By: Max Newnham
Loan agreements need to be drawn up when shareholders are paid.
There are many reasons why small business owners choose to operate through a company structure. One of the most important is the legal protection a company provides to the personal assets of the owners.
When a business is operated as a sole trader, partnership of individuals or discretionary family trust with individuals acting as trustees there is the risk that the personal assets of the owners can be attacked if the business fails or is sued. Where a family discretionary trust has a company act as trustee the assets of the owners can be protected.
There is no flexibility with regard to the time frame over which a shareholder’s loan must be paid back. Photo: Jim Rice
Another benefit of operating through a company for small businesses that are in a growth phase is the lower company tax rate allows more business profit to be reinvested back in the business.
This benefit does come at the cost of the owners missing out on some of the small business capital gains tax concessions.
It also means that because companies are more regulated than other business entities administration costs can be higher. In addition, when owners withdraw money from a business operated through a company, known as division 7A loans, documentation must be prepared to avoid penalty rates of tax being paid.
Q. I have been spending my personal income to establish a business that is set up through a company. I have read when an owner borrows money from a company a loan agreement must be drawn up. What are the tax implications of the business paying me back for the money I have loaned it? The business has made zero income to date, but I believe in the future it will earn enough to allow this to happen. Is the money paid back to me tax free?
A. You are right about the requirement for loan agreements needing to be drawn up when shareholders are paid money by a company that has accumulated profits. The loan agreement must include the amount of the loan taken by the shareholders and the term of the loan.
There is no flexibility with regard to the time frame over which a shareholder’s loan must be paid back. If a loan to a shareholder is not 100 per cent secured by property it must be paid back within seven years. Loans secured by a property can be paid back in 25 years. In addition, interest must be paid on the loan at the division 7A benchmark interest rate, which is now 5.4 per cent.
When a shareholder loans money to a company it is not necessary to draw up documentation, but it does make sense if the shareholders want to protect themselves. In this case a loan agreement should be drawn up with the amount owing to them secured by a registered debenture.
Repayments by the company of your loan to it will not be treated as taxable income in your hands and therefore will be tax-free. If after the company has become profitable it pays you more than the amount than you loaned it a division 7A loan agreement must be drawn up.
Source: The Sydney Morning Herald
