Understanding Your Minimum Repayment Obligations

If you own a private company and have taken a loan as a shareholder or an associate of a shareholder, it is crucial to understand your repayment obligations. Failing to meet these obligations could have significant tax consequences. This blog will guide you through the essential considerations regarding loan repayments, including the concept of minimum yearly repayments, Division 7A loan agreements, and the financial impact of borrowing from a private company.

Understanding Shareholder Loans

A shareholder loan occurs when a private company lends money to a shareholder or an associate. You can verify whether such a borrowing exists by reviewing the company’s balance sheet as of 30 June 2024. Typically, the loan will be recorded as an asset of the company. Alternatively, some companies may categorize it as a negative liability, but recording it as an asset is the preferred approach.

If you have withdrawn funds from your company, these are considered loans by the company to you. If the amounts drawn exceed what is otherwise owed to you by the company, a loan is created, and appropriate action must be taken to avoid negative tax implications.

Tax Implications of Unpaid Loans

Under tax law, if you do not fully repay the loan by the earlier of the due date for lodging the company’s tax return or the actual lodgment date, the loan amount may be classified as a deemed unfranked dividend. This means that the borrowed amount will be treated as taxable income to the borrower for the financial year ending 30 June 2024.

Division 7A Loan Agreements

To prevent a deemed dividend from arising, you can place the loan under a complying Division 7A loan agreement. Under this agreement:

The benchmark interest rate set by the ATO must be applied. For the financial year ending 30 June 2025, this rate is 8.77%.
The loan must be repaid with principal and interest over a maximum of 7 years.
If the loan is secured by a mortgage over real property and other conditions are met, the repayment period can extend up to 25 years.

Minimum Yearly Repayments

Once a loan is placed under a complying Division 7A agreement, the borrower must make minimum yearly repayments by 30 June each year. If the full minimum repayment is not made, the shortfall will be treated as a deemed unfranked dividend.

Example: Great Calculations Pty Ltd

To illustrate, consider the following example:

Great Calculations Pty Ltd lent $50,000 to a shareholder, Petra, on 9 May 2022. Since Petra could not repay the full amount by the company’s tax return lodgment date, she entered into a 7-year Division 7A loan agreement. This requires her to make minimum yearly repayments as follows:

Year ending 30 June 2025: $9,681 (Interest: $3,319.97, Remaining principal: $31,519, Interest rate: 8.77%)
Year ended 30 June 2023: $8,569 (Interest: $2,383.88, Remaining principal: $43,814.88, Interest rate: 4.77%)
Year ended 30 June 2024: $9,555 (Interest: $3,613.52, Remaining principal: $37,880.26, Interest rate: 8.27%)

Since the benchmark interest rate changes annually, the exact repayment amounts for future years are not yet available.

Petra must ensure she has sufficient funds to meet her repayment obligations each year. This financial commitment will continue until the loan is fully repaid. Additionally:

Interest paid to the private company is assessable income for the company.
Petra may be able to claim a tax deduction on the interest paid, depending on whether the loan was used for an income-generating purpose.

If you have borrowed from a private company, it is essential to be aware of your repayment obligations and tax implications. A failure to properly structure and repay these loans can result in unintended tax liabilities. Understanding Division 7A loan agreements and planning for minimum yearly repayments can help ensure compliance and avoid unnecessary financial strain. If you are unsure about your obligations, consulting a tax professional can help you navigate these complexities effectively.

Want to learn how you can ensure you’re meeting your obligations? Contact our expert team today: hello@mksgroup.com.au