• Loans made under written agreements

    44. What criteria must a loan meet so as not to be treated as a dividend in the year it is made?

    Loans that meet all the following criteria will not be treated as dividends in the year the loan is made.

    • The loan is put under a written agreement. The written agreement must be in place:

    (a) for private company loans made in the 2003-04 or an earlier income year - before any amount is advanced to the shareholder or shareholder's associate. However, Practice Statement Law Administration PS LA 2005/3 (GA) sets out an administrative concession for the 2003-04 income year. For loans made during the 1997-98 income year, this requirement will be satisfied if the written agreement was put in place before 1 July 1998

    (b) for private company loans made in the 2004-05 or a later income year - before the 'lodgment day'

    (c) for trustee loans made on or after 12 December 2002 - before the 'lodgment day'.

    • The rate of interest payable on the loan in the income years after the year the loan is made equals or exceeds the Indicator Lending Rates - Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the private company's or trustee's income year.
    • The term of the loan does not exceed the maximum term prescribed by the legislation for that kind of loan (see below).

    (See subsections 109N(1) and (2).)

    The maximum term allowed is:

    • 25 years, if 100% of the loan is secured by a registered mortgage over real property and, when the loan is made, the market value of the property, less the amounts of any other liabilities secured over the property in priority to the loan, is at least 110% of the amount of the loan, and
    • seven years for any other loan.

    From the income year in which 1 July 2006 occurred, there is provision for a secured loan to be converted to an unsecured loan and similarly an unsecured loan to be converted to a secured loan. In each case the maximum term is adjusted. See question 46.

    (See subsections 109N(3), (3A), (3B), (3C) and (3D).)

    The 'lodgment day' is the earlier of the due date for lodgment and date of lodgment of the lender's tax return for the income year in which the loan is made. If the Commissioner has deferred the due date for lodgment of the tax return then the due date for lodgment is the deferred due date.

    The 'lender' is the private company or trustee who made the loan that is subject to Division 7A.

    45. What elements of the loan agreement need to be in writing?

    If a private company makes a loan to a shareholder or their associate in an income year and the loan has not been fully repaid, the entire agreement between the parties must be in writing for the purposes of paragraph 109N(1)(a) of Division 7A of Part III of the Income Tax Assessment Act 1936. This includes:

    • the names of the parties
    • the loan terms (that is, the amount of the loan and the date the loan amount is drawn, the requirement to repay the loan amount, the period of the loan and the interest rate payable)
    • that the parties named have agreed to the terms, and
    • when the written agreement was made - for example, the date it was signed or executed.

    An agreement that is partly oral and partly in writing is not an agreement in writing for the purposes of this paragraph.

    The requirement for the agreement to be in writing would also be sufficiently satisfied if there is written confirmation of the existence of the agreement and the essential elements. For example, an exchange of letters, emails, fax, or other means of communication would be sufficient if they are dated and provide written evidence of the terms of the agreement and the parties' acceptance of those terms.

    If a formal written loan agreement between the parties does not contain all the essential elements, the requirement of paragraph 109N(1)(a) may still be satisfied provided there is supporting written evidence of the remaining elements of the agreement between the parties.

    The essential elements of the agreement need to be in writing before the company's lodgment day for the income year in which the loan was made (or at the time of making the loan for the 2003-04 and earlier income years).

    For more information on (and examples of) elements of the loan agreement that need to be in writing, refer to Taxation Determination TD 2008/8.

    46. What are the new maximum terms when loans are refinanced from unsecured to secured loans or secured loans to unsecured loans?

    Unsecured loan to secured loan

    The maximum term of the secured loan is 25 years reduced by the period of the term already expired in the unsecured loan. For example, if an unsecured loan with a term of seven years is refinanced after three years the maximum term of the secured loan will be 22 years.

    Secured loan to unsecured loan

    The combined period of the secured and unsecured loans cannot exceed 25 years. Therefore, if:

    • the expired term of the secured loan was less than 18 years the maximum term of the unsecured loan will be seven years.
    • the expired term of the secured loan exceeded 18 years then the maximum term of the unsecured loan is seven years reduced by the number of years in excess of 18 years. For example, if an secured loan with a term of 25 years is refinanced after 20 years the maximum term of the unsecured loan will be five years (that is, 7 years - (20 years - 18 years)).

    (See subsections 109E(3), (3A), (3B), (3C) and (3D).)

    47. Where are the 'indicator lending rates - bank variable housing loans interest rates' found?

    They are published in the Reserve Bank of Australia Bulletin. Also, the ATO annually publishes the benchmark interest rate that applies each year for private companies whose income year ends on 30 June.

    Different rules apply to companies that have been granted leave to adopt a substituted accounting period. For more information, refer to Taxation Determination TD 2001/18.

    48. Can a loan that meets the minimum interest rate and maximum term criteria ever be treated as a dividend?

    Yes. Such a loan may be treated as a dividend in a later income year if minimum yearly repayments are not met.

    49. Is a written agreement required for each debit entry to a shareholder's or beneficiary's loan account?

    No. For example, a written agreement put in place at the beginning of the income year in which the private company or trustee agrees to lend money from time to time would be acceptable. A correctly worded written agreement could cover all loans to be made for a number of income years into the future.

    50. What if the loan account fluctuates from credit to debit during the income year?

    The written agreement must be in place by the 'required time' for each loan not fully repaid.

    The 'required time' is:

    • For private company loans made in the 2003-04 and earlier income years:
    •  
    • For private company loans made in the 2004-05 and later income years and trustee loans made on or after 12 December 2002:
      • before the 'lodgment day' of the 'lender'.
       

    The 'lodgment day' is the earlier of the due date for lodgment and date of lodgment of the lender's tax return for the income year in which the loan is made. If the Commissioner has deferred the due date for lodgment of the tax return then the due date for lodgment is the deferred due date.

    The 'lender' is the private company or trustee who made the loan that is subject to Division 7A.

    51. What should be in the written agreement?

    There is no prescribed format. However, as a minimum, the agreement should:

    • identify the lender and borrower
    • set out the essential conditions of the loan (that is, the amount of the loan, the requirement to repay, the interest rate payable, and the term of the loan), and
    • be signed and dated by the lender and borrower.

    52. Does the loan agreement need to be approved by the ATO?

    No. The ATO cannot prescribe the form of the written agreement, but upon application by one of the parties to the agreement, it may give a private ruling on the way in which Division 7A applies to the applicant in relation to the agreement.

    53. Does the shareholder or shareholder's associate need to make a loan repayment in the income year the loan is made to avoid the private company being taken to have paid a dividend?

    No. Division 7A only requires the shareholder or shareholder's associate to make minimum yearly repayments in the income years after the income year in which the loan is made.

    (See subsection 109E(1).)

    54. What are the Division 7A consequences of having an interest only loan?

    An interest only loan, which is made under a written agreement and which meets the minimum interest rate and maximum term criteria, is not treated as a dividend in the income year it is made. However, it is unlikely to satisfy the minimum yearly repayment requirement in subsequent income years. This is because the formula for the minimum yearly repayment works out the minimum principal and interest repayment that must be made on the loan whereas an interest only loan does not require the repayment of principal.

    (See subsection 109E(6).)

    55. Is any form of security, other than a mortgage registered under state or territory law over real property, acceptable to qualify for a maximum term of 25 years?

    No. The loan must be secured by a mortgage over real property that has been registered in accordance with a law of a state or territory. No other form of security is acceptable.

    For example, a charge registered at the Australian Securities and Investments Commission under the Corporations Act 2001 is not acceptable. Although it qualifies as a mortgage for tax purposes (see the definition of 'mortgage' in subsection 6(1) of the ITAA 1936), it cannot be a mortgage over real property (see subsection 262(8) of the Corporations Act 2001). Also, it is registered under a law of the Commonwealth, not a law of a state or territory.

    (See subparagraph 109N(3)(a)(i).)

    56. Can the registered mortgage security be provided by an entity other than the shareholder or shareholder's associate?

    Yes. An entity other than the shareholder or shareholder's associate can provide the registered mortgage security for a loan. However, for Division 7A purposes, the giving of security constitutes a guarantee. Consequently, if the entity providing the security is a private company and the borrower is a shareholder or shareholder's associate of that private company, the provision of security may be treated as the payment of a dividend under sections 109U and 109UA.

    For example, a private company (the guarantor) provides registered mortgage security for a loan that another private company makes to its shareholder. The shareholder is also a shareholder of the guarantor and so, under section 109U, the provision of security may be treated as the payment of a dividend by the guarantor to the shareholder.

    57. Can the security provided for a loan to a shareholder or shareholder's associate be a registered second, third or fourth mortgage over real property?

    Yes. This is provided that 100% of the value of the loan is secured by the registered mortgage and, when the loan is made, the market value of the property less the amounts of any other liabilities secured over that property in priority to the loan, is at least 110% of the value of the loan.

    (See subsection 109N(3).)

    58. For a loan with a maximum term of 25 years, when does the registered mortgage security have to be in place?

    Private company loans made in the 2003-04 and earlier income years

    The legislation indicates that the mortgage needs to be registered at the time the loan agreement is signed. However, as a matter of practicality, the mortgage documentation should be signed at the same time as the signing of the loan agreement and then be registered as soon as practicable after the signing. However Practice Statement Law Administration PS LA 2005/3 (GA) sets out an administrative concession for the 2003-04 income year.

    Private company loans made in the 2004-05 and later income years and trustee loans made on or after 12 December 2002

    The legislation indicates that the mortgage needs to be registered before the 'lodgment day'

    The 'lodgment day' is the earlier of the due date for lodgment and date of lodgment of the lender's tax return for the income year in which the loan is made. If the Commissioner has deferred the due date for lodgment of the tax return then the due date for lodgment is the deferred due date.

    The 'lender' is the private company or trustee who made the loan that is subject to Division 7A.

    (See subsection 109N(3).)

    59. A 20 year loan is made after obtaining security satisfying the criteria for a maximum term of 25 years. In subsequent income years, the value of the real property securing the loan falls to below 110% of the value of the loan. What are the Division 7A implications?

    A decrease in property values in a year after the loan is made will not result in a deemed dividend. Property valuations are not required for Division 7A purposes after the loan is made.

    (See paragraph 109N(3)(a).)

      Last modified: 14 Sep 2010QC 16852