Where a complying Division 7A loan facility agreement is in place (s109N ITAA 1936), and the minimum yearly repayments (MYR) are not met, subject to there being a distributable surplus, the shortfall on the MYR will be treated as a deemed unfranked dividend assessable to the borrower (s109E ITAA 1936).
This deemed dividend amount, does not reduce the balance of the loan. For example, if no MYR’s are ever made, the entirety of the loan remains outstanding on the balance sheet of the company, despite it having been taxed to the borrower as deemed dividends.
One question this raises, is what happens when the 7-year loan term has expired for Division 7A purposes, but the loan remains on the balance sheet of the company. This scenario can create additional costs to a client, which are considered in the below:
- For Division 7A purposes, there are no further MYR required, the loan is essentially quarantined on the balance sheet until it is repaid by the borrower or forgiven.
- Despite no further repayments being required, the loan facility agreement, may still be in force given that legally the loan remains outstanding. The loan agreement should therefore be reviewed to ensure all things have been done to comply with it. This may include continuing to charge interest on the outstanding balance of the loan (which may also require interest to be charged on unpaid interest), which will be assessable to the company.
- For Division 7A purposes, the definition of a ‘’loan’’, includes ‘’any other form of financial accommodation’’. If a borrower does not pay interest due under a loan, the unpaid interest may itself amount to a “loan” on the basis that it is a form of financial accommodation in terms of s109D(3)(b). In this regard, where the loan term is expired, and the interest is unpaid, it will constitute a new loan in the current income year, which will itself be subject to MYR’s going forward.
- Where the loan is not repaid, but forgiven, under s109F ITAA 1936, it is noted that s109G provides that, the dividend will be reduced if the company is taken to pay a dividend at the end of an earlier year of income in relation to the loan. Therefore, forgiveness of such a loan should not give rise to a dividend where the amount has already been taxed. However, the commercial debt forgiveness and capital loss provisions will need to be considered.
If you have any questions, please feel free to reach out.