Company Money: A Guide For Owners

When you start up a business, inevitably, it consumes not just a lot of time but a lot of cash and much of this is money you have already paid tax on. So, it only seems fair that when the business is up and running the business can pay you back. Right?

As a business owner, it’s natural to want to reap the rewards of your hard work and investment. You may consider various methods to receive payback from the company, such as through dividends, salary and wages, or even employing family members. However, it’s important to keep in mind that once funds are in the company’s possession, they are considered company money.

Understanding the flow of money in and out of a business is crucial for avoiding potential pitfalls that could cause problems down the line. In this article, we explore some common challenges that business owners face when it comes to managing company finances and provide insights to help navigate these issues.

Repaying money loaned to the company

If you’ve loaned money to your own business, it’s possible to draw it out as a loan repayment. Keep in mind that the repayment isn’t deductible to the company, but any interest payments made to you will be, if the borrowed money was used in the company’s business activities (assuming interest has been charged on the loan).

On the other hand, any repayments made by the company on the loan principal aren’t considered income for tax purposes. However, you’ll need to declare any interest earned in your income tax return. It’s important to document all loans, including the loan term and repayments.

Dividends: Paying out profits

In simple terms, dividends are payments made by a company to its shareholders using the profits it has earned. If the company has already paid income tax, it might have franking credits which can be passed on to shareholders to reduce their personal tax liability. When a private company pays dividends, it must provide a distribution statement to its shareholders within four months after the end of the financial year. This statement outlines the extent to which dividends are franked.

If any of the shares in the company are held by a discretionary trust, there are additional issues that need to be considered. This includes whether the trust has a positive net income for the year, whether the trust has made a family trust election for tax purposes, and who will be entitled to the distributions made by the trust for that year.

Repaying share capital

In some cases, private companies may have a small amount of share capital, while others may have a larger balance. If a company has a significant share capital balance, it may be possible to return a portion of it to the shareholders. However, the feasibility of this will depend on the company’s constitution and corporate law requirements.

From a tax perspective, a return of share capital generally reduces the cost base of the shares for capital gains tax (CGT) purposes. This could result in a larger capital gain on the sale of the shares in the future, but it does not necessarily create an immediate tax liability. Nonetheless, there are some tax integrity rules to consider. The risk of these rules being triggered is higher if the company has retained profits that could be paid out as dividends.

Shareholder loans, payments, and forgiven debts: Using company money

Division 7A is a set of tax laws that govern how business owners can access funds from their company. The rules are designed to prevent business owners from using funds in a way that avoids income tax. Under Division 7A, any payments, loans, or forgiven debts are treated as if they were dividends for tax purposes unless there is a loan agreement in place that meets certain strict requirements.

These ‘deemed’ dividends cannot normally be franked. To avoid this deemed dividend from being triggered, business owners who have taken money out of the company bank account can repay the loan or place it under a complying loan agreement before the earlier of the due date and actual lodgement date of the company’s tax return for that year.

A complying loan agreement requires minimum annual repayments to be made over a set period of time, and there is a minimum benchmark interest rate that applies. For the 2022-23 financial year, the minimum benchmark interest rate is 4.77%. It’s important to be aware of these rules to avoid any unintended tax consequences.

If a business owner uses company funds for personal expenses, such as paying school fees or reducing their home loan, it’s important to pay back the amount or establish a complying loan agreement to avoid triggering a deemed unfranked dividend under Division 7A of the tax law. This dividend would be treated as personal income and taxed without the benefit of any franking credits, resulting in double taxation of the same company profits. Therefore, it’s crucial to understand the requirements for complying loan agreements, including minimum annual repayments and a benchmark interest rate, to ensure compliance with Division 7A and avoid unwanted tax consequences.

When it comes to loan repayments, the tax law has strict guidelines in place. If a repayment is made to a shareholder, but the same or a higher amount is loaned back to them soon after, there are specific rules that may apply to disregard the repayment. It’s important to note that there are some exceptions to these rules, and the situation needs to be managed carefully to avoid any negative tax implications.