Family businesses are being warned that loans made during the COVID-19 pandemic could be counted as dividends by the Tax Office, a potentially nasty surprise from the crisis.
After changes announced in late June, some loans that are not compliant with requirements under division 7A of the Income Tax Assessment Act could be treated as taxable income, potentially hurting small businesses that lend money to boost the cash flow of a family member or associate.
Rigby Cooke Lawyers tax counsel Tamara Cardan said a last-minute extension to minimum yearly repayments for borrowers announced by the ATO had left businesses until June 2021 to make 2019-20 repayments.
“The purpose of the division 7A rules is to prevent shareholders and their associates in private companies receiving tax-free benefits from companies in which they have an interest,” she said.
With non-compliant loans being a common mistake for family businesses – given the propensity of some owners to treat the operation like a bank account – Ms Cardan said it was essential to have the right paperwork in place.
“One way to mitigate the risk of division 7A, if you are intending to loan amounts to your shareholders or family members of those shareholders, is to put a division 7A compliant loan agreement in place,” she said.
“I have seen many situations where you have money going back and forth in a business with no loan agreements.
“When this occurs, these payments may actually be considered dividends, and therefore be taxable.”
Loans repaid in the tax year could avoid the outcome, but even if a shareholder intended to repay, a written agreement was advisable, Ms Cardan said.
Deemed dividend rules in division 7A are in place to prevent shareholders from withdrawing tax-free funds from the business.
Ms Cardan said the ATO’s repayments extension did not offer any leniency towards non-compliant loan agreements, and a lack of intent was an inadequate excuse in the eyes of the ATO.
“It’s often the case family businesses that make interest-free loans to shareholders, usually members of their family, are not doing this to wilfully avoid tax,” she said.
“Like much of the ATO’s leniency during the pandemic, this extension defers the issue rather than alleviate the financial burden of a tax debt.”
RSM Australia associate director Tracey Dunn said that given the late release of the guidance and complexity in the application form, the change could be too little, too late.
“With COVID-19 having a significant impact on the economy, many division 7A borrowers may find they are unable to meet their minimum yearly repayment due to job losses, the financial impact on business or general financial hardship.
“Under the ATO guidance, a borrower who is unable to make their division 7A minimum yearly repayment due to the impact of COVID-19 may be able to request an extension on making the minimum yearly repayment provided they meet certain conditions. If the request is approved, the borrower may be provided with an extension to pay by up to 12 months.”