A Comprehensive Guide for Business Owners
Starting a business can be an exhilarating journey, demanding not just your time but also a substantial financial commitment. Often, you fund these ventures with hard-earned money that you’ve already paid taxes on. So, when the business starts operating successfully, it’s natural to expect some form of payback, right?
Business owners seek compensation from their companies in various ways. They may draw dividends or salary, employ family members, or even charge personal expenses to the company. However, it’s important to remember that once you inject funds into the company, they become company assets.
In this guide, we will discuss the flow of money into and out of a company and highlight common pitfalls for business owners.
Drawing Back Loans Made to the Company
If you’ve loaned money to your business, you can retrieve it as a loan repayment. While these repayments aren’t tax-deductible for the company, any interest payments will be, assuming the borrowed funds were used for business activities and the loan was interest-bearing.
On the flip side, the loan principal repaid to you is not considered taxable income, but you must declare any interest earned in your income tax return. It’s crucial to document all loan details, including terms and repayment schedules.
Dividends: A Share of the Profits
Dividends are portions of company profits distributed to shareholders. If the company has paid income tax, the dividends could be franked, which means shareholders can use these franking credits to reduce their personal tax liability.
Private companies have a four-month window after the financial year ends to provide a distribution statement to shareholders, during which they determine to what extent dividends will be franked.
Shares held by a discretionary trust add an extra layer of complexity, requiring considerations like the trust’s net income, any family trust elections for tax purposes, and who is entitled to trust distributions.
Returning Share Capital
Most private companies start with a small share capital. However, if a company has a more substantial share capital balance, there could be room for a return of share capital to shareholders. This process is contingent on the company constitution and needs to navigate corporate law issues.
From a tax perspective, a return of share capital usually reduces the cost base of shares for Capital Gains Tax (CGT) purposes, potentially leading to a higher capital gain in case of future share sales. But this doesn’t automatically trigger an immediate tax liability. However, some tax system integrity rules should be considered, especially if the company has retained profits.
Borrowing from Company Funds: Understanding Division 7A
Division 7A is a section of tax law designed to prevent business owners from accessing company funds in a way that bypasses income tax. Any payments, loans, or forgiven debts taken out of the company by owners are treated as dividends for tax purposes, unless a complying loan agreement that meets specific requirements is in place. These ‘deemed’ dividends cannot normally be franked.
To avoid triggering a deemed dividend, the loan should be fully repaid or placed under a compliant loan agreement before the earlier of the due date and the actual lodgement date of the company’s tax return for that year.
For example, if you take money out of the company to pay personal expenses like school fees or your mortgage, this amount could be treated as an unfranked deemed dividend if not repaid or placed under a compliant loan agreement. You would have to declare this amount on your personal income tax return as a dividend without any franking credits. This could lead to double taxation of the same company profits.
Careful management is crucial in loan repayments, as certain special rules could nullify the repayment if the same amount or more is borrowed by the shareholder shortly afterward.
Update: Super Balances Over $3m Taxation
Recently, the Treasury released draft legislation to enact the Government’s proposal to impose a 30% tax on future superannuation fund earnings when the member’s total superannuation balance exceeds $3m.
If passed, the legislation would:
- Apply the tax to member accounts with superannuation balances over $3 million from 1 July 2025; and
- Levy the additional 15% tax to ‘unrealised gains’, meaning a tax liability could arise if the asset values increase.
Currently, fund income is taxed at 15%, or 10% for capital assets held by the fund for over 12 months. The proposed change means that those affected could end up paying tax on paper gains without having the cash from an asset sale to cover the tax payment.
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