Issue
If a private company secures a previously unsecured loan made to a shareholder, by taking a registered mortgage over real property which satisfies the criteria in paragraph 109N(3)(a) of the Income Tax Assessment Act 1936 (ITAA 1936), but does not create a new loan, does this extend the 'maximum term' of the loan to 25 years?
Decision
No. The taking of security by the private company over the previously unsecured loan, where a new loan is not created, does not extend the 'maximum term' of the loan under subsection 109N(3) of the ITAA 1936.
Facts
A private company made an unsecured loan to a shareholder during the income year ended 30 June 2000. The loan was made under a written agreement, with an interest rate equal to the 'benchmark interest rate' (as defined in subsection 109N(2) of the ITAA 1936) for the income year and a term of 6 years.
During the income year ended 30 June 2001, the shareholder made the minimum yearly repayment (as defined in subsection 109E(5) of the ITAA 1936) to the private company in respect of the loan.
During the income year ended 30 June 2002, the private company secured 100% of the outstanding balance of the loan by taking a registered mortgage over the shareholder's house. When the security was taken, the market value of the real property, less other liabilities secured over that property in priority to the loan, was at least 110% of the amount of the company's loan. The taking of security did not result in a new loan agreement being entered into.
Reasons for Decision
A private company is taken to pay a dividend to a shareholder under subsection 109D(1) of the ITAA 1936 if the private company makes a loan to a shareholder during the income year, the loan is not fully repaid by the end of that income year, and subdivision D of Division 7A of Part III of the ITAA 1936 does not prevent the private company from being taken to pay a dividend.
Subsection 109N(1) of Subdivision D of Division 7A of Part III of the ITAA 1936 prevents a private company from being taken to pay a dividend under section 109D of the ITAA 1936 if the loan is made under a written agreement, the rate of interest payable on the loan equals or exceeds the benchmark interest rate, and the term of the loan does not exceed the 'maximum term' for that kind of loan.
Subsection 109N(3) of the ITAA 1936 defines the 'maximum term' as: • 25 years for a loan if 100% of the value of the loan is secured by a mortgage over real property that has been registered under State or Territory law and, when the loan is first made, the market value of the real property (less the amounts of any other liabilities secured in priority over the property) is at least 110% of the amount of the loan; or • 7 years for any other loan.
The maximum term is calculated from the year the loan is made. Subsection 109D(4) of the ITAA 1936 states that a loan is made when the amount of the loan is paid to the shareholder.
Subsection 109E(1) of the ITAA 1936 provides that, in the years following the income year a loan is made, the private company may be taken to pay a dividend to its shareholder if the loan is not repaid and the 'minimum yearly repayment' has not been made.
In this case, the unsecured loan made by the private company to the shareholder during the income year ended 30 June 2000 satisfies the conditions in subsection 109N(1) of the ITAA 1936. Accordingly, the private company is not taken to pay a dividend to the shareholder under subsection 109D(1) of the ITAA 1936.
Nor is the private company taken to pay a dividend to the shareholder during the income year ended 30 June 2001 under subsection 109E(1) of the ITAA 1936, as the shareholder made the minimum yearly repayment in respect of the loan.
During the income year ended 30 June 2002, the private company secured 100% of the outstanding balance of the loan by taking a registered mortgage over real property which satisfied the criteria in subsection 109N(3) of the ITAA 1936. If the loan was a new loan, the maximum term would be 25 years. However, a new loan agreement was not entered into and so the maximum term of the loan is calculated from the year the loan was made (that is, the year ended 30 June 2000). The loan was not secured in that year and so the maximum term of the loan is 7 years.
Therefore, the maximum term of the loan under subsection 109N(3) of the ITAA 1936 is not extended to 25 years as a result of the private company taking security over the previously unsecured loan.