• Small business carve-out from debt/equity rules

    Legislation was recently enacted to simplify the tax treatment of related party 'at call' loans of small companies to ensure that those companies with an annual turnover of less than $20 million will treat their related party 'at call' loans as debt interests for the purposes of Division 974 (refer to the link to Tax Laws Amendment (2005 Measures No. 5) Act 2005 under the heading 'More information' at the end of this guide).

    Annual turnover test

    The recently enacted legislation provides that 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. To pass the test, the company's annual turnover must be less than $20 million. This test is already used by small companies for GST purposes.

    The amendments in the recently enacted legislation will apply from 1 July 2005. The existing transitional provision which deemed related party 'at call' loans to be debt, expired on 30 June 2005.

    The recent changes to the legislation also provide that private companies with related party 'at call' loans that do not qualify for debt treatment may still 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.

    What does this change mean for a company with an annual turnover of less than $20 million?

    From 1 July 2005, these companies will continue to treat related party 'at call' loans as debt interests for the purposes of the debt/equity rules.

    What does this change mean for a company with an annual turnover of more than $20 million?

    Companies that have not amended the terms of their 'at call' loans before 1 July 2005 must treat such loans as equity interests under the debt/equity rules.

    Companies that have amended the terms of their 'at call' loans before 1 July 2005 (so that the loans are debt interests under the debt/equity rules) will continue to receive debt treatment after 1 July 2005.

    Can a private company with an annual turnover of more than $20 million still elect to have their 'at call' loans treated as debt interests?

    The recent amendments recognise that a company may qualify for deemed debt treatment under the debt/equity rules for one year but not the next, because the company ceases to satisfy the turnover test. This means that related party 'at call' loans to the company could change from being debt interests to being equity interests if their turnover exceeds $20 million.

    The government amendments recognise that taxpayers might not become aware of their increased turnover and resulting equity interests until the end of an income year when calculating annual turnover. Accordingly, taxpayers that are private companies may amend the terms of their 'at call' 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. They must make this election before the earlier of the due date for the company's tax return or the date of actual lodgment for that year. This removes the need to treat the loan as an equity interest for that previous year.

      Last modified: 13 Feb 2006QC 18207