ATO cracks down on shareholder loans

The Australian Taxation Office has sent hundreds of letters to tax agents representing shareholders of private companies, warning them against breaching rules while taking out personal loans from their businesses.

The letters are reportedly an attempt to crackdown on companies which are not charging commercial interest rates to shareholders and associates, where loan repayments are not being made and on shareholders who are combining their private and company expenses.

If the ATO finds shareholders have breached any of these laws, they could be charged a penalty tax rate of up to 46.5% on their loans.

Deputy tax commissioner Mark Konza told the Australian Financial Review the letters are part of an early intervention program.

“These letters are an attempt to give people a reminder so they can get those matters right before the tax returns are lodged,” he said. “These letters are building a growing emphasis on Division 7A [private company loans laws] over the past few years.”

The letters, which are being sent to tax practitioners with business clients of annual turnover between $2-250 million, “aim to help you and your business clients and improve voluntary compliance”.

“Private company operators in their role as shareholders or associates of shareholders can be affected by Division 7A if they don’t keep private expenses separate to their company expenses,” the ATO said in a statement.

Division 7A of the tax act states payments to shareholders are automatically classed as “unfranked dividends”, unless formal loan agreements are place – with strict interest and capital payments required to meet minimum standards by the end of the financial year.

The ATO’s objective is to crackdown on businesses disguising their profits as loans, and therefore distributing them tax free to shareholders.

Ray Cummings, partner at Pitcher Partners, says the warnings are a timely reminder for shareholders prior to lodging their tax returns.

“At its simplest, if you’ve got a company that’s either given a loan to shareholders then the tax office is looking to see if you’ve done one of two things, which is either repay the loan, or reduce the loan to writing in compliance with division 7A provisions.”

“If you have a company with $700,000 in profit, what can happen is that $700,000 is given out to shareholders as loans rather than paid as dividends, which would require tax to be paid. These division 7A provisions stop them accessing that profit for their own personal gain.”