Avoiding a Taxable Dividend
If shareholders in a family company decide to sell company property to reduce bank debt, as are many farmers tackling financial difficulties due to the drought, the sale should be treated as as a loan in order to avoid it being viewed as a taxable dividend.
In one case a couple decided to sell part of the property owned by the family company. A neighbour agreed to buy for $350,000.
The couple owed the debt to the bank. Once the sale was complete, the full sale proceeds were handed over to the bank in exchange for a discharge of mortgage.
However, to the extent that they are part of its distributable surplus, payments by a company on behalf of shareholders are considered a taxable dividend under tax law. The family company has therefore paid the couple an unfranked taxable dividend of $350,000.
To avoid this, if it is not possible to liquidate the company, repayment of the bank debt needs to be treated as a loan to the couple, documented in a way that meets tax law requirements. The appropriate interest rate needs to be charged and terms of repayment specified. (For an unsecured loan, the term must not exceed seven years. If the loan is sufficiently secured, the term can be up to 25 years.)
Of course, the payment by a company is only a deemed dividend if there is a distributable surplus. Given difficult financial circumstances, there may well be no such surplus.
Contact Blackwell Short Lawyers if you are in any doubt about your rights or liabilities concerning this article.