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  • Companies are full of tax traps.
  • When you see a red flag, research the problem or call for help.

Division 7A of the Income Tax Assessment Act 1936 is a poisonous well of hissing snakes for general practitioners when dealing with companies. In very broad and simple terms, it can claim income tax on amounts paid to, or loaned to, or debts forgiven from, shareholders or related individuals or entities.

The following examples are simplistic and there are many qualifications and exceptions, but each one carries a bright red flag.

Be careful with guarantees

Betty’s company is giving a mortgage to her bank to support a borrowing by her business partnership. Betty asks you to advise her. You point out, amongst other things, that the company is jointly liable with the partnership for the debt. She says “what the heck” and happily signs.

The sting: Under s 109UA, the partners of Betty’s partnership will be liable for tax on the amount of the loan unless the company’s liability under the guarantee is contingent on the partnership defaulting.

Be careful paying off a mortgage

You acted for Chloe on the sale of a company property mortgaged to secure borrowings of her business partnership. The mortgage was discharged out of the sale proceeds.

The sting: Section 109C(3)(a) states that ‘payment to an entity’ includes ‘a payment to the extent … it is … on behalf of the entity …’. Clearly, the company paying off the partnership debt is ‘on behalf of’ it, so the partners cop tax on the amount of the debt repaid.

Be careful with succession

Michael and his wife Suzy own the shares in the company that owns the family farm. They want to pass it on to their son, Charlie. You tell them that if the company transfers the land direct to Charlie, it will be stamp duty-free under the intergenerational exemption in s 274 of the Duties Act 1997 (NSW).

The sting: Under s 109C, a transfer of property is taken to be payment of an amount equal to the market value. Charlie will therefore be liable for income tax on the farm’s market value.

Be careful with what you buy

Terry looks after his mother. He wants to provide her with a house. He has a family company with lots of money, so buys the house in the company name for his mum to live in rent-free.

The sting: Under s 109CA, ‘Payment to an entity includes the provision of an asset for use by the entity’. People are entities for tax purposes. Terry’s mum will therefore be liable to pay tax on the market value of the rent.

Be careful with leases

None of Peter’s children want to be farmers, so Peter has agreed to lease the farm to his nephew, Harry. He wants the relationship to be legally binding but doesn’t want to put too much pressure on Harry. This farm is owned by his family company. So you fix up the lease with a 50 per cent discount on the rent compared to market value.

The sting: This is trickier. A note to s 109CA states that ‘provision of an asset’ includes ‘provision under a lease or licence’. So, on the face of it, Harry is okay because the section does not apply where the market value amount of rent would be tax-deductible if paid in full. However, on its website, the ATO takes the view that: ‘a right to use property that is made by way of a lease of real property involves a transfer of property to the lessee and is considered a payment for Division 7A purposes.’ This reflects paragraph 1.6 of the Explanatory Memorandum to the Tax Laws Amendment (2010 Measures No. 2) Act 2010, which states that a ‘transfer of property’ includes a ‘lease of real property’. Poor Harry is therefore stuck with the rental discount to be added to his assessable income.

Be careful with family debts

Fred is handing over his plumbing business (conducted through his family company) to his daughter, Annabelle, by transferring the shares to her. Fred owes the company quite a lot of money, which he doesn’t want to be liable for when Annabelle takes over. So he asks you to prepare a deed of forgiveness of the debt.

The sting: Section 109F includes the amount of a forgiven debt in the assessable income of a shareholder. Fred may not have to repay the debt, but he is liable for tax on the amount of it.

Jim Main is an Accredited Specialist, Business Law and a certified tax adviser at JMA Legal, Sydney, Cootamundra, Gundagai, Junee and Tumut.