Tax Treatment of a Related-Party Loan and the Ethics of a 'Helpful' Adjustment
Bramble & Co, a small proprietary company, lends $500,000 to its sole director, Mr. Okafor, interest-free, repayable on demand. The loan is recorded as a receivable. The company's accountant, Ms. Lin, is preparing the tax return. She knows that a loan to a shareholder or associate can give rise to a deemed dividend (franking account implications) unless a specific exclusion applies, such as the loan being made in the ordinary course of business on commercial terms, or being fully repaid within the required period. The loan was made in July and remains outstanding at year-end. Mr. Okafor tells Ms. Lin, 'Just treat it as repaid - I'll pay it back next month, and anyway the company makes enough profit that no one will look.' Ms. Lin is also the director's cousin and fears losing the engagement. The company's taxable income before any adjustment is $180,000.
1. Identify the tax risk arising from the director's loan and evaluate whether Ms. Lin may record it as repaid.
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An interest-free loan to a director/shareholder that remains outstanding at year-end is at high risk of being treated as a deemed dividend under the shareholder-loan rules, unless an exclusion applies. The ordinary-course-of-business exclusion is unlikely to apply to a one-off loan to a director on non-commercial terms. The loan was not repaid within the required period, so the deemed-dividend exposure stands and may affect the company's franking account and the director's personal tax position.
Ms. Lin may not record the loan as repaid. It is not repaid: the cash has not returned, and a promise to repay next month does not change the year-end position. Recording a repayment that has not occurred would misstate the accounts and the return - a false statement, potentially an offence, and a breach of professional ethics (integrity and compliance with laws).
The correct treatment is to disclose the loan as outstanding, assess the deemed-dividend consequence, and advise the director of the options: repay within the permitted period, put the loan on commercial terms with interest, or accept the deemed-dividend treatment. The tax return should reflect the actual position.
2. Ms. Lin is the director's cousin and fears losing the engagement. Advise her on the ethical and professional steps she should take.
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Ms. Lin faces a conflict of interest and a self-interest threat to her objectivity. Her family relationship with the sole director, combined with fear of losing the engagement, creates pressure to accept an improper instruction. Professional codes require her to identify, evaluate, and address such threats.
Steps: (1) Do not make the requested entry; document the instruction and her refusal in writing. (2) Disclose the relationship to the company and, if she is a member of a professional body, consider whether safeguards (independent review of the tax return by another practitioner) are sufficient or whether she must decline the engagement. (3) Escalate the matter to the director in writing, setting out the tax consequences and the risks of misstatement. (4) If the director insists on the false treatment, she should withdraw from the engagement and consider whether reporting obligations apply. (5) Retain records of her advice.
Losing a client is preferable to participating in a false return. The engagement letter and professional indemnity position should be reviewed before withdrawal.