Drafting Div 7A Loans – ATO’s 4 concerns

The ATO has just audited my new client’s Div 7A agreement. It did not go well. Many Div 7A Loan agreements are not ‘commercial’ and therefore not valid based on 4 common drafting errors:

  1. The Div 7A Loan must be signed as a ‘Deed’ not as an ‘agreement’. ‘Agreements’ require consideration – money changing hands. Often no money changes hands because of the close relationship of the parties. ‘Journal entries’ are fine, but don’t suffice as ‘consideration’. In contrast to an ‘agreement’, a ‘Deed’ does not require consideration.
    What is the difference between a “deed” and an “agreement”?

    1. Agreements can generally be made orally or in writing. A deed must be in writing.
    2. The deed must make it clear that it is intended to be a deed. This often means specific wording is inserted above the signatures confirming that the document is intended to be a deed;
    3. As mentioned above, under an agreement each party has to provide “consideration” to be valid. Deeds, on the other hand, do not require consideration to be valid. It is best to give a gift in a Deed as it could be unenforceable due to lack of consideration from one party;
    4. A deed requires additional formalities. Often a witness may be required if an individual is signing;
    5. Deeds last longer.
    6. Contracts also have own requirements. The classic elements of a contract are then:
      • Offer and Acceptance: An offer from one party and acceptance from the other
      • Intention: There must be the intention to be legally bound, social or domestic agreements don’t count.
      • Consideration: as discussed above, it’s the payment given for the promise of the contract.
      • Capacity: The parties must be competent to contract – must be of sound mind, old enough, etc.
      • Free Consent: There can be no coercion, undue influence, fraud, misrepresentation, or mistake.
      • Lawful Object: The purpose of the contract can’t be illegal or if the court thinks it is immoral or against public policy.
      • Certainty: The agreement must be clear as to what the words mean.
      • Possibility of Performance: Must not be impossible to perform, physically or legally.
  2. There are Div 7A loans sold at websites (operated by non-lawyers) that refer to ‘ATO Practice Statement PS LA 2007/20’. That PS was withdrawn and is no longer applicable. This contaminates the validity of the document.
  3. Failure to contain an ‘Acceleration clause’. This is if the person owing the money defaults on the loan. On this one, I agree with the ATO. ‘Commercial’ loan agreements have acceleration clauses. See a full copy of our Sample Div 7A Deed here.
    • If you don’t have an Acceleration clause then it is not a ‘commercial’ loan and can fall foul of the ATO. An acceleration clauses is a particular term in a loan agreement, usually associated with mortgages. It means that if there is a failure to pay one of the regular instalments, all interest and all capital becomes immediately owing. It is “accelerated.”
  4. Make references to section 109E(5) Income Tax Assessment Act 1936. If and when that section is changed the integrity of the Div 7A loan is in jeopardy. The correct way of drafting a Div 7A loan is to reference the laws, from time to time.

As a community service, we have reduced our Division 7A Loan Deeds from $88 to $44 until midnight 30 June. This is an opportunity to ensure that your Div 7A loan – which is the basis of the whole system – complies with the law.

Because you are building your legal document at a law firm’s website you:

  1. Retain legal professional privilege
  2. Access the law firm’s PI insurance
  3. Get legal advice – just ring 24/7
  4. Get a letter of advice confirming what you have built – our law firm’s letter on your accountant’s due diligence file goes a long way in protecting both you and your accountant.

For more information please telephone us.

Adjunct Professor Brett Davies,  CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
39 Stirling Highway, Nedlands, WA (Post Office Box 5169, Dalkeith, WA 6009)
Mobile:       04777-96959
Direct:        08 6389-0400
Reception: 08 6389-0100
Email:         [email protected]
Skype:        brettkennethdavies

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