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Tax implications of related party loans

To be published in the 2022 February edition of the Queensland Hotels Association's QHA Review.

With the beginning of 2022, many pubs or their owners may be considering new loans to pursue opportunities for growth or perhaps assist in managing current economic challenges. One of the most common forms to achieve finance is a related party loan. But before you accept a loan from a related party (such as a Director, a related company, a relative, or a family trust or superannuation fund), you should consider the implications of this decision. This article highlights the importance of properly documenting your related party loan to avoid pitfalls such as getting an unexpected bill at tax time.

The loan documentation

Due to their personal nature, it is not unusual for these sorts of loans to be made without a proper loan agreement. Whilst this can have huge implications should a dispute arise between the parties, it can also impact the categorisation of your loan which can impact its tax treatment or the Borrower's obligation to repay the loan. This is because, in the absence of proper loan documentation, the Family Court, the Commissioner of Taxation or a liquidator, may seek to categorise related party finance as some other type of transaction.

Tax implications are particularly relevant to loans made by companies and/or superannuation funds, which can both attract tax at punitive rates if you get it wrong.  The Family Court has been known to rule a loan as a party's contribution and not repayable in the usual sense.

Superannuation fund loans

Your superannuation fund may be an attractive source of funding, but a superannuation fund can generally only invest in arm's length investments.  Investments or loans to related parties are effectively prohibited by the in-house asset test. 

It is possible to lend to a private entity (usually a unit trust) that is not controlled by a member of the fund or a related party of that member, but problems arise if one of the business partners wishes to leave the partnership, or later becomes a related entity (for example a marriage between relevant families).

Once the investment by a superannuation fund becomes an in-house asset, the fund ceases to be a complying superannuation fund and the arrangement must be un-wound.  Punitive tax rates can apply to non-complying funds.  The range of penalties for wilfully entering into a transaction of this nature knowing it breaches the relevant Act include jail sentences.

Company loans

A loan by a company to a related person or entity that is not itself a company can be taxed as a dividend if the loan does not meet the exemptions in Division 7A of the Tax Act. Whilst loans by one company to another related company are exempt from this, this is not the case if the borrower is the trustee of a trust. 

The exceptions require the loan to have an interest rate and repayment arrangements which the Australian Tax Office Commissioner considers a proxy for an arm's length loan.

Unsecured loans must have a maximum term of seven years. Loans secured by a mortgage over land and/or buildings with a security value of at least 110% of the loan amount can have a term of 25 years.

Summary

The golden rule of loans is to get your documentation in place and fully executed before the loan is made. Failing to do so may lead to conflict with your family, friends or business partners, a loss of your investment or punitive tax rates applying to the funding arrangements.

Should you require assistance regarding any loans for your hotel, please contact me on 07 3224 0380.

Article written by Curt Schatz (Managing Partner) 

"The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication."