Powerfully Exempting Division 7A: Party Loan Exclusion
Client Background: Our firm recently welcomed a new client who had utilised company funds amounting to $500,000 to repay a bank loan associated with a commercial investment property. This property was owned by a related family trust. Following this transaction, the client had established an internal loan agreement, separate from a division 7A agreement, with the family trust. The client was keen to understand if this internal loan arrangement could be excluded from the rules outlined in Division 7A.
Our Advice: Our team of tax experts assessed the client’s situation and provided the following guidance:
- Scope of Division 7A:
- We explained that Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) typically applies when a private company makes a loan to a related trust. Division 7A is triggered if either:
- The trust holds any shares in the company, or
- Anyone who could potentially receive a benefit from the trust, directly or indirectly, holds any shares in the company.
- Given that the client had utilised company funds to repay a loan associated with a family trust and he was the primary beneficiary of the Trust, it was likely that the transaction fell within the scope of Division 7A, particularly since the parties involved were related.
- We explained that Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) typically applies when a private company makes a loan to a related trust. Division 7A is triggered if either:
- Deemed Unfranked Dividend:
- We highlighted that, under Division 7A, a deemed unfranked dividend would ordinarily arise unless the loan is fully repaid or is placed under a complying Division 7A loan agreement by the earlier of the due date and actual lodgement date of the company’s tax return for the year the loan was made.
- Complying Division 7A Loan Agreement:
- Section 109N of the ITAA 1936 sets out the stringent requirements for a loan agreement to qualify as a complying Division 7A loan agreement. Key conditions include:
- The agreement must be in writing.
- The loan term must not exceed 7 years.
- The interest rate must be at least as much as the Division 7A benchmark rate for each year of the loan, which is updated annually by the Australian Taxation Office (ATO).
- The latest Division 7A benchmark interest rates can be found in the ATO website, which was forwarded to the client.
- Section 109N of the ITAA 1936 sets out the stringent requirements for a loan agreement to qualify as a complying Division 7A loan agreement. Key conditions include:
- Exception:
- We informed the client that, in general, the loan term cannot exceed seven years. However, section 109N ITAA 1936 allows for an extension of the maximum loan term to 25 years if specific conditions are met, including:
- 100% of the loan value is secured by a registered mortgage over real property.
- The market value of the real property (excluding other secured liabilities) is at least 110% of the loan amount when the loan is initially made.
- We informed the client that, in general, the loan term cannot exceed seven years. However, section 109N ITAA 1936 allows for an extension of the maximum loan term to 25 years if specific conditions are met, including:
Conclusion: In this case, the client sought guidance on excluding an internal loan agreement between a company and a related family trust from the Division 7A rules. Our comprehensive advice outlined the conditions and requirements for complying with Division 7A regulations.
Navigating Division 7A can be complex, and it is crucial for individuals and businesses to seek professional guidance to ensure compliance with tax laws and optimise their financial arrangements. Our firm is committed to providing tailored solutions for our client’s unique tax challenges, enabling them to make informed decisions while meeting their tax obligations.