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  • Small business carve-out

    If a company has a turnover of less than $20 million, there is a carve-out which means related party ‘at call’ loans will be treated as being debt interests rather than equity interests.

    A company's annual turnover (worked out at the end of an income year) is to be determined in accordance with subsection 188-10(2) of the Goods and Services Tax (GST) Act 1999. This test is already used by small companies for GST purposes.

    Private companies with related party 'at call' loans that do not qualify for debt treatment may change their loans so they are debt interests under the debt/equity rules. Taxpayers may elect to treat this change as if it occurred at the beginning of the previous income year. This election must be made before the earlier of the due date for the company's tax return or the date of actual lodgment for that year.

    Because the turnover test applies on an annual basis, a company may qualify for deemed debt treatment under the debt/equity rules for one year but not the next. This means related party 'at call' loans to the company could change from being debt interests to being equity interests if their turnover exceeds $20 million.

    At call loan as debt interest

    An 'at call' loan will satisfy the debt test in two situations:

    • If the 'at call' loan has a maximum term of 10 years or less, and there is an effectively non-contingent obligation to repay (at least) the amount that was borrowed, the 'at call' loan will be a debt interest, irrespective of whether it pays interest.
    • If the loan is repayable 'at call' and has no fixed term, in order for it to be a debt interest there needs to be an effectively non-contingent obligation to pay an interest rate that is high enough to pass the debt test on a present value basis (an arm's length interest rate will achieve this).

    Tax consequences of a debt interest

    If an 'at call' loan satisfies the debt test and is classified as a debt interest, any payments in the nature of interest made by the company on the 'at call' loan may be deductible but cannot be franked.

    Whether or not the interest payments would be deductible is determined by reference to the general deduction provisions of the income tax law (in particular, section 8-1 of the Income Tax Assessment Act 1997). This requires an assessment of, among other things, the use to which the borrowed funds are put.

    A company may be indifferent as to whether an 'at call' loan is a debt interest or an equity interest. However, if the company is to pay interest on the loan and wants to be able to claim deductions for the interest paid (subject to section 8-1), the entity will need to ensure the terms of the 'at call' loan satisfy the debt test.

    How to make an 'at call' loan a debt interest

    If debt treatment is required, the company should review its 'at call' loan funding arrangements and amend the terms and conditions in such a way that the requirements of the debt test are satisfied.

    To ensure debt treatment, the term of the loan should either be fixed at no more than 10 years, or, if the loan is for a term greater than 10 years or has no fixed term, an arm's length rate of interest will need to be paid. It is advisable that the loan be documented so that these terms can be demonstrated to be effectively non-contingent obligations of the company. One possible approach would be for the connected entity and the company to enter into a facility agreement making all money outstanding from time to time fall due and be repayable on a date not more than 10 years from the time the facility agreement is entered into.

    Practically, the review of the 'at call' loan will not be important until a transaction occurs in respect of the loan, for example, when the company makes a payment of principal or interest. Prior to a transaction occurring, there will be no major taxation consequences of the 'at call' loan being classified as an equity interest (other than the requirement to keep a non-share capital account).

    Amending 'at call' loans so they give rise to a debt interest

    An 'at call' loan that is altered to either specify a term of 10 years or less, or requires that an arm's length rate of interest be paid, will be treated as a debt interest from the time the alteration occurred.

      Last modified: 23 Jan 2017QC 18207