LSB September 2021 LR

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TAX FILES Loan accounts: Trouble? STEPHEN HEATH, PARTNER, WALLMANS LAWYERS As time marches on, the matters across my desk more frequently give rise to difficult commercial and technical issues associated with related party loans and unpaid present entitlements (UPEs). Circumstances not infrequently encountered include: 1. private companies carrying related party debit loans; 2. differences of opinion between family members as to the true character of related party credit loans; 3. lack of clarity in financial statements (trusts in particular) as to the distinction between UPEs and loans; 4. a desire of controllers of companies and trusts to forgive debts. My suspicion is that there will be increased disputation and litigation relating to such matters in the years to come. The tension points can arise in a number of circumstances: insolvency, matrimonial property disputes, estate disputes and disputes with the Australian Taxation Office, all being examples. The difference between a loan and a UPE, which usually arises in the context of trust financial statements, often causes confusion. There is no lender / borrower relationship in the context of a UPE which arises when a trust makes a taxable distribution to a beneficiary which remains unpaid. The prevalence of these issues may be connected with the “baby boomer” generation fast approaching their latter years and with many trust and private company structures being saddled with legacy issues resulting from the adoption of tax optimisation strategies over extended periods. PRIVATE COMPANIES AND DEBIT LOANS It is common to sight private company balance sheets carrying significant retained 32 THE BULLETIN September 2021 earnings coupled with debit loans to shareholders/associates of shareholders. Strictly, these loans generally require a seven year loan agreement to be struck on terms meeting strict Tax Act guidelines so as not to result in adverse deemed dividends under Division 7A of the Tax Act. These guidelines are well overdue for legislative overhaul but are nonetheless continuing to attract rigorous enforcement by the Australian Taxation Office. In that regard, my experience is that many private company proprietors are walking a tightrope between not wanting to pass on the “problem” to the next generation and the incurrence of unwanted tax liabilities. DIFFERENCES OF OPINION BETWEEN FAMILY MEMBERS Where advisers (legal and accounting) have been accustomed to acting for a family group over a long period of time succession planning gives rise to professional conflict issues since it is not possible to serve the interests of all parties. This is not aided by the lack of understanding by family members of why a conflict arises as well as lack of enthusiasm for the appointment of multiple advisers. Moreover, involvement of multiple legal advisers does have a habit of resulting in points of contention which were not of concern to the parties in the first instance. A simple factual scenario can demonstrate the point: Land owner owns Farm A and Farm B and wants to implement an inter vivos succession plan to migrate Farm A and Farm B to the control of child A and child B respectively. In my experience, child A and child B can be prone to remembering all aspects of the plan apart from the vendor finance. VENDOR FINANCE FARM A TRUST A (controlled by child A) LAND OWNER OWNS TRANSFER AT MARKET VALUE FARM B TRUST B (controlled by child B) VENDOR FINANCE Nevertheless, there may be good reason to keep the vendor finance on foot: 1. protection of child A and child B from future creditor / matrimonial property claims; 2. landowner is likely to have future financial needs and therefore a bona fide need to call on the debt, at least in part at some future point; 3. there may be other siblings, and to achieve equity in an overall succession plan, Trust A and Trust B may need to pay out some of the purchase price of the land; 4. tax advisers will always say that credit loans are invaluable and should be retained on the balance sheet. CLARITY IN TRUST FINANCIAL STATEMENTS Clarity and accuracy in financial statements should also not be underestimated. All too often, trust balance sheets are cluttered up with debit and credit loans/UPE entries which can readily be subject of set-off. Another common observation is to sight “related party” items
TAX FILES in a balance sheet without any reference to who the related party is. Good accounting practice does entail clear description of the true character of all related party dealings. Where a trust is carrying both beneficiary loans and UPEs, the accounts should carry separate items between each beneficiary and as between the loan and UPE items. Where there are UPEs with companies, separate items should be recorded as between any pre and post 16 December, 2009 UPEs. This enables tax advisers to best manage any Division 7A deemed dividend risks. DEBT FORGIVENESS One of the common themes in my formative years as a tax lawyer was to avoid the forgiveness of debts and to be awake to the consequences which follow whenever a debt might be forgiven. This was before the introduction of value shifting and commercial debt forgiveness rules in the tax legislation which only serve to compound the potential complications. Issues which come to mind include: 1. the forgiveness of a company loan (other than to another company) being a deemed dividend; 2. the forgiveness of a company to company loan resulting in one company carrying the retained earnings and the other company carrying the associated franking credits; 3. the risk of forgiveness of a trust loan resulting in the insolvency of the trust; 4. the non-payment of trust UPEs in consequence of forgiveness or trust insolvency attracting enquiry from the Australian Taxation Office; 5. application of the commercial debt forgiveness rules to any debt forgiveness; the greatest risk arising where the debtor has a “busy” balance sheet coupled with the lender being entitled to claim a capital loss for taxation purposes. OTHER MATTERS Matters which are likely to arise in the course of future litigation include: 1. remedies being sought in connection with promises made between family members “around the kitchen table”; 2. questions about loans becoming statute barred; 3. whether mere accounting records substantiate the existence of loans as a primary record; 4. whether utilisation of inchoate instruments such as promissory notes make any difference; 5. how are the terms of a loan to be construed when not reduced to writing; 6. is the forgiveness of a loan in a Will or bequest capable of challenge under the Family Inheritance Provision legislation; 7. what constitutes an effective assignment of debt and what are the revenue ramifications; 8. a family member having become legally incapacitated followed by actions of a donee under power of attorney being challenged. CONCLUSION In my opinion, all legal advisers providing commercial advice are well served to consider the multiplicity of practical and technical issues arising from lending arrangements between family members. Well advised families will benefit from good advice with mitigation of dispute risk. One suspects nevertheless no shortage of the need for good dispute resolution support where and when inevitable hostilities break out. B MEMBERS ON THE MOVE ERIN FREEBAIRN PETER BEREKALLY Adelaide based Commercial & Legal is pleased to announce the promotion of two staff, Erin Freebairn and Peter Berekally, to Senior Associates. Commercial & Legal, Principal Partner, Elias Farah was delighted to announce these promotions, a reflection of both Erin and Peter being valued members of the firm Erin joined the firm in 2019, working in C&L’s property and projects team and as well as being experienced advising on all aspects of transactions relating to property acquisition and development. Erin specialises in the negotiation and documentation of property acquisitions and disposals and associated due diligence processes. Peter joined the firm in 2019 and practises across commercial property law, contracts and advisory, small and medium sized business advisory and dispute resolutions. September 2021 2020 THE BULLETIN 33
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LSB September 2021 LR

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