One of the benefits of operating a business through a private company is the ability to access a flat 30% tax rate on profits. However, shareholders often forget that the 30% corporate tax rate is only intended to apply while the profits are being used in the company's business or investment activities.
Even though accessing company profits is an issue affecting all shareholders of private companies, the tax rules can be extraordinarily complex and can lead to some very harsh tax outcomes. The Government and ATO's expectation is that top-up tax (if any applies) should be paid by shareholders at their marginal tax rates once they have access to these profits.
Business owners who take money from the company bank account for personal reasons - for example, renovations to their home - need to be careful about how they access their profits. One option is for the company to pay a fully-franked dividend, if the owner is a single shareholder. Assuming that the shareholder is on the top marginal rate of 46.5%, top-up-tax will need to be paid by the shareholder after they have claimed the benefit of the franking credits attached to the dividend.
Another way of accessing the funds is to treat the arrangement as a loan from the company to the shareholder. However this requires that a complying loan agreement is put in place before the shareholder lodges their tax return otherwise the ATO will treat the loan as a tax dividend – and that could attract a substantially higher tax liability.
Managing loans from the company and deferring the top-up-tax liability usually involves a loan agreement with a 7 year loan term and the interest rate linked to the ATO's benchmark rates each year. This may defer paying some additional tax in the short term, however it may not be the best out come over the term of the loan.
Because interest will accrue each year, 30c of every dollar of interest accruing on the loan is paid to the ATO in tax by the company.
The downside of the loan approach is that when the shareholder wants to access those funds again, there can be a further top-up of 16.5% when dividends are paid.
In some cases, using a loan agreement between the company and the shareholder may still be the best option from a tax perspective.
If so, the loan needs to be managed carefully on a year-to-year basis to ensure that minimum annual repayments are being met. Also, shareholders should look to make repayments as early as possible each year to minimise the interest that accrues on the loan. Every dollar of interest saved can represent a cash saving of up to 46.5c to the shareholders when the funds eventually come back to them.
These scenarios only cover a fraction of the tax issues that can be triggered when shareholders want to access company profits. The general rule is, if something belongs to a company (including cash, boats, holiday homes etc.,) and is used by a shareholder (or a family member or other related entity), then there might be some tax to pay unless the situation is managed very carefully.
In some cases shareholders may actually be better off triggering an up-front tax liability by declaring franked dividends and then borrowing funds from a bank to fund the top-up tax rather than trying to access company profits in the form of a loan.
Given the complexity of the tax system and the significant tax liabilities that can be triggered when a shareholder or other related party accesses company profits or assets, it is important to seek advice and explore the alternatives available. Contact us on 02 9957 4033 for a confidential discussion with our team.
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Last updated June 2013. This article is provided for information purposes only and should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.