By Jaye Mankelow
When you need to borrow money, one option is to take out a loan from a bank, while another is to borrow from your own private company. If you are a shareholder or an associate of a private company, borrowing from the company is subject to Division 7A of the Income Tax Assessment Act 1936 (Div 7A).
This legislation is designed to prevent shareholders from accessing company funds tax-free under the guise of a loan.
A key consideration when borrowing from a private company is whether to register a mortgage over 25 years or use a shorter loan term, as Division 7A prescribes strict repayment terms. This article explores the advantages and disadvantages of borrowing from a bank versus borrowing from your own private company under Div 7A, including the impact of registering a mortgage for a 25-year term.
Borrowing from a bank is the traditional route for securing funds, whether for personal use, investment, or business purposes. Banks offer a range of loan products, including secured and unsecured loans, with varying terms and interest rates.
✅ Longer Loan Terms Available – Banks commonly offer home loans with terms of up to 30 years, which can result in lower monthly repayments compared to shorter-term loans.
✅ Flexible Repayment Options – Borrowers can access features such as interest-only periods, offset accounts, and redraw facilities, helping with cash flow management.
✅ Competitive Interest Rates – Banks generally offer lower interest rates, particularly for secured loans where assets such as real estate are used as collateral.
✅ No Tax Implications from Division 7A – Unlike borrowing from your own private company, loans from a bank do not trigger Division 7A compliance issues.
❌ Strict Lending Criteria – Banks assess creditworthiness, income stability, and collateral before approving a loan, making it harder to qualify, especially for self-employed individuals.
❌ Loan Fees and Charges – Application fees, annual fees, and discharge fees can add to the total cost of the loan.
❌ Personal Guarantees or Security May Be Required – If the loan is for a business, directors may need to provide personal guarantees, which put their personal assets at risk.
If you own a private company with accumulated profits, you may consider borrowing money from it instead of a bank. However, such loans are heavily regulated under Division 7A, which ensures that company profits are not distributed to shareholders tax-free.
Under Division 7A, loans must meet specific conditions to avoid being treated as an unfranked dividend, which would be taxable in the hands of the borrower. One way to comply is by setting up a Division 7A compliant loan agreement, which can either be:
✅ Easier Access to Funds – Borrowing from your own company eliminates the need for bank approval and credit checks.
✅ Lower or No Bank Fees – You avoid bank application fees, annual fees, and early repayment penalties.
✅ Potentially More Favourable Repayment Terms – As long as the minimum Div 7A requirements are met, you may have more flexibility in structuring the loan.
✅ Interest Paid Stays Within the Business Group – Instead of paying interest to a bank, the borrower pays interest to the company, potentially increasing company profits.
❌ Strict Division 7A Compliance – The loan must meet the minimum interest rate (benchmark rate set by the ATO) and minimum annual repayments to avoid it being treated as a taxable dividend.
❌ Shorter Loan Terms Unless Secured by Real Property – If the loan is unsecured, the maximum term is only 7 years. If secured with a registered mortgage over real property, the term can extend to 25 years.
❌ ATO Scrutiny and Potential Penalties – If the loan is not repaid correctly or does not meet the required conditions, the entire balance may be deemed an unfranked dividend, leading to significant tax liabilities.
❌ Opportunity Cost for the Company – The company might have better uses for its funds, such as reinvesting in the business rather than lending money to shareholders.
A Division 7A loan term can be extended up to 25 years if the loan is secured by a registered mortgage over real property. This can be beneficial for cash flow, but it comes with additional costs and considerations.
✅ Lower Annual Repayments – Spreading the repayments over 25 years reduces the annual repayment burden compared to a 7-year loan.
✅ Compliance with Division 7A Rules – By securing the loan with a registered mortgage, you ensure that the loan remains Division 7A compliant and is not deemed an unfranked dividend.
✅ Flexibility for Shareholders – The longer loan term provides greater flexibility in managing personal finances and investments.
❌ Cost of Registering a Mortgage – Legal and administrative costs are involved in registering a mortgage over real property.
❌ Company’s Funds Are Locked for a Longer Period – If the company needs funds in the future, it may face cash flow constraints due to the long-term loan commitment.
❌ Higher Total Interest Payments – Although the annual repayments are lower, more interest is paid over 25 years compared to a shorter loan term.
Final Thoughts: Which Option Is Best?
The decision to borrow from a bank or from your private company depends on your financial situation, tax implications, and long-term goals.
It is highly recommended to seek professional tax and legal advice before entering into a Division 7A loan agreement to ensure compliance and to optimise tax outcomes.
For the latest Division 7A guidelines, visit the Australian Taxation Office (ATO) website:
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