Naturally, starting a company can require a lot of money as well as time, much of which is money that has already been taxed. It therefore seems only fair that the company can reimburse you once it is operational. Right?
Owners might seek compensation from the business for their time and money in a variety of ways, including dividends, salaries and wages or cash advances. However, once the money is in the business, it belongs to the company and care should be taken with any loans from the company.
We examine a company’s cash inflow and outflow as well as the challenges faced by business owners.
Repaying loans made to company
You can withdraw this money as a loan payback if you have lent money to your company. The company cannot deduct the loan repayment, but it can deduct any interest payments paid to you as long as the borrowed funds were utilised for business purposes (provided interest was in fact charged on the loan).
On the other hand, the company’s repayments of the loan’s principal are not considered income for tax reasons; however, you must report any interest you receive on your income tax return. All loans should be documented, along with the loan length and payback schedule.
Paying out profits: Dividends
Dividends are essentially the company’s distribution of profits to its shareholders. The dividends may be franked if the company has franking credits from income tax it has paid, and the shareholder can frequently utilise the credits to lower their own tax liability.
Within four months of the end of the financial year, a private firm that pays a dividend must provide a distribution statement to the shareholders. Due to this, private companies have up to four months after the end of their financial year to determine how heavily franked their dividends will be.
There are some additional considerations that must be made if any of the company’s shares are held by a discretionary trust, including whether the trust has a positive net income for the year, whether it has made a family trust election for tax purposes, and who will be entitled to distributions the trust makes for that year.
Share capital repayments
Many private businesses are founded with a sizable amount of share capital. On the other hand, if a company has a greater share capital balance, there may be room for it to return funds to shareholders. The provisions of the business constitution will determine if this is feasible, and there are some corporate law issues that must be resolved.
A return of share capital typically lowers the cost base of the shares for CGT purposes, which could result in a higher capital gain on future sales of the shares but may not result in an immediate tax obligation. However, there are some integrity rules in the tax system that must be taken into account. If the business has maintained income that could be distributed as dividends, the likelihood that these rules will be applied is typically higher.
Using company money for shareholder loans, payments, and forgiveness of debts
The treatment of money taken out of a company is governed by certain tax laws, including Division 7A. Division 7A is a very complex tax provision meant to stop business owners from using company money to avoid paying income tax. Division 7A ensures that any payments, loans, or forgiven debts are treated as dividends for tax purposes unless there is a loan agreement in place that satisfies certain strict requirements, despite the fact that sums taken from a company bank account by the owners are frequently debited to a shareholder’s loan account in the financial statements. Normally, these ‘deemed’ profits cannot be franked.
The main ways to prevent this deemed dividend from being activated if you have taken money out of the company bank account are to make sure the loan is fully repaid or placed 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. The loan agreement must have a minimum benchmark interest rate that applies and minimum yearly repayments paid over a predetermined time period in order to be considered compliant; that rate is now 4.77% for 2022–2023.
For instance, if your business pays your children’s tuition or you withdraw funds from the business bank account to pay off your personal mortgage, if you don’t repay the money or put a complying loan agreement in place, it may be deemed an unfranked dividend. In other words, you must disclose this sum in your personal income tax return as a dividend, free of any franking credits. This implies that even if the business has already paid tax on this amount, you will still be taxed on it without being able to claim a credit for the tax that the business has already paid. This is known as double taxation.
When it comes to loan repayments, the terms are fairly strict. There are some unique conditions that may apply to essentially overlook a payback if it is made but soon after, the shareholder withdraws the same amount or more. There are some exceptions to these laws, therefore it’s important to manage the situation carefully to prevent unfavourable tax effects.
Starting a business and the cash injection needed requires expert support to manage your money efficiently in order to set your business up for success. If you’d like to discuss setting up a new business, how to structure your business and the tax implications that come with your new venture, chat with an accountant based locally in Ormeau. Get in touch with MB Accounting and Business Services, your local Ormeau Accountant and we’ll help you with your tax today.