What the funds are used for may be a significant consideration in how the transfer may be structured from the family business entity, or group of entities, as there may be several financial, taxation and legal consequences.
Are the funds a gift or loan?
The first consideration when parents transfer money to their children should be whether the funds would be considered a gift, or a loan. In Australia there are no restrictions or taxation consequences on making a cash gift to your children. However, one thing to consider is your eligibility for certain Centrelink pension benefits – family gifts may be taken into consideration for meeting certain assets or income tests. This may include not only cash gifts to your children, but also paying off their debts or transferring assets such as homes or cars for less than market value.
If a gift of funds is made or received internationally, the regulations of the international jurisdiction need to be considered – do not assume that because there are no reporting or income tax consequences of making or receiving a cash gift in Australia that the rules are the same internationally.
The right documentation is key
Once it has been established that the funds are a loan, and not a gift, then the next step would be accurate documentation. Regardless of what you use the funds for, or how the entity lends funds, the loan amount and terms should be documented, as disputes as to whether the funds were a gift, or a loan often arise in the Family Court.
In a relationship breakdown, when establishing the asset and liability pools, the Family Court will need to understand if funds were gifted or loaned. In many instances funds transferred are not documented as either a loan or a gift, which can cause some perceived inequity in a proposed asset split. Regardless of the purpose of the loan, or the entity or person who lent it, having it in writing will always be advantageous.
Additional loan considerations
Where a loan is made from a family business entity, some additional items to consider:
- Is the loan caught under Division 7A rules – currently requiring a maximum term of 7 years (unsecured) or 25 years (secured) with an ATO benchmark interest rate to be applied (currently 4.77 per cent). Some entities may not be required to apply these rules, but if your business entity is required to do so, are the terms of the loan to your children more favourable to these terms?
- If your entity is required to apply the rules under Division 7A, and you do not meet these conditions, you may find there are unfavourable outcomes, such as the requirement to declare dividends to meet minimum repayments, and there may be a tax liability on declaration of said dividends, payable by you.
- Would the funds being lent from the business to purchase an interest in that business be considered ‘provision of financial assistance’ under Section 260A of the Corporations Act 2001 (Cwth)?
- For a company to lend money to a shareholder to purchase an interest in that company, you should ensure the requirements of Section 260A are met. This may require resolutions, general meetings and lodgement of forms with ASIC to ensure the company has complied before lending the money.
- Where assisting a child to ‘buy-in’ to the family business, this may need to also be factored into retirement planning and specialist financial advice should be sought.
- Would the funds lent impact the cashflow of the business and its solvency?
- Funds lent should not unfairly prejudice the business to meet its debts as and when they fall due. Should the funds lead to the business becoming insolvent, the funds could be considered a preference payment and clawed back. If an asset was purchased with the funds lent, it is possible that asset could be forced to be sold to pay back the funds to creditors.
- Would the funds lent to one child need to be considered as part of your estate planning to ‘even up’ the net asset pool with other children?
- Many families lend money to their children and there is an informal ‘evening up’ to occur upon death of the parents. It is essential any funds lent, either documented through a family business entity or not, are considered when discussing the estate plan of the parents to ensure all interested parties are heard.
There are many reasons for loans (or gifts) of money to be made by parents to their children but understanding the impact of lending from your family business to your children is imperative. It is easier to make a recommendation from either a financial, taxation or legal perspective before the money is transferred, rather than after - and as always, documentation is key.
We’re here to help
Considering lending your children money from the family business? Our Family Business Advisory team can advise you on the most tax effective way to structure the payment that offers asset protection to both generations.
Contact our team today for assistance with your family business.
