Fix shareholder debit loan accounts

If you need to arrange personal finance to repay the loan, talk to your bank now as new finance arrangements can take a month or more to set up.

Division 7A covering private company loans to shareholders, is effective from 4 December 1997. The important point for year-end tax planning is that the critical date for determining the balance of the loan account and the payment of interest, is one day in the year - 30 June!

In a nutshell, debit loan account balances with shareholders from 4 December 1997 must be paid out by 30 June each year or structured as ‘excluded loans' (see below) to avoid the very nasty punishments set out in Division 7A. Unfortunately many small companies will unwittingly fall foul of the provisions. The consequences can be severe.

Strategies to deal with debit loan accounts

Does not apply to loans to employees (including directors or shareholders) that are subject to the Fringe Benefits Tax rules. If FBT applies to the loan Division 7A does not apply. It is often difficult to distinguish between shareholder loan and an employee loan when an individual is both a shareholder and employee, but it must be done.

Quarantine prior 4 December 1997 loans - Altering the terms or increasing the balance of an existing loan effectively creates a new loan. Do not tamper with pre December 1997 loans. Interest due should be actually PAID before 30 June (not accrued or journalised).

Any further draw-downs after 4 December 1997 should be treated as new loans. The financial statements must clearly distinguish between pre and post 4 December 1997 loans. All new loans should be structured as excluded loans.

New Shareholder Loans Must be Excluded Loans - Loans made after 4 December 1997 MUST comply with the new requirements ie. written agreement (with stamp duty) benchmark interest rate charged (6.8% for 2002 year) and repayments sufficient to repay the loan over the maximum allowable time. Maximum loan terms are seven years, or 25 years where the loan is secured by a registered mortgage over real property and the value of the property at the time of making the loan is at least 110% of the loan amount.

Ensure excluded loan repayments are made prior to 30 June in respect of any excluded loans that existed as at 30 June 2001. Non-payment of required minimum repayments can have the effect of converting the balance of the excluded loan into a deemed dividend – not just the unpaid instalments. Where minimum repayments cannot be made, in full, a further new excluded loan may be appropriate.

If the new loan does not comply with the above, consider a further loan from the company of similar amount that DOES comply. Pay out the non-complying loan. This should not activate the anti-avoidance provision 109R (which catches a subsequent re-borrowing).

Reduce the new loans to nil. Alternatively to the above, arrange to have the full amount of the loan repaid in the same tax year eg. by declaring dividends, paying bonuses, transferring assets to the company or arranging with your bank for personal borrowings to repay the loan.

Re-classify debit entries as fringe benefits. Consider whether some of the transactions increasing the loan account from 1 April (beginning of the new FBT year) could be re-classified as fringe benefits.

The new rules also apply to any forgiveness of debts from 4 December 1997, regardless of when the debts were created.

Source: Produced by James McGowan & Associates, Chartered Accountants & Tax Consultants. Contact James McGowan 02 9437 3030.