Do you know the tax implications for related party loans?

Do you know the tax implications for related party loans?

08 December 2023

As the profits roll in and your balance sheet is consecutively cashflow positive, you may be tempted to withdraw some of the profit, but unfortunately, it’s not that simple. You may be surprised to learn that withdrawing profits could be considered a related party loan and there are several tax implications that you need to consider.  

Related party loans also known as a division 7a loan occur when an entity, such as a company, or trust, lends funds to a controlling individual or another related party of the controlling individual. Common scenarios of a related party loan could include: 

  • Business owners withdrawing funds for personal use without it being treated as a dividend or wage. 

  • Shareholders using company funds to acquire personal assets like investments, cars or houses. 

  • Using company assets for your own personal purposes without payment, for example, enjoying a company-held holiday house. 

These loans are often complex in nature and misunderstood by the company’s directors. AR Advisors Director, Kris Elliot, emphasises the significance of this by explaining, ‘If you use a company asset or take an asset out of the company or trust without paying for them, then they are considered a related party loan. Increasingly, these loans are attracting the attention of the Australian Taxation Office (ATO) with several cases being pursued through the courts. These cases are leading to interest and penalties being imposed on businesses that are mismanaging their obligations.’ 

So, are related party loans worth it?  

Kris believes they can be, 'Related party loans are not inherently problematic. They can be beneficial if they are structured properly, offering positive tax outcomes such as achieving a better net tax position and accessing company assets for a period of time whilst minimising the tax implications.’ 

To meet all your tax obligations when entering a related party loan, company directors should consider the following: 

  1. Prepare a complying loan agreement. 
    The complying loan agreement should clearly set out the commercial terms of the loan which may also need to satisfy the legislative requirements. Failure to do so can lead to implications if a dispute arises between the parties. 

  2. Declare dividends to the shareholders of the company. 
    An important aspect of maintaining compliance with tax regulations, particularly division 7a of the Australian Income Tax Assessment Act 1936, is declaring dividends to shareholders of the company. It provides an approach to address outstanding balances and allows for the proper management of financial transactions, mitigating the risk of deemed unfranked dividends.  

  3. Ensure the loan is repaid in a timely manner. 
    The loan period for most related party loans is generally a maximum of seven years although secured loans can be extended up to 25 years. It is important when entering a related party loan that you meet repayment deadlines to establish that the loan is conducted on arm’s length terms. Essentially, you want to be able to demonstrate that the loan is a commercial transaction with terms and conditions like those between unrelated parties. This demonstrates the legitimacy of the loan to the ATO.  

While the laws governing related party loans haven’t changed, the ATO’s interpretations of this law have evolved, highlighting the importance of seeking professional advice before undertaking this type of loan. Kris underscores the retrospective nature of this, ‘AR Advisors are often approached after the loan has been undertaken. Whilst we can help to rectify and resolve the loans to get the right outcome, it’s better to seek advice early, so we can plan and strategise to ensure the best possible tax outcomes while minimising any implications.’ 

For more information and advice on related party loans, call 9321 3362 or email info@aradvisors.com.au

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