Loan to a company – to prove a loan & not equity: escape Debt Equity rules

Related party ‘at call’ loans to a company: Debt/Equity Rules

Your company buys a truck. Instead of the company borrowing the money from a bank, you draw the money out of your own bank account. Did you loan the money to the company? Or was it an injection of equity? The ATO says because there is no legally enforceable Company Loan Agreement it was an injection of cash. This means that it is difficult to get the money back tax-free.

If you hand money to a company it is either a loan (good) or an injection of equity (generally bad).

Loan to a company

The Debt/Equity tax rules started 1 July 2001. They bias financial interests in companies as equity, rather than debt.

It is generally better to treat money you put into your company as a ‘loan’ rather than an injection of ‘equity’. Where your loan is classified as equity rather than debt then:

1. any interest payable on the loan is not tax deductible (but potentially frankable as a dividend)
2. any repayment of the loan by your company is usually treated as the payment of a dividend
3. the thin capitalisation rules that apply to disallow debt deductions may also be impacted by the debt/equity classification of ‘at call’ loans

In other words, if the loan is deemed to be an injection of equity it is expensive and hard to get the money out of the company.

What are ‘related party at-call’ loans?

A related party ‘at-call’ loan is a financing arrangement. This is between a company and someone related or connected to your company. For example, the lender maybe you, your spouse, children, shareholder or a Family Trust. ‘At call’ means that the lender can demand back the money at any time. (In contrast, a loan may be for a fixed period. E.g. you will pay me back the money in 5 years’ time.)

Let’s say you make a loan to your company – but there is nothing in writing. There is no written company loan agreement. In your minutes and in your accounts, you classified the loan as a related party ‘at-call’ loan. But, sadly, this is not good enough.

Debt / Equity rules for ‘at-call’ loans

Consider this loan to a company  ‘at call’ loan:

Keith owns shares in his company. Keith lends $100,000 to his company. He forgets to build a Company Loan Agreement at www.legalconsolidated.com.au. Sadly:

1. there is no written company loan agreement
2. there is, therefore, nothing documenting the loan
3. also, there is no fixed repayment term for the loan

The arrangement between Keith and his company is that the loan is repaid when Keith demands repayment – ‘at call’.

Sadly, under the Debt/Equity rules, the ATO treats the loan as an injection of equity; not as a loan.

Therefore:

1. any interest payable on the loan is not deductible to Keith’s company
2. where the loan is subsequently repaid to Keith, the repayment is often classified as a non-share dividend paid from his company, therefore, Keith is assessed on the repayment of the loan.

$20 million turnover exception (de minimis exception)

The above rules do not apply to companies with an annual turnover of less than $20 million (excluding GST). However, it is not worth the risk. Your accountant for proper accounting standards and business practice requires the attached Company Loan Agreement. This puts the matter beyond doubt.

Further, if in any year your company does achieve a $20m plus turnover all loans are turned into equity. This is at that time.

Loan to a company ‘expire’ every 6 years

Even with your Company Loan Agreement, there is a risk that over time it stops working. In Australia, each State and Territory has a Statute of Limitation. Your unsecured loan to a company goes ‘stale’ or ‘expires’ if no repayments are paid or none are demanded.

The limitation periods for each State and Territory for unsecured loans are:

• Australian Capital Territory: 6 years
• New South Wales: 6 years
• Northern Territory: 3 years (the odd one out)
• Queensland: 6 years
• South Australia: 6 years
• Tasmania: 6 years
• Victoria: 6 years
• Western Australia: 6 years

So in the Northern Territory diaries every two years to come back to our website, log in and print your Deed of Loan again. And sign it again to freshen it up.

For all other jurisdictions, you have 6 years before your Company Deed of Loan is barred by the Statute of Limitation. In that case, diarise every 5 years to come back to our website log in and print out your Deed of Loan again. And sign it again to freshen it up. It starts the 6 year period running again.

What does Debt Equity ‘at call’ Loan contain?

1. Company Loan Agreement deed
2. Our law firm’s letter of advice on our law firm’s letterhead and signed by one of our Partners.

Can I just do a Company Deed of Loan on the back of an envelope?

In the movies, IOUs are often handwritten on a piece of paper. Sometimes instead of a Deed of Loan, someone does a ‘minute’. Both approaches fail. In Rowntree v FCT [2018] 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 Deed of Loan of a company satisfies the ATO, Bankruptcy Courts and Family Court.

Why is it better to prepare my Debt Equity ‘at call’ loan to a company on a law firm’s website?

You are dealing directly with a law firm’s website, therefore you:

1. retain legal professional privilege
2. benefit directly from the law firm’s PI insurance
3. receive legal advice from us
4. You are supported by our 100% money back guarantee on every document you build

For more legal advice telephone us. We are a law firm. We can help you answer the questions.

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
Mobile: 0477 796 959
National: 1800 141 612
Email: brett@legalconsolidated.com
Skype: brettkennethdavies