If you operate a private company you would have heard of Division 7A and how it applies to loans from private companies. Section 109R in Division 7A is an integrity measure aimed at targeting ‘non-genuine loan repayments’. In summary, a repayment must be disregarded if a “reasonable person” would conclude that when the repayment was made, it was intended that another loan (with a similar or larger amount) would be made by the company.
This rule generally applies in the following circumstances:
- A Division 7A loan is repaid by the lodgement date of the relevant tax return; or
- A minimum repayment is made for a Division 7A compliant loan; AND
- A similar or larger amount of the repayment is lent to the borrower by the company.
The effect of section 109R is to disregard the ‘non-genuine’ loan repayment.
Consider the following question we often get asked by clients:
Can I borrow funds from my company and use these funds to repay my mortgage, then later re-draw the same amount and pay this to the company to repay my loan when I legally have to and then transfer back the funds immediately after to reduce my mortgage?
The initial borrowing of funds from the company will result in a Division 7A loan. Unless the funds are repaid by the lodgement date of the company’s tax return for the year in which the loan was made, a deemed dividend will be assessable to you. The repayment of the loan by the lodgement date using the funds drawn down will satisfy the repayment requirement. However, as the funds are later loaned back to the borrower, section 109R will disregard the repayment, resulting in a deemed dividend for the amount initially borrowed.
Whilst the above example is an obvious breach of section 109R, there are circumstances where it is more difficult to identify such breaches.
Consider the scenario where an amount of $100,000 has been borrowed by a shareholder during the 2021 financial year and then repaid just prior to 30 June 2021. The 2021 financial statements will not reflect a shareholder loan by the end of that year. The company then again lends $100,000 to the shareholder on 2 July 2021. This loan is treated as a 2022 Division 7A loan and is again placed on a complying loan agreement by the lodgement date of the company’s 2022 tax return.
Notwithstanding this, section 109R would not recognise the $100,000 loan repayment during the 2021 financial year as a genuine repayment, resulting in a deemed dividend of $100,000 assessable in the 2021 year.
We understand that the ATO are considering the application of section 109R with a view to providing some further public guidance to deal with various loan repayment arrangements.
If you have any queries in relation to the above, please contact our office on 08 9388 9744.