Tax relief and tax danger in defaulting loans
Communication with your bank is essential if you are in danger of defaulting on a loan.
Take the example of a farming couple who have just had a crop failure, and as a result are unable to meet their latest interest payment to the bank.
The couple trade as a partnership and their bank borrowings of $500,000 are in their personal names.
Their farm is owned by the family company. They own all of the shares in the company, which has no debts.
The company acts as guarantor for the partnership debts and the guarantee is supported by a mortgage over the farm.
When the guarantee was entered into, the liability of the company was contingent on the couple defaulting.
However, as soon as the couple miss an interest payment they are in default under the terms of their loan agreement, and the guarantee by the company becomes ‘other than contingent’.
As the company has a distributable surplus, the loan of $500,000 then becomes a deemed dividend to the couple.
In addition to missing their interest payment, they may now have to pay tax on the loan, assuming their farming losses are not big enough to offset the dividend, The Commissioner of Taxation has discretion not to treat the loan amount as a dividend if satisfied that the couple would suffer hardship because of the dividend and that when they entered into the loan with their bank they had the capacity to pay it.
However, what amounts to hardship in the eyes of the Commissioner and the intended meaning of capacity to pay have not been the subject of judicial or tax office comment.
On a happier note, the tax office has announced that it can help those affected by the drought by giving them more time to lodge and pay income tax and activity statements.
Contact Blackwell Short Lawyers if you are in any doubt about your rights or liabilities concerning this article.