If you are a director of a private company in Australia, you may be tempted to borrow money from your company for personal use. However, before you do so, you should be aware of the tax implications of such a loan.
A director's loan is a loan from a private company to a shareholder or their associate, which includes a director or their spouse, child, relative or business partner. A director's loan can be made in various forms, such as an advance of money, a provision of credit, a payment on behalf of the director, or any other transaction that is equivalent to a loan of money.
The main tax issue with a director's loan is that it may be treated as a dividend under Division 7A of the Income Tax Assessment Act 1936 (Cth) (the Act), unless certain conditions are met. A dividend is generally taxable income for the recipient and may also trigger franking credit rules for the payer.
To avoid being treated as a dividend, a director's loan must either be repaid in full by the lodgment day of the company's tax return for the income year in which the loan was made, or comply with the following requirements:
- A written loan agreement must be in place before the lodgment day, specifying the amount, interest rate, term and repayment schedule of the loan.
- The interest rate for each year of the loan must at least equal the benchmark interest rate prescribed by the Act, which was 4.52% for 2020-21 and 3.89% for 2021-22.
- The term of the loan must not exceed 25 years if it is secured by a registered mortgage over real property with sufficient equity, or 7 years for any other loan.
- The minimum yearly repayment amount must be made by 30 June of each income year, calculated as a principal and interest payment based on the benchmark interest rate and the term of the loan. Any shortfall in repayment will be treated as a dividend in that year.
The interest on the loan must be included in the company's assessable income and may be deductible for the director if the loan is used for income-producing purposes.
If a director's loan does not meet these conditions and is deemed to be a dividend, it will be included in the director's assessable income and may also attract penalties and interest charges. The company may also lose its entitlement to franking credits on the dividend.
A director's loan may also have other tax implications, such as:
- Fringe benefits tax (FBT) if the loan is made to an employee or an associate of an employee of the company unless it is treated as a dividend or a complying loan under Division 7A.
- Capital gains tax (CGT) if the loan is forgiven or released by the company, unless it is treated as a dividend or arises from natural love and affection.
- Goods and services tax (GST) if the loan is made in connection with a taxable supply by the company, such as goods or services.
Therefore, before making or receiving a director's loan from your company, you should seek professional advice from an Accountant on how to structure it properly and comply with the relevant tax laws. A director's loan can be a convenient and flexible way of accessing funds from your company, but it can also expose you to significant tax risks if not handled correctly.