As jobs are lost and revenues shrink during the COVID-19 pandemic in Australia, many people are staying solvent by treating the family business as a ‘family bank’.

Family members receiving a loan from the family business to help with cash flow or emergencies is not unusual. However, it’s essential that a loan complies with Division 7A of the Income Tax Assessment Act 1936. If not, the loan may be counted as a dividend, and considered part of the recipient’s taxable income.

How to ensure the ATO treats a loan as a loan

In my experience, non-compliant loans are a common mistake within family businesses, especially if some family members treat the business like their own bank account. I’ve seen many situations where money is going back and forth in a business with no loan agreements.

“I’ve seen many situations where money is going back and forth in a business with no loan agreements.”

So if you’re the recipient of a loan from the family business, ensure there is an agreement in place. Without one, that money could be considered unfranked dividends, which then form part of your taxable income.

The deemed dividend rules in Division 7A are there to prevent shareholders withdrawing tax-free funds from the business. However, I regularly see family businesses making non-compliant loans not to avoid tax, but because they’re unaware of the requirements under the legislation.

It’s understandable that families want to help each other out by loaning some money from the family business, but they need to ensure they are putting the right agreements in place. Ignorance of their obligations is not a sufficient reason for leniency from the Australian Taxation Office (ATO).

Having a compliant loan agreement will generally prevent the ATO from treating loans made to shareholders as dividends, but it’s also important that minimum yearly repayments are made in each income year.

The ATO mandates minimum yearly repayment to ensure that indefinite ‘loans’ are not made to shareholders.

That means anyone borrowing money from the family business needs to consider whether or not they’ll be able to make these repayments.

What if the borrower can’t pay the loan back?

This year, the ATO announced an eleventh-hour extension to borrowers, giving them until June 2021 to make their 2019-20 minimum yearly repayments.

This extension will be welcome relief for some borrowers, as it gives those with COVID-linked cash-flow issues some breathing room.

But that decision doesn’t change the ATO’s position on non-compliant loans, which may still be treated as dividends. It may simply push the problem into the future, as the economic downturn caused by the pandemic continues.

If family members cannot make the required repayments due to their financial situation, they should seek advice. If they are unlikely to be able to make the required repayments in future tax years, then they should consider alternative forms of financial assistance, rather than loans from the family business.

When to seek advice

Although the ATO is offering relief in the form of payment extensions and plans, there is no indication it will be lax with enforcement during the pandemic.

If family businesses are concerned that they have made non-compliant loans, or if they are planning to loan money to a family member from the family business, it is important they seek legal and financial advice.

We are all doing our best to help each other through the COVID-19 crisis but without the right advice, a withdrawal from the ‘family bank’ may be a decision that family members come to regret at tax time.

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