It is not uncommon for businesses to provide loans to shareholders or associates of a company. However, business owners should know the conditions that their loan must satisfy under Division 7A, to avoid the amount being deemed a dividend.
Division 7A loan agreements need to be made under a written agreement before the private company’s lodgement date. As a minimum, the written agreement should:
- identify the parties,
- set out the essential terms of the loans (e.g. the amount and term of the loan, the interest rate payable under the loan), and
- be signed and dated by all parties involved.
Minimum interest rate
Loans must have an interest rate greater than or equal to the annual benchmark interest rate outlined in Division 7A. The benchmark interest rate for 2020 is 5.35% and will be 4.52% in 2021. This interest rate needs to be applied for each year after the year in which the loan was made.
The maximum term for a loan agreement is seven years. If the loan is secured by a registered mortgage over real property, the maximum term is 25 years. For this maximum term, the market value of the property (not including any other liabilities for securing the property prior to the loan) must also be at least 110% of the amount of the loan.
From the 2007 income year onwards, loans that can be refinanced without resulting in a deemed dividend include:
- An unsecured loan which is converted to a loan secured by a registered mortgage over real property can have the loan term extended (with relative terms).
- A secured loan which is converted to an unsecured loan with a corresponding reduction in the loan term.
- A loan which becomes subordinated to another loan from another entity due to circumstances beyond the control of the original entity.
If these loan conditions are not met, Division 7A of the Income Assessment Act 1936 applies and the loan is deemed a dividend. This dividend is treated
as taxable income and the company receives no tax deductions for its loan to you or your shareholders.