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Potential tax shock for businesses with shareholder bank loans

Adrian Flores
Adrian Flores
30 June 2020 1 minute readShare
Tamara Cardan

Small businesses should check they have loan agreements for any loans which may have been made to shareholders during the COVID-19 pandemic, or else face an unsavoury tax bill, warns a law firm.

The warning from Rigby Cooke Lawyers comes as the ATO announced a last-minute extension to minimum yearly repayments for borrowers, giving them until June 2021 to make their 2019–20 repayments.

The law firm noted that many family businesses make loans to shareholders, often to help with family members’ cash flow.

It said loans that are not compliant with Division 7A of the Income Tax Assessment Act 1936 may be counted as dividends, and therefore treated as taxable income for the shareholder.

Rigby Cooke Lawyers tax counsel Tamara Cardan said non-compliant loans were quite a common mistake for family businesses to make, given the propensity for some family members to treat the family business like their own bank account.

“I have seen many situations where you have money going back and forth in a business with no loan agreements,” Ms Cardan said.

“When this occurs, these payments may actually be considered dividends, and therefore be taxable.”

Ms Cardan said if the loan is repaid in the tax year, this may not occur. However, she added that even if a shareholder intends to repay the loan, an agreement should still be in place.

“It is understandable that families may want to help each other by loaning some money from the family business in these difficult times,” she said.

“However, it’s essential that they have the right paperwork in place; otherwise, that generosity could see their family member end up with an unwanted tax bill.

“Deemed dividend rules in Division 7A of the tax legislation are in place to prevent shareholders from withdrawing tax-free funds from the business.”

Ms Cardan said the ATO’s repayments extension doesn’t offer any leniency towards non-compliant loan agreements.

“While borrowers will welcome the relief, those borrowers who have failed to put the appropriate agreements in place will not sleep any easier,” she said.

Finally, Ms Cardan said it’s often the case family businesses that make interest-free loans to shareholders, usually members of their family, are not doing this to wilfully avoid tax.

But she also warned that a lack of intent is not a sufficient reason for leniency.

“Like much of the ATO’s leniency during the pandemic, this extension defers the issue rather than alleviate the financial burden of a tax debt,” Ms Cardan said.

“There hasn’t been any indication that the ATO will be pursuing more lax enforcement to help businesses or individuals navigate the COVID-19 crisis.”

Potential tax shock for businesses with shareholder bank loans
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Adrian Flores
Adrian Flores

Adrian Flores is the deputy editor of MyBusiness. Before that, he was the deputy editor for SMSF Adviser as well as features editor for ifa (Independent Financial Adviser), InvestorDaily, Risk Adviser, Fintech Business and Adviser Innovation.

You can email Adrian at [email protected].

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