26/05/2010

It is important for trustees of Self Managed Superannuation Funds who are borrowing from a related party to give consideration to the provisions of Division 7A of Income Tax Assessment Act 1936 (Cth) (ITAA36) if the related party lender is a private company or a discretionary trust with a corporate beneficiary.

 

Division 7A states that where a private company makes a loan to a shareholder or shareholder’s associate during an income year and the amount is not fully repaid by the lodgement date for that income year, the amount unpaid will be deemed a dividend in the hands of the borrower, unless a specific exclusion applies.

 

The provision is aimed at preventing private companies using loans to effectively make tax-free distributions of profits to shareholders or their associates.  “Associate” is defined for the purposes of Division 7A to include a superannuation fund where a shareholder (or an associate of the shareholder) benefits under the fund (i.e. is a member of the SMSF).

 

Division 7A therefore applies to loans made to a fund by a private company which has a shareholder who is a member of the fund.

 

Division 7A also applies to loans made to a fund by a discretionary trust which has a corporate beneficiary with an unpaid present entitlement and a shareholder of that corporate beneficiary is also a member of the fund.

 

If the loan is made after the borrower ceased to be a shareholder or associate, it may still be a dividend if a reasonable person would consider the loan was given because the borrower was formerly a shareholder or shareholder’s associate.

 

Section 109N(1) of ITAA36 provides that the unpaid loan amount will not be a deemed dividend to the borrower if, before the income year lodgement day for the company:

 

·                the company and the borrower enter into a written loan agreement in respect of the amount advanced; and

·                the rate of interest charged on the principal is either equal to or greater than the benchmark interest rate; and

·                the term of the loan does not exceed:

-               25 years if 100% of the loan is secured by a registered mortgage over real property and the equity in the property is at least 110% of the amount of the loan; or

-               seven years for any other loan.

 

Division 7A deems the borrower to have received a dividend if the borrower fails to make a minimum repayment in income years following the income year in which the loan was made. The amount of the dividend is the amount of the loan not repaid at the end of the following income year. The minimum yearly repayment is calculated in accordance with a formula set out in the legislation.

 

It is important to bear in mind that where the loan to the trustee of the SMSF is caught by Division 7A, the trustee must ensure the terms of the loan are consistent with superannuation law, that a market interest rate is provided for (but is equal to or greater than the benchmark interest rate), that the loan term does not exceed the maximum prescribed period and that minimum repayments are made.

 

For further enquiries, please contact Lawrence Shim of TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.