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Funding and finance

How to prepare robust tax governance practices so you can manage tax risks that arise around funding your business.

Last updated 20 September 2021

Robust tax governance practices can manage tax risks that arise around funding your business, such as in relation to:

  • funding through private company profits, and Division 7A
  • characterisation of funding as debt, and interest deductibility
  • characterisation of funding as equity, and dividend franking
  • withholding tax on foreign sources of funding
  • for international businesses, the impact of transfer pricing and thin capitalisation on interest deductions.

See also

Funding for less complex business structures

The most common sources of funding for less complex business structures are debt financing (either internally or externally) and gifting.

It's important to identify the specific entity from which the funding is sourced. The tax consequences can be very different if the funding is sourced from an individual acting in his or her own right, as opposed to an individual acting either as a trustee of the family trust or as the sole director of the family-owned private company.

Example: Loans from a private company to family members

You lend $100,000 to your sister on interest-free terms to help with her new business venture. This transaction has no immediate tax consequences for you or your sister.

However, your sister has asked you for a further loan. As the director and sole shareholder of a company, you transfer $100,000 from the company bank account to your sister's bank account. This transaction could result in a deemed dividend from the company being assessed to your sister. However, your family's tax agent has set up basic governance procedures which require that all loans from family companies be subject to loan agreements and an annual tax review. You ensure the correct loan agreement is in place and is reviewed annually. Your governance procedures have prevented an unexpected tax problem occurring.

End of example

Governance practices to manage risks around funding and financing can include the following:

  • Ensure all loans are properly executed and legally-binding, including any variations. Such documents would only need to cover the main terms of the loan, such as the parties to the agreement, the amount of the loan, the duration of the loan, repayment terms and interest rate. The documents do not need to be complex or lengthy.
  • Where funding or finance is sourced from a related company, ensure it's in accordance with the powers and procedures set out in the company’s constitution and documented accordingly.
  • Where funding or finance is sourced from a related trust, ensure that the trustee acted within their powers under the trust deed.
  • Ensure that the terms of the loan meet any tax law requirements that may apply.
  • Ensure appropriate accounting for the loan account, including evidence of repayments made.
  • Ensure all gifts are properly recorded in the books, and, where appropriate, other contemporaneous evidence of the gifting is kept.
  • Separate bank accounts are maintained for different entities in your business structure.

Any funding should be appropriately recorded, with contemporaneous documentation kept to evidence the type of funding, the source of funding and the relevant terms, such as:

  • properly executed loan agreements and variations (if any)
  • bank statements showing evidence of the initial payment (loan or gift) and repayments, including interest and capital repayments
  • tax working papers, including evidence of deductibility of the interest expense
  • loan accounts.

This documentation can be prepared by you or your staff in conjunction with your advisers. We suggest discussing these issues with advisers at pre-determined times during the year and before the tax return is prepared.

Funding for complex business structures

As a business grows in size and complexity, more options and opportunities become available for both debt and equity funding.

Debt finance can be sourced from an external lender, such as:

  • financial institutions
  • retailers
  • suppliers
  • finance companies
  • factor companies
  • family or friends.

Equity finance for a private company is typically sourced from:

  • self-funding
  • family or friends
  • private investors
  • venture capitalists or private equity
  • crowd funding.

The tax treatment of a funding transaction depends on the circumstances. Adopt practices whereby you consult with your adviser to determine the correct tax position for each major funding transaction. You may also ask us for advice.

Relevant tax laws include:

As the complexity of your business structure grows, it becomes more vital to implement a greater level of operational control. Effective governance practices can be demonstrated by:

  • clearly identifying roles and responsibilities for management and staff
  • ensuring responsible staff have the required experience, skill and tax knowledge to undertake their roles
  • specifying what would be considered a significant tax issue where escalation or additional sign-off is required
  • maintaining a good record-keeping policy and process for all funding and associated tax outcomes
  • maintaining a tax-related issues report
  • meeting with your adviser at least annually to discuss the tax-related issues report.

As part of the tax-related issues report, you and your adviser should consider and document any tax positions taken (including any reasonably arguable position where your tax treatment differs from the published ATO view).

Contemporaneous documentation to be kept under your tax governance procedures could include:

Debt finance

  • properly executed and legally binding financing documentation, including applications for loans, loan approvals and loan documents
  • company minutes or trustee resolutions evidencing approval for the loan
  • accounting records for each type of funding, including evidence of repayments
  • loan accounts
  • financial accounts
  • professional advice received.

Equity finance

  • valuation report
  • completed application for shares
  • directors' minutes approving the issue of shares
  • updated share register
  • documents necessary to meet other regulatory requirements, such as those of ASIC
  • for initial public offerings (IPOs), any due diligence committee minutes that consider the valuation report, the due diligence planning memorandum, the prospectus and the underwriter’s agreement
  • financial accounts (audited or unaudited)
  • professional advice received.

It's important to keep any other records of any decisions made by the directors or decision makers demonstrating the commercial purpose or reasoning behind particular transactions.

Example: Raising new finance

Your company recently wrote off significant bad debts due to the liquidation of a large customer. This resulted in cash flow problems and required new finance to be raised.

You have a strong tax governance framework in place that requires escalation of tax issues arising from proposed new sources of finance and strong documentation.

You raise new finance by borrowing from an overseas bank and issuing redeemable preference shares to existing shareholders. Tax governance policies ensure that all decisions are documented, finance staff identify and escalate the tax risks, and professional advice is obtained.

The ATO later reviews the restructure. You provide contemporaneous tax and finance documentation to support your position and show how your tax governance processes successfully managed the tax risks involved. The ATO provides practical certainty on the restructure, and the effective governance displayed is reflected in the company's tax profile.

End of example