Lending Money to a Company - No loan agreement

We sometimes see posts here about how to use personally borrowed funds and ensure that the entity can access a interest deduction. This requires loan agreements etc

It sometimes can be avoided and can be achieved in a different and easier way.

Eg Fred and Mary seek to lend $500K to ABC Pty Ltd. Interest of $26,000pa is to be incurred. Can the company claim the interest ? Yes, but it reduces company profit and requires legal issues like loan agreements and more.

Well there may be another option.

Fred and Mary could invest the 500K and buy additional shares in ABC Pty Ltd. But that alone wont make their borrowing deductible since there needs to be an expectation of the company shares paying a dividend. And thats the tip - Allow ABC Pty Ltd to pay a dividend at 30 June of that year. In doing this Fred and Mary can claim a PERSONAL deduction for the interest on the loan against their dividend income.

How much should the dividend be? Well there isnt a test. It can just be $1. So Fred and Mary may each have a neg geared benefit of $26K less $2 shared between them.

However, Shortens new neg gearing plan may prevent this. His exception for new premises etc wouldnt apply to a passive interest in shares.

Benefits of this arrangement :
1. Company profit is maximised and not reduced by the interest cost - ie a margginal tax rate of 27.5% or 30%
2. The individual taxpayers may benefit from a deduction at their marginal tax rate. Perhaps higher than 27.5% or 30% ?
3. Fred and Mary may even obtain neg geared if the dividend amount is less than the interest cost.
4. No complex legal (ie loan agreement) and loan maintenance issues for the company or the individuals.

Downside : This process doesnt easily work for a discretionary trust and the proposed future cap on neg gearing.

 

Can also be better for loan serviceability with banks.

One issue though is that debts can be assigned without duty, shares can be transferred too but sometimes there may be duty, and always a CGT event.

Estate planning implications too as you won't have the loan to leave via the will but will have shares. Different consequences. Debts can be forgiven too.

If the company folds in either case loss of capital and possibly a capital loss. Holding shares may be better in this regard.

And there are issues if there is more than one shareholder.

 

Yes. For larger divs servicing can be a real winner..If the dividend was a large amount banks may include that in servicing and it could vastly enhance capacity. Many lenders will look at the TAXABLE value of a dividend and not the cash value... If that strategy is used then the dividend should exceed the interest so its positively geared.

ie $100K fully franked div. Taxable income will increase by up to $142,857 where the tax payable may only increase by no more than $24,285 or even $0 if its the sole income. In cases like this lenders often look at the individuals notice and like to see no tax debt payable as any debt may also impact servicing.

Return of capital issues can also be a benefit with shares vs a loan. A capital gain subject to 50% discount even. CGT impacts must be determined of course.