Private companies may be incentivised to make loans to a shareholder or their associate during the income year in an effort to save on income tax. In order to remedy any inequities as a result of making shareholder loan agreements, the Government enforces compliance through a set number of rules. Loans which follow such rules under the Income Assessment Act 1936 will also be exempted from being a dividend.
Minimum interest rate
Loans must have an interest rate greater than or equal to the benchmark interest rate outlined in Division 7A of the Income Tax Assessment Act 1936, published by the ATO annually. The benchmark interest rate for 2020 is 5.35% (under bank variable housing loans interest rates) and is 4.52% for 2021. This interest rate needs to be applied for each year after the year in which the loan was made.
The maximum term for a complying loan agreement is seven years. In the case that the loan is secured by a registered mortgage over real property, the maximum term is 25 years. For a maximum term of 25 years, the market value of the property (not including any other liabilities for securing the property prior to the loan) must also be at least 110% of the amount of the loan.
In addition to meeting the minimum interest rate and maximum term criteria, complying loan agreements need to be made under a written agreement before the private company’s lodgement date. Loan agreements that meet such requirements will not be treated as a dividend in the income year the loan is made.
There is no prescribed form for the written agreement. However, as a minimum, the agreement should:
- identify the parties,
- set out the essential terms of the loans (for example, the amount and term of the loan, the requirement to repay and the interest rate payable under the loan), and
- be signed and dated by all parties involved.