[Insert DD Month YYYY]
[Insert Client Name]
[Insert Client Position]
[Insert Company Name]
[Insert Company Address]
[Suburb State Post Code]
Dear [Insert Client Name]
Re:
RELATED PARTY ‘AT-CALL’ LOANS PROVIDED TO COMPANIES – APPLICATION OF
DEBT / EQUITY RULES
Background
The Debt / Equity tax rules were introduced into the income tax legislation effective from 1 July 2001
and seek to classify financial interests in companies as either debt or equity having regard to the
essential characteristics of the relevant financial interest rather than its legal form.
Importantly, where a loan is classified as equity rather than debt, any interest payable on the loan will
not be tax deductible but frankable like a dividend. In addition, any repayment of the loan by a
company could, in certain circumstances, be treated as the payment of a dividend.
Furthermore, the thin capitalisation rules that apply to disallow debt deductions, in certain
circumstances, will also be impacted by the debt / equity classification of ‘at call’ loans.
What are ‘related party at-call’ loans?
A related party ‘at-call’ loan is a financing arrangement between a company and its connected entities
that take the form of a loan that is repayable on the demand of the lender rather than having a fixed
repayment term. For example, a loan made by a shareholder to a company where there is no written
loan agreement defining the loan term would be classified as a related party ‘at-call’ loan.
Potential application of Debt / Equity rules to ‘at-call’ loans
The following example illustrates the potential application of the Debt / Equity rules to related party ‘atcall’ loans:
Mr A is the controlling shareholder in Company A. Mr A lends $50,000 to Company A. There is no
written loan agreement supporting the loan and no fixed repayment term for the loan. The
arrangement between Mr A and Company A is that the loan will be repaid if and when Mr A
demands repayment and to the extent that Company A is able to repay the loan.
In accordance with the Debt / Equity rules (subject to the important de minimis exception noted
below), the above loan may be recharacterised as an equity interest rather than a debt interest
unless remedial action is taken.
Assuming the above loan is classified as an equity interest, any interest payable on the loan would
not be deductible to Company A for tax purposes. In addition, where the loan is subsequently
repaid by Company A, the repayment could, depending on the records maintained, be classified
as a non-share dividend paid from Company A, in which case Mr A would be assessed on the
repayment of the loan.
-2[Insert DD Month YYYY]
[Insert Client Name, Insert Company Name]
$20 million turnover exception
In recognition of the adverse implications that this measure may have to SMEs, an important
exception exists to cater for smaller corporate taxpayers. Related party at-call loans provided to
companies with an annual turnover of less than $20 million (excluding GST) will not be subject to the
Debt / Equity rules (and thus will continue to be classified as debt according to ordinary principles).
Note that where the $20 million threshold is unable to be satisfied, the Debt / Equity rules will
potentially apply to any related party at call loans.
Conclusion
Given that the Debt / Equity rules can apply to related ‘at call’ loans, (subject to the $20 million
turnover test), it is important that taxpayers annually monitor whether their related party ‘at call’ loans
are subject to these rules. If it is determined that a company will not satisfy the $20 million turnover
test, appropriate action will need to be undertaken to ensure that the related party ‘at-call’ loan
continues to be classified as debt under the Debt / Equity rules, if so desired.
To commence this process, please do not hesitate to contact me on [insert telephone number of
partner].
Yours faithfully
[Insert name of Partner]