Written by
Samuel Guzman
Reviewed by
Directors are entitled to borrow money from their company (also known as a director’s loan or shareholder loan). However, there are quite a few limitations and potential tax implications that you should be aware of. This article will explain whether it’s legal for a director to borrow money, what a director’s loan is and a few things to consider before pursuing one.
Director’s loan
Generally speaking, if done properly, you will not need to pay tax on a director’s loan. However, it is important to distinguish a ‘loan’ from a ‘payment’ for the purposes of Division 7A of the Income Tax Assessment Act 1936 (Cth) (Act). In the latter case, you may be subject to fringe benefit tax charge(s).
A loan for the purposes of the Act includes:
- An advance of money
- The provision of credit or some other form of finances
- A transaction that is the same as a monetary loan
For example, a company loans its director $10,000 which must be paid back. As an advance of money, it is a loan for the purposes of the Act.
For the loan to comply with the Act and be tax exempt, the following conditions must be met:
- The loan must be agreed on in writing (as outlined in the next section)
- The interest rate of the loan must be equal to or more than the Division 7A – benchmark interest rate.
- The maximum term must not exceed:
- 7 years; or
- 25 years where the whole of the loan secured is by a mortgage over real property, and the market value of the property at the time of the loan agreement is at least 110% of the loan amount.
How it works
Firstly, the director’s loan will need to be approved by shareholders.
You will also need to ensure that the loan is set up properly. Specifically, there must be a loan agreement active before the company’s yearly income is lodged. The loan agreement will need to include:
- The identity of the parties (the company and the director)
- Any essential terms and conditions of the loan (including the amount, repayment details and interest rate payable – which come into the company’s assessable income)
- The signature of the parties (the company and the director)
- The date
If the loan is not set up properly (for example, there is no loan agreement) or you do not make the required minimum yearly repayment on the loan by 30 June, it becomes a dividend in that financial year. This means that you can be taxed on the entire amount.
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What to consider
Ultimately, you should be careful of taking out a director’s loan. There are some circumstances where it may be appropriate to borrow money from your company. For example, if:
- Your company has excess funds available to loan
- You will be able and intend to repay the loan
- The loan is not too extravagant (for example, it does not represent a large proportion of your company’s assets)
However, there are also circumstances where taking out a director’s loan can lead to certain issues, particularly with your company. Generally, you should avoid borrowing money from your company as a director if and/or when:
- You intend to use the money for personal bills or lifestyle expenses
- Your company only has a limited amount of funds available
- You will be unable to repay the loan
- You intend the funds to supplement insufficient wages
Conclusion
As a director, while it can be beneficial and simple to borrow money from your company, there are various things you should consider before proceeding. Otherwise, it can lead to unfortunate consequences, especially for your company. You can find more information from the Australian Taxation Office (ATO) here. As many of these concepts can be confusing, consult an accountant or company lawyer today for further assistance and advice.
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