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by Brett Davies
"I lent my company a large sum of money some time ago. I need it back. However, my accountant told me that it comes out as a dividend because it is no longer a loan. She says it was an injection of capital. This is pure rubbish - it went in as a loan. Please give me something to give to my accountant."
Answer: With respect, you don't understand the Debt/Equity Rules. However, your accountant certainly does.
What are the Debt and equity rules?
Ever lent money to your company? What happens when the company pays you back? Is that a "repayment of a loan" or a "deemed dividend"? Obviously, you want to get the money back out tax-free - like any normal repayment of capital. But the laws changed. If you are not careful, then the ATO says that your loan has magically turned into an injection of capital. If this happens to you, then the company is not "repaying a loan" it is "paying you a taxable dividend". Any money coming out is a dividend. Your company pays lots of tax on dividends. You also pay more tax on the dividend - if your tax rate is above 30%.
That is the potential disaster known as the Debt/Equity rules.
How do you retain the loan as a "loan" or a "dividend"?
You protect the status of the loan by doing a Loan Agreement. The Loan Agreement must comply with the legislation. For example, you could have put in place a 10-year loan agreement with a zero interest rate - or you can charge a commercial interest rate. Without the Loan Agreement, the money you lent is deemed an injection of capital - not a loan.
Depending on whether you have a loan agreement, Division 974 determines whether a return paid by a company to you is:
- a dividend; or
- a payment of interest on the "loan" (i.e. treated as interest on a debt).
You escape the debt and equity rules if you have a loan agreement that:
- is a financing arrangement for the company, that gives rise to an interest as a member or stockholder of the company. In other words, it * is a loan agreement between the company and you as the shareholder;
- the entity (or a connected entity) receives a financial benefit under the scheme. The shareholder gets an interest on the money it lends to the company;
- the entity has a non-contingent obligation under the scheme to provide financial benefit(s) to one or more entities. This obligation arises after you give the first financial benefits in (2). It is an enforceable obligation on an enforceable loan; and
- it is substantially more likely than not that the value under (3) is at least equal to the value received under (2). The agreement looks commercial or arms length.
Even if you fail (4), the you still satisfy the debt test if the ATO determines that it is substantially more likely than not that:
- the non-contingent financial benefits provided under (3), offsets a substantial part of the value received under (2);
- any shortfall is offset by other financial benefits provided by the entity under the scheme (section 974-65).
However, why take the risk? Just do a loan agreement under 10 years on commercial terms.
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