You 'own' your company. Therefore, take whatever money you want from the company.
You see a wonderful piece of jewellery for your wife. Out comes the company credit card. You buy her the gift.
This is a personal item. It is not part of the business. You have gained a financial advantage from your company.
The ATO says you are wrong. You are not your company. Your company is a separate legal entity. It has its own tax obligations.
Without a Div 7A Loan Deed, you suffer a 'deemed dividend'. The tax penalties of you taking the money from your company are almost 100%.
Instead, you should have 'borrowed' the money from your company. The Div 7A Loan Deed treats the company money as a tax effective 'loan'.
What is the mischief in borrowing money from my company?
Companies pay a low flat rate of tax. In contrast, mum and dad pay a high marginal tax rate.
1. Therefore, in the good old days (before Div7A), mum and dad have the company earn the income.
2. The company pays tax at the lower tax rate. (It saves mum and dad paying a higher rate of tax.)
3. The company lends the money to mum and dad. Mum and dad buy a boat, have a holiday or whatever.
4. Mum and dad never bother to pay back the debt. Therefore, mum and dad never bother to pay the difference between the low company tax rate and their higher marginal tax rate.
The government got sick and tired of this and introduced Division 7A Income Tax Assessment Act 1936.
Div 7A 'ensures that private companies are no longer able to make tax-free distributions of profits to shareholders': Explanatory Memorandum to Act No 47 of 1998. Further:
'It ensures that all advances, loans and other credits by private companies to shareholders, are treated as assessable dividends. In addition, debts owed by shareholders which are forgiven by private companies are treated as dividends.'
Now, mum and dad need a proper commercial loan deed. Plus mum and dad have to pay back the money that the company lent them.
Our Div7A protects you in 5 ways
Your Div 7A Loan Deed protects you when:
1. you get money from your company
2. you get a financial benefit from your company (use of the company boat)
3. you get a loan from your company
4. your company forgives a debt you owe to the company
5. your Trust has 'unpaid present entitlements' owing to the company
Drafting a Div7A Loan – ATO’s 5 concerns
Recently the ATO audited a Division 7A loan agreement. It failed because of 5 common drafting errors:
1. Sign the Div7A Loan as a ‘Deed’; not as an ‘agreement’
‘Agreements’ require consideration. This is money changing hands. Often no money changes hands. This is because of the close relationship of the parties. ‘Journal entries’ 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”?
a) Agreements are orally or in writing. A deed must is in writing.
b) The deed must make it clear that it is intended to be a deed. Specific wording is inserted above the signatures. This confirms that the document is intended as a deed.
c) 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.
d) A deed requires additional formalities. A witness is required if an individual is signing.
e) Deeds last longer.
2. The ATO looks to ensure that the Div7A loan contains these requirements:
* Offer and Acceptance: an offer from one party and acceptance from the other
* Intention: intention to be legally bound; social or domestic agreements don’t count
* Consideration: payment is given for the promise (i.e. signed as a Deed)
* Capacity: parties are competent to contract; old enough and of sound mind
* Free Consent: no coercion, undue influence, fraud, misrepresentation, or mistake
* Lawful Object: purpose of the contract can’t be illegal, immoral or against public policy
* Certainty: clear as to what the words mean.
* Possibility of Performance: possible to perform, physically or legally.
3. Out of date legislation
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.
4. 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. All ‘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. It risks falling foul of the ATO. An acceleration clause is a particular term in a loan agreement. All Australian loans and mortgages contain acceleration clauses. It means that if there is a failure to pay one of the regular instalments, interest and capital is immediately owing. It is “accelerated.”
5. Sections of acts that change
Div7A loans incorrectly 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 at risk. 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.
What is the benchmark interest rate?
The government requires that you pay a minimum interest rate on the money your company lends to you and your family.
That rate is published by the ATO each year.
It is called the 'benchmark interest rate'. It changes every year. The benchmark interest rate adopts the Indicator Lending Rates - Standard Bank Variable Housing Loans Interest Rate published by the Reserve Bank of Australia. The ATO gives you the interest rate before the start of the new financial year.
Your Legal Consolidated Div 7A adopts the benchmark interest rate automatically. Your interest rate is always up to date.
You need a separate Div7A Loan Deed for each person
For example, if you have:
5. Trustee of a Family Trust
Then you need 5 separate Division 7A Loan Deeds. Sign them, date them and put them in your company secretary file.
The Deed is a revolving line of credit. Therefore, you don't need to create a new Deed each year.
Seven deadly sins of Div 7A
Recently I was privy to the ATO's checklist for Division 7A Loan Deeds. These are the 7 deadly sins of Div 7A - and how to avoid them:
1. Sign the Div 7A Deed BEFORE you lodge the company returns
2. Sign the Deed as a 'Deed', not as an 'agreement'. Agreements are not usual or commercial for loan agreements. Commercial loan documents are signed as 'deeds'. All Legal Consolidated Div 7A Deeds are deeds. As lawyers, we would never let you build 'agreements'. If you are unsure look to the area where the Deed is signed it should say 'Signed as a Deed'. If not go back to the lawyer that drafted the Div 7A and ask for your money back.)
3. Payback 1/7 of each separate debt each financial year. Therefore, at the end of year 7, that particular loan is fully paid off. (Telephone us if you want a secured 25-year loan.)
4. Ensure the Deed automatically adjusts each year to the new ATO set 'benchmark interest rate'
5. Pay the 'benchmark interest rate' set by the government each financial year
6. Build a Div 7A Loan Deed for the shareholders, children and loved ones who may get some money from the company
7. Ensure that your Div 7A Loan deed is 'revolving'. This means you don't have to do a new one every year. The same Div 7A Loan Deed deals with each new '7-year loan' you create each year.
What do I get when I build the Div7A loan on your website?
We email you within 12 seconds of you building the document:
* Division 7A Loan Deed
* Our law firm's letter of advice on our law firm's letterhead and signed by one of our Partners
How do I build the Division 7A loan agreement?
* Answer the questions on our website
* Read the Summary page
* Lock and Build your document
* Type in your Credit Card details
* We email the Agreement, our covering letter and Tax Invoice to you
* Print and sign the Agreement
Update the Family Trust for Bamford streaming only:
Or, update Bamford streaming PLUS update the rest of the Deed:
Or update for Bamford streaming PLUS the Deed PLUS update the Appointor & Trustee:
Or just update the Trustee:
Or just update the Appointor:
To deal with Division 7A (loan or UPE from your company to the Family Trust):
Or, to forgive the 'loan account' and UPEs (loans from humans to Family Trust):
Change the name of your Family Trust:
To wind up and vest the Family Trust, when you no longer want it:
Telephone us for legal advice on building this document.
Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
National Australian law firm
Toll free: 1800 141 612
Mobile: 0477 796 959