It is common for business owners to devote their money into a business to get it up and running until it can sustain and survive on its own. A recent case highlights the dangers of taking money out of a company without considering tax implications.
Case Study – Private and Company Expense
A taxpayer who blurred the lines between his private and company expenses lost a case before the Administrate Appeals Tribunal (AAT).
Over several years, he made withdrawals and paid private expenses from the company account without recognising the payments as assessable income.
Following an audit, the ATO assessed the withdrawals and payments as either:
- Ordinary income assessable to the taxpayer, or
- Deemed dividends under Division 7A
Division 7A contains rules aimed at situations where a private company provided benefits to shareholders or their associates in the form of a loan, payment or by forgiving a debt. If Division 7A is triggered, then the recipient of the benefit is taken to have received a deemed unfranked dividend for tax purposes.
The taxpayer argued that the withdrawals were the repayments of loans originally advanced by him to the company, so should not be assessable as ordinary income. Thus, there was no deemed dividend under Division 7A because the company did not have any “distributable surplus”.
However, the AAT discovered issues with the quality of the taxpayer’s evidence, failing to prove that the ATO’s assessment was excessive. A range of factors were taken into account:
- The taxpayer produced a number of different iterations of his financial affairs and tax return
- Could not satisfactorily explain how he was able to fund the original loans to the company given tax loss declarations in multiple years around the time when the loan was made.
The taxpayer attempted to justify that some of his loans to the company was sourced originally from borrowings from his brother, but the AAT considered this implausible given the brother’s own tax return showed modest income.
So… How Should You Fund A Start-Up Company?
It depends on the situation, but for small start-ups, common avenues are:
- Structure the contribution as a loan for the company
- Arrange an issue of shares with the amounts paid treated as share capital
Before you make a decision, consider a range of factors:
- Commercial issues
- Ease of withdrawing funds
- Regulatory requirements
- Tax implications
The avenue in which you inject money into a company impacts how you can withdraw funds from the company. If you have any questions, contact our Solomons Tax and Accounting to see how we can help you make the right decision.
