Tax Tip 279: Don’t let a Related your Company Guarantee your Loan

Most investors involved with companies would have heard of the phrase ‘Division 7A’. This is a division of the 1936 ITAA which can make financial accommodation received from a related company be taxed as a deemed dividend.

This applies to loans, debts forgiven, use of company assets and also guarantees given by companies to associates.

The relevant legislation is s109UA.

This section deems a guarantee to be a dividend (unfranked too) unless the guarantee is a contingent liability. Here ‘contingent liability’ is not defined but it would be guarantee that is only triggered on default of the borrower.

The example given in s109UA is:

Example: A private company guarantees a loan that a bank makes to a shareholder in the private company and the shareholder defaults on the loan. As a result, the company has a presently existing liability to make a payment to the bank. Section 109T operates as if the private company had made a payment to the bank, so the company is treated by section 109V as making a payment to the shareholder (because the bank is interposed between company and shareholder).


Case Study

Thelma operates a small business via a company structure. Thelma is the shareholder and director of the company. Thelma goes to a non-bank lender who agrees to give her a loan to purchase property provided Thelma’s company gives a guarantee for the loan. This is because Thelma is relying on the income from the company to service the debt.

The loan agreement says that the company is liable for the debt with Thelma.

Thelma is borrowing $500,000.

The following year the ATO adds $500,000 to Thelma’s income as a dividend from the company because of s109UA. The tax could be as high as $235,000.

Say the guarantee was contingent on Thelma defaulting under the loan.

Due to the Corona Virus and associated disruptions Thelma misses a repayment on her loan – she has breached the loan agreement and the guarantee is triggered, even if it is not enforced by the lender. A deemed dividend results.


Legislation

S 109UA ITAA36 http://www.austlii.edu.au/au//legis/cth/consol_act/itaa1936240/s109ua.html


Tip – never allow a company to guarantee a loan of a shareholder or associate of a shareholder. Try a different lender if you have to.

 

Of course I should mention that to avoid the dividend being deemed you could enter into a complying loan agreement with the company - but interest and principal repayments would be required.