What starts out with the best intentions can soon result in family disharmony. The tragedy is that this is so easy to avoid if you take some simple precautions from the outset.
The economic consequences of COVID-19 mean that family members may be relying on you more than ever, and that support is likely to take the form of ‘financial assistance’. Lending to family members can be problematic – the danger being that either you won’t be repaid, or an important relationship will be spoilt. To minimise the downside of inter-family loans, and to help you to achieve your ultimate objectives, i.e. provide temporary assistance to a loved family member, we have the following tips:
Gift or Loan?
What sort of help are you offering?
Is the financial assistance you are providing a gift or a loan? A loan must be repaid. A gift does not. Have you made it clear what your intentions are? “Let me help you out,” might mean ‘loan’ to you, and ‘gift’ to them.
You must put your intentions in writing, whether it be a gift or a loan, but especially if it is a loan. To avoid a mismatch of intentions, the loan agreement should cover such things as the amount and purpose of the loan, how long the loan is going to be for, your entitlement to interest and whether there is any security being provided for the loan. The loan terms should be realistic and capable of being enforced and adhered to.
Even if you are making a gift, it is still important to record this intention in writing. If you die and this is unclear, then chances are your beneficiaries will argue about what you have done. The person you gave the money to will argue it is a gift, while your other beneficiaries will argue that it was a loan that needs to be repaid to your estate.
Who are you lending the money to?
You need to know who you are lending the money to and for what purpose.
Are you lending money to your family member’s business or assisting them (and perhaps their spouse) to purchase their home? In these situations, it’s very important that the loan is formally recorded, with all relevant borrowers on the hook. Failure to do so could result in the financial assistance being classified as a gift and ‘gifted money’ can end up in unintended places, for example with a child’s creditors or ex-spouse and can be the source of discord where deceased estates are concerned.
Where directors or related parties are lending money to a business, they need to ensure that the loan is properly recorded and acknowledged by the business. It is also crucial that the appropriate security is taken and registered as soon as the loan documents are signed to protect your position. .
Who is the lender?
There are different things to consider depending on who is the lender.
A personal loan will likely be the simplest to document, though this doesn’t mean any less thought needs to be given to the structure of the loan. You should think about how you want the loan to be structured – as a general loan, for principal and/or interest, or as an ‘equity’ loan, where you are entitled to be repaid principal, as well as some share of the increase in value of the secured property. Loan terms, interest rates and possible early repayment are other considerations. The purpose of the loan will be relevant here.
The same consideration should be given to a loan made by a trust. In addition, a loan from a trust will at all times need to comply with the terms of the relevant trust deed. You should ensure that the trustee’s powers capture a right to make loans and ensure that the form of loan you intend to give is not prohibited by the terms of the trust deed. You also need to consider who is likely to control the trust after you have died, as they will be able to demand repayment (or not).
A loan from a company will need to be documented very carefully, to ensure that it complies with Division 7A - Division 7A is a set of rules that treats certain disguised distributions (i.e. loans and other such arrangements) as if they are actual distributions of income. So long as you comply with the requirements for Division 7A loans (as set out in the Tax Act), the loan will be allowed. However, be aware that there are specific time frames (7 years for unsecured, and 25 years for secured loans) and interest and principal rules that apply.
Loans and financial assistance from an SMSF to members of the SMSF or a member’s relative are strictly prohibited. Lending from an SMSF to a related entity is only be possible in very limited circumstances and care must be taken so that you do not breach the Sole Purpose and In-House Asset tests.
Register the security
In Australia, you must register your security interest over non-land assets on the Personal Property Securities Register (PPSR). If your borrower’s business becomes insolvent, and you are registered on the PPSR, you will have a priority ranking over unsecured creditors when the assets of the business are sold. Getting advice about what level of protection you are entitled to under the PPSR and making sure the security is validly registered and ‘perfected’ are essential steps.
If you have lent the borrower money to purchase their home, then you are able to caveat your interest or register a mortgage with the land titles registry of the State in which the property is located. By registering a mortgage over the property, you ensure that your loan will be repaid from the sale of the property.
If the borrower is a child and they have a spouse, it is important to make your child’s spouse a party to loan agreements where appropriate, or otherwise have them formally acknowledge the loan. You might regret not doing this if the couple divorce in the future.
Get it right – the first time
As you can see, making a loan to a family member is never just as simple as signing on the dotted line (or just extending the cash). In the challenging circumstances brought about by the
