A Loan Agreement is an agreement between a Lender and a Borrower. This Loan Agreement is a formal way of setting out the terms and conditions of the loan.
The Loan Agreement addresses what the rights are of the parties, including:
1. the initial amount being borrowed
2. how it is repaid
3. any interest payable
5. right to use the loan to support mortgages, debentures, charges and PPSR (Personal Property Securities Register) registrations.
The lender may be a human or a company. The Borrower can be a human or a company. This loan agreement can be used for intercompany loans also – from one company to a related company.
Because of the freedom to determine when repayments are made, it is also possible for this loan agreement to be used as an “at-call” loan, where it is payable on demand if that is what the Lender chooses.
It is important that the Borrower fully understands the nature of what they are getting into as the consequences of not repaying can be very serious.
The beauty of this document is that you can design it to suit your circumstances. What if you don’t know the amount that you are lending? That’s ok. If you don’t know you can leave it as the default answer; “as lent from time to time”. This gives you some wiggle room.
Or sometimes you might not want to set a specific date in the agreement. You can leave it as the default answer; “payable on demand as demanded by the Lender”. Or you can put in an actual date, or you can add the instalment dates or time periods.
With your interest, you have a few options too. You can charge Nil, or leave it open to be decided in writing later (‘as demanded from the lender from time to time’) or a flat rate or varying rate.
Some people argue that children have never been a sound financial investment. However, we are seeing a growing trend of a child lending money to parents to get into a good retirement home. In that case, the child should build this Loan Agreement.
When mum and dad die the other children can’t argue that the loan was just a gift to dad and mum. Secondly, if mum and dad go hostile, lose their money or marry a gold digger then at least you get back some or all of the money, as it was a legally documented loan.
The Loan Agreement allows you to lodge caveats, mortgages, fixed & floating charges, debentures and encumbrances over the Borrower’s assets.
The Lender is authorised to direct the Borrower to sign all documents required to charge and register all the Borrower’s interest in:
a) land the Borrower owns or controls from time to time (this includes the right to lodge mortgages, equitable mortgages, Mortgages, caveats and other encumbrances of any nature whatsoever); and
b) other assets, fixtures, choses in action and chattels owned or controlled by the Borrower including by way of debentures, fixed & floating charges, mortgages, equitable mortgages, caveats, Personal Property Securities Register (PPSR) and share capital
If the Lender wishes, the Lender can add some additional people to guarantee the repayment of the loan.
Consider Chadbourne and FCT  AATA 2441:
Mr Chadbourne borrows money from the Commonwealth Bank. This is to finance the purchase of income-producing investment properties. But, Mr Chadbourne purchases the properties in the name of his discretionary trust.
Later Mr Chadbourne borrows more money. This is to finance the purchase of shares. Once again, the shares are purchased by the trust, not the taxpayer.
Without a Loan Agreement, the ATO contents that there is no nexus between Mr Chadbourne’s interest expense and the assessable income from the trust’s investments. We agree with the ATO.
Without a Loan Agreement between Mr Chadbourne and his family trust, he becomes desperate. Clutching at straws, Mr Chadbourne claims a deduction for the interest expense against the income derived by the trust. However, in truth, the interest expense is claimed against the distribution of income he received from the trust. This is NOT income derived by Mr Chadbourne.
Mr Chadbourne does not derive the assessable income for the purposes of the Income Tax Assessment Act. Without the protection of the Loan Agreement, he merely receives a trust distribution of income.
This makes all the difference. Without a Loan Agreement, there is no nexus between the income and the expense. It denies him a tax deduction for the interest. If Mr Chadbourne had merely built a Loan Agreement lending the money to his trust then the interest is claimable.
One wonders, as well as suing the accountant and lawyer, whether Mr Chadbourne, has a claim against the Commonwealth Bank.
QUESTION: My business entity needs some money. My business entity can borrow money from the bank. However, the bank lends me the money at a lower interest rate. Can I borrow the money and on-lend it to my business entity? Importantly, I want to claim a tax deduction for the interest that the bank charges me.
ANSWER: It is sad that the bank lends money to mum and dad with a home as collateral, cheaper than it lends money to your business entity.
It is common for you to borrow money from the bank with the bank using your family home as security. You then on-lend the money to your business entity.
Importantly: You can only claim the interest that the bank charges you if you make a ‘profit’ by on-lending the money.
Even a small ‘profit’ of 0.1% may be enough. For example, you borrow money from the bank at 10%. You need to make a profit. So, you lend the money to your business entity with a small mark up. So, you may charge 10.1%. However, you never know what the bank is going to charge. It changes. Therefore, leave in the default wording ‘as demanded by the Lender from time to time’.
But seeks advice from your accountant. Your accountant considers:
SECTION 8-1 General deductions
8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income.
Q: In one of your hints you state “Setting an interest rate acceptable to the ATO”. You say the interest rate on the loan must be above the interest rate of the mortgage. However, my accountant says charging the same rate is fine. By way of background, the loan is to the corporate trustee of my family trust. The Family Trust then distributes income every year to my wife. My wife is both a beneficiary. And my wife is also the lender. Is it acceptable for my wife to on-lend the money to the Family Trust at the same interest rate?
A: Your wife is borrowing some money. She is then going to on-lend it to the family trust. She is charged interest by the bank. She wants to claim back that interest in her tax return as an expense. But she can only do so if she has a profit motive. So we are of the view that your wife should charge a higher interest rate. This ‘higher rate’ can be a very small percentage. E.g. 0.001%. But at least she is then making a profit. That is our position. I do not think it a great issue to charge a touch more. However, if your accountant suggests something different, then get that advice in writing.
QUESTION: You say I can borrow from my mortgage and lend it to my discretionary trust and deduct the interest so long as I make a profit. Is this still applicable if the trustee of the trust is me? Is it allowed when I am in effect lending to myself?
ANSWER: Whether you can claim a tax deduction is subject to many rules over and above what is in a loan agreement. Just because you charge a higher interest is only one of the tests you need to pass. Talk with your accountant about tax deductibility for both you and your business. As to the second part of your question, you are not lending to yourself you are lending to a Family Trust. (You just happen to be the trustee of the family trust, at the moment.) You and your trust have different ABNs and TFNs, they are not the same person.
For the full answers start building the Loan Agreement and read the full hint on this topic.
I am not sure what you mean by ‘commercial rates’. Best to talk with your accountant.
As to whether you can claim a tax deduction is a question to should pose to your accountant. This is because everyone’s situation is different. Your accountant knows your individual circumstances.
However, I dispute that you borrow the money at 2.59%. It may be a variable interest rate that can change anytime. Better to peg the interest rate to the bank’s rate and charge a small markup so you can claim the interest rate that the bank charges. But talk with your accountant. They know your circumstances. We are only taxation lawyers. We are not accountants.
We are not accountants. We are only taxation lawyers. We also do not know your individuall circumstances. Best to talk with your accountant. However, it is not unusual for the Lender to ‘capitalise’ the interest and the capital. Actual payments are probably not generally required to satisfy the laws for borrowing and lending.
In a service trust, the doctor, engineer, or other professional hires the services of his family members and family trust to do jobs for the practice. The service trust does the bookkeeping, cleaning, providing staff etc… It can also lend money to the doctor for business purposes. The charges have to be fair and commercial. Similarly, be careful not to charge an interest rate that is over the fair market rate.
For the full answer start building the Loan Agreement and read the full hint on this topic.
There are two types of Lenders:
This Loan Agreement is for non-professional lenders. If you are a bank requiring loan agreements, then please contact us for a quote.
Seek advice and due diligence, legal and otherwise, on the credit worthiness and ability for the Borrower to make repayments and perform its obligations under the Loan Agreement.
The Lender seeks such advice independently. You should not rely on any person associated or related to the Borrower to give you such advice.
You need to make sure the person you are lending to is the person they say they are. If you are in doubt, seek professional and legal help.
You should undertake extensive checks on the identity of the person you are lending money to. You should ask to see their Drivers Licenses, Passports and perform other due diligence.
If you are lending to a company, then do a full historical search of that company with the Australian Securities and Investments Commission (ASIC). You should also make sure that the directors of the company are either the Borrowers as well, or as least are Guarantors under the Loan Agreement.
There are professional businesses that provide extensive and written credit checks on potential Borrowers. Use their services before you hand over any money. Use their services before you sign the Loan Agreement.
In the movies, IOUs are often handwritten on a piece of paper. Sometimes instead of a Loan Agreement, someone does a ‘minute’. Both approaches fail. In Rowntree v FCT  FCA 182 shows the additional care required to document even simple related-party transactions, such as loans. In this case, the taxpayer, a practising NSW lawyer, claimed he borrowed over $4m from his group of private companies. The Court said:
‘Mr Rowntree has not deliberately chosen to ignore the law. His evidence presented to the Tribunal suggests that he genuinely believed that there were arguments to support his view that a loan was in existence.’
He failed. Only a legally prepared Loan Agreement satisfies the ATO, Bankruptcy Courts and Family Court. Only a legally prepared Loan Agreement supports mortgages and debentures.
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If you do know but are paying it in instalments, then put it all in as one figure.
Otherwise, just put in the total figure. Remember to put in the dollar sign.
If you want it all paid back on the one date, just enter that date in.
If it is being paid back in instalments, you can word it how you like. for example
1) “Payable in instalments of 10% per calendar month”
2) “Half to be paid on 21 September 2018, and the remainder to be paid on 21 September”
3) “$100 to be repaid weekly for 10 weeks starting from 4 July”
1) If you are charging no interest, put the word “Nil”
2) If you aren’t sure what the interest rate is yet, leave it as the default, which is “as demanded from the lender from time to time”
3) You can put in a flat rate, for example, “5%” (don’t forget to put the % sign in)
4) Keep it variable, for example, “2% above the Commonwealth Bank interest rate”.
5) You can also use the inflation rate. You could word it something like “calculated according to the percentage increase in the Consumer Price Index (all groups) for the average of the capital cities of the Commonwealth of Australia. (As published by the Australian Bureau of Statistics or body that takes over that function.)”.
Adj Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
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