Q&As

Q&A Div 7A when a company lends working capital to a unit trust

by Knowledge Shop Help Desk

4 min read

02/02/24 14:22

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Here’s a question from one of our awesome members on the interaction between a company and a unit trust.

Note that the answer is only applicable to the question asked.

Question

Our client (a Company) owns 33% of the units in a related party unit trust.

The company has transferred $50K of working capital to the unit trust which has created a debit loan in its accounts.

Is this a Division 7A issue or is there a special carve-out for debit loans to related party unit trusts?

Know the answer?

This would normally fall within the scope of Division 7A. It doesn't look like there are any carve-outs for loans made to related unit trusts.

1. If the company makes a loan to the trust then this is likely to fall within the scope of Division 7A if:

The trust holds any shares in the company; or
Anyone who could potentially receive a benefit from the trust, directly or indirectly, holds any shares in the company.

If the company holds any units in the trust then this would normally mean that the loan is being made to an associate of a shareholder. This is because the shareholders can presumably receive an indirect benefit from the trust (ie, as income passes from the trust to the company and then to the shareholders).

2. If the loan falls within the scope of Division 7A then a deemed unfranked dividend would normally arise unless the loan is fully repaid or is placed under a complying Division 7A loan agreement by the earlier of the due date and actual lodgement date of the company's tax return for the year the loan was made.

Section 109N sets out the strict requirements that need to be met for a loan agreement to qualify as a complying Division 7A loan agreement. In broad terms, the agreement must be in writing, the loan term must not exceed 7 years (unless further conditions are satisfied to extend this to 25 years) and the interest rate needs to be at least as much as the Division 7A benchmark rate for each year of the loan. Loan arrangements that don't meet these conditions won't normally be effective for Division 7A purposes even if the arrangement appears to be consistent with normal commercial terms.

As noted above, the loan term cannot generally exceed 7 years, although section 109N states that the maximum term for the loan can be extended to 25 years if:

100% of the value of the loan is secured by a mortgage over real property that has been registered in accordance with the law of a State or Territory; and
When the loan is first made, the market value of the real property (less the amounts of any other liabilities secured over that property in priority to the loan) is at least 110% of the amount of the loan.

3. Section 109M provides an exception from Division 7A where the company makes a loan to a shareholder / associate that meets the following conditions:

It is made in the ordinary course of the company's business; and
It is on the usual terms on which the company makes similar loans to parties at arm's length.

However, in ATO ID 2003/588 the ATO indicates that the exception in section 109M ITAA 1936 cannot apply if the company does not provide loans to arm's length parties. If the company only makes loans to related parties then the ATO's view is that the exception cannot apply even if the company carries on a business of lending money.

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