The term "loan account" gets thrown around a lot, and it covers quite a few different scenarios. That breadth can make it tricky to get your head around.
Here's what it actually means for your business given your financial position, and what you need to know to stay on the right side of the tax rules.
What Is a Shareholder Loan?
A shareholder loan is when a company borrows funds under a structured loan agreement from one of its shareholders, rather than from a bank or outside lender.
These loans are common in startups, family-owned businesses, and private companies, particularly when options for cash flow from outside financing are limited. They can provide quick, flexible funding for cash flow support or early-stage growth, without diluting ownership.
What Does a Loan Account Actually Track?
Very generally, a shareholder's loan account represents what the business owes you, and/or what you owe the business.
Your loan account could be made up of any combination of the following:
- Amounts you've loaned the company
- Amounts the company has loaned you
- Expenses paid on your behalf (or vice versa)
- Profits credited to you that haven't yet been withdrawn in cash
- Contributions towards fringe benefits
Repayments can be made through direct cash payments, offsets against dividends or salaries, or conversion into equity if both parties agree.
It's also worth noting that trust beneficiary accounts are sometimes referred to colloquially as loans. A private company beneficiary can provide financial accommodation or loans to a trust, which may have tax implications under Division 7A.
Credit vs. Debit Loan Accounts, what's the Difference?
Credit loan accounts are amounts the business owes you. These sit as liabilities on the balance sheet.
- The entity will repay you at some point in the future (assuming it's solvent)
- There's no requirement for the entity to regularly repay you
- Loan terms, including repayment schedule and interest rate, are agreed between you and the company
- Interest can be paid in cash or added to the loan balance, depending on your agreement
- All terms should be set out in a formal written agreement
Debit loan accounts are amounts you owe the business. These sit as assets on the balance sheet.
These come with specific tax law requirements, which is where Division 7A comes in.
Understanding Division 7A
Division 7A is a set of tax rules that the ATO has designed to prevent private companies from making tax-free payments or loans to shareholders or their associates.
When amounts are drawn from a company and the overall tally results in a debit loan, Division 7A kicks in. Here's what you need to know:
- A written agreement must be in place before the company's lodgement date for the income year in which the loan was made
- A Division 7A loan must be properly structured to avoid being classified as a deemed dividend
- Maximum loan terms: 7 years for unsecured loans; up to 25 years for loans secured by real property
- Minimum yearly repayments are calculated by multiplying the outstanding loan balance at the end of the previous income year by the current benchmark interest rate, divided by a factor based on the remaining loan term
- Interest income received by shareholders is taxable; interest paid by the company is generally tax-deductible
- If repayments are missed, the process outlined in the agreement should be followed, including notices and default interest
- Division 7A also applies to certain payments, loans, and debt forgiveness made by trustees to shareholders or their associates
- The distributable surplus limits the amount that can be treated as a dividend under Division 7A
Under tax law if a shareholder loan isn't properly documented, the ATO may reclassify it as a deemed dividend, meaning it gets included in your assessable income and tax penalties can follow.
Practical Examples
To put it in plain terms:
- Terry Pty Ltd loans $20,000 to Ann - This needs to be documented as a Division 7A loan with a written agreement and minimum annual repayments.
- Lucas Pty Ltd provides $10,000 to Belinda by promissory note - The same rules apply; the structure and terms matter.
These examples show how shareholder loans work day-to-day, and why getting the paperwork right from the start saves headaches later.
Key Risks to Be Across
Shareholder loans aren't inherently problematic, but there are real risks if they're not managed properly:
- Compliance issues - If the loan isn't documented or structured correctly
- Tax penalties - If it's reclassified as a deemed dividend
- Insolvency implications - If the company becomes insolvent shareholder loans are typically treated as subordinate debt
- Related party governance - Arrangements need proper transparency to hold up under scrutiny
Commercial sense should be applied to interest rates and loan terms to make sure they're reasonable and in line with standard business practice.
Secured vs. Unsecured Shareholder Loans
Shareholder loans can be structured as either unsecured or secured.
Secured loans are typically backed by real property and may need to be registered on the Personal Property Securities Register (PPSR). They also carry a longer maximum term under Division 7A, up to 25 years compared to 7 years for unsecured loans.
The key terms to nail down in any loan agreement include:
- Loan status (unsecured loan or secured)
- Loan amount (the principal)
- Interest rate
- Repayment schedule
- Security arrangements (if any)
So, What Do You Actually Need to Do?
If you need to take action on your loan account, speak to a C&N Adviser who will guide you on the best approach. That might involve:
- Full repayment
- A formal loan agreement over a set term
- Paying out profits
- Or a combination of the above
Here are two pieces of information direct from our advisers:
1. Review your loan transactions regularly. Check what's being recorded against your loan (or "drawings") to make sure the entries are genuinely personal, especially if you have a bookkeeper or third party handling your accounts. Catching errors while the transaction is fresh is a lot easier than untangling them at year-end.
2. Always talk to an adviser before any large personal purchases using company funds. A quick conversation upfront can save a lot of trouble down the track.
If you're ever unsure, don't hesitate to reach out to our team.
This article is general in nature. Please speak with a C&N Adviser to discuss your specific circumstances.
