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  • When will an 'at call' loan be an equity interest?

    An 'at call' loan will generally be an equity interest if it does not satisfy the debt test in section 974-20 of the Income Tax Assessment Act 1997, and is not carved-out by the turnover test.  

    A loan between a company and a connected entity which does not have a fixed term but is repayable on demand, and does not have a requirement to pay arms' length interest, will usually be an equity interest. Such a loan can meet the requirements of item 3 of the equity table in subsection 974-75(1) of the ITAA 1997 if the right to, or amount of, the return under the arrangement is at the discretion of the company that has been advanced the funds, or at the discretion of a connected entity of the company, such as a controlling shareholder of the company.

    Accordingly, if the turnover test is failed, it will generally be the case that where a controlling shareholder lends money to a company, repayable on demand, with no fixed maximum term, and the loan is either interest free or has a low interest rate, the loan will be an equity interest for certain tax purposes.

    Tax consequences of an equity interest

    The tax consequences of an 'at call' loan being an equity interest are that any payment of interest on the loan will not be deductible but may be frankable. A
    non-share capital account is also kept in this instance (refer to Division 164 of the Income Tax Assessment Act 1997).

    An 'at call' loan that gives rise to an equity interest may, in specific circumstances, attract the application of the dividend substitution provisions contained in section 45B of the Income Tax Assessment Act 1936.

    Section 45B is designed to prevent the distribution of profits to shareholders as preferentially taxed capital rather than dividends.

    The ATO considers that section 45B might apply if an 'at call' loan is repaid under a scheme which has, as one of its purposes, the enabling of a taxpayer to obtain a tax benefit. There are a number of relevant circumstances that need to be considered in working out whether section 45B might apply.

    These circumstances, which are non-exhaustive, are set out in subsection 45B(8) and include such things as the pattern of distributions of dividends, bonus shares and returns of capital or share premium; whether the taxpayer has capital losses that might have otherwise been carried forward and whether the taxpayer is a non-resident. Accordingly, the application or otherwise of section 45B of the ITAA 1936 to related party 'at call' loans will be determined by the facts and circumstances of the relevant taxpayer.

      Last modified: 23 Jan 2017QC 18207