- money is advanced to a shareholder and remains unpaid;
- loans or payments are made to certain associates of shareholders; or
- a private company forgives a debt owed by a shareholder or associate.
For example, imagine a shareholder takes $40,000 from their private company to help fund a personal purchase.
The company’s accounts record the $40,000 as a shareholder loan.
That accounting entry does not, by itself, determine the tax treatment of the transaction. The circumstances surrounding the payment, the timing of any repayment and the terms of the loan may all be relevant.
Who Is Considered an Associate?
Another reason Division 7A can be misunderstood is that it is not necessarily restricted to money provided directly to the company’s shareholder.
The rules can also apply to certain associates of shareholders.
Depending on the circumstances, this can include relatives, partners, trusts, companies and other connected entities.
As a result, directing a company payment or loan to another person or entity does not necessarily take the transaction outside Division 7A.
What Is a Complying Division 7A Loan?
Where money is genuinely intended to remain a loan, the arrangement may be able to be structured on complying Division 7A terms.
Generally, a complying loan requires an appropriate written agreement and must satisfy requirements concerning interest, repayments and the term of the loan.
The interest rate generally must be at least the applicable Division 7A benchmark interest rate.
The ATO publishes the current and historical Division 7A benchmark interest rates.
Minimum yearly repayments may also be required.
The ATO provides a Division 7A calculator and decision tool to assist taxpayers and advisers in calculating minimum yearly repayments and interest.
The maximum loan term is generally seven years, although certain loans secured by a registered mortgage over real property can have a longer maximum term.
Importantly, compliance does not end when the loan agreement is signed. The loan needs to continue to be administered in accordance with the applicable requirements.
What Happens If Division 7A Applies?
Where the Division 7A requirements are not satisfied, an amount may potentially be treated as an unfranked dividend to the shareholder or associate.
This can create a very different tax result from the one originally expected.
A problem may also remain unnoticed for some time.
Division 7A issues may be identified when:
- an accountant reviews the company’s shareholder loan accounts;
- annual financial statements are prepared;
- a business is restructured;
- historical company transactions are reviewed; or
- the Australian Taxation Office examines the company’s affairs.
For this reason, shareholder loan accounts should not simply be allowed to accumulate without considering their tax treatment.
What If I Have Already Borrowed Money From My Company?
If you have already borrowed money from your company, discovering a shareholder loan account does not automatically determine the tax outcome.
The circumstances need to be examined.
Relevant matters may include:
- how much money was taken;
- when the transactions occurred;
- who received the money or benefit;
- why the money was provided;
- how the transactions were recorded;
- whether repayments have been made;
- whether an appropriate loan agreement exists; and
- what has happened since the original transaction.
Timing can be particularly important.
The ATO notes that, in relevant circumstances, a payment or benefit potentially subject to Division 7A may avoid being treated as a Division 7A dividend where it is repaid or converted to a complying loan by the company’s applicable lodgment day.
If money has already been withdrawn from a private company, obtaining appropriate taxation advice before attempting to restructure transactions or create documentation can therefore be important.
When Does a Division 7A Problem Become an ATO Tax Dispute?
Not every Division 7A issue becomes a legal dispute.
Many matters are identified and addressed through ordinary taxation and accounting processes.
However, matters can become more complex where there is disagreement about:
- whether a transaction constituted a payment or loan;
- whether a person or entity was an associate;
- whether a loan satisfied the Division 7A requirements;
- the treatment of historical shareholder loan accounts;
- whether an amount should be treated as a deemed dividend; or
- the ATO’s interpretation of the relevant transactions.
Where the ATO has commenced an audit, review or assessment process, a Division 7A issue may become part of a broader tax dispute.
Read more about ATO tax disputes and when legal representation may be required.
Accountants, Solicitors and Division 7A Matters
Accountants commonly identify Division 7A issues while reviewing the accounts and taxation affairs of private companies.
Some matters can be addressed through accounting and tax compliance.
Others may raise questions requiring legal interpretation, particularly where historical transactions are involved, the ATO has taken a different position or substantial amounts are in dispute.
In more complex matters, accountants and solicitors may consider briefing tax counsel for advice on the application of Division 7A to the particular circumstances.
Chris Garlick provides advice on Australian taxation matters, including Division 7A issues, private company taxation and disputes with the Australian Taxation Office.
Before You Borrow Money From Your Company
The important point is that company money should not automatically be treated as a shareholder’s personal money.
If you borrow money from your company, receive a company payment or have personal expenses paid by the company, Division 7A may need to be considered.
The fact that money has been recorded as a shareholder loan does not necessarily determine its tax treatment.
Understanding the position before company funds are withdrawn is generally preferable to trying to reconstruct transactions later.
Where a Division 7A matter is complex, uncertain or disputed, obtaining taxation advice early can help clarify how the legislation applies to the particular circumstances.