Taking Money Out of Your Private Company: How to Avoid Division 7A Penalties

How can you withdraw money from your company?

As a business owner, you may be wondering if you can withdraw money for personal use from your own company. The answer is yes, but the process of doing so safely and without heavy financial implications requires a more detailed explanation.

Since your company is a separate legal entity, you need to know the proper ways to access its funds.

Here are the top methods used by Australian business owners to withdraw money from their company:

1. Pay yourself a salary or wages: This is subject to PAYG withholding tax and is a legitimate way to take money out of the company.
2. Receive director’s fees: This is also subject to PAYG withholding tax and is a legitimate way to take money out of the company.
3. Receive allowances, commissions, or bonuses: These are legitimate forms of compensation and are not subject to Division 7A.
4. Declaring Franked Dividends: A company can choose to issue a dividend payment to shareholders, which is generally franked to avoid double taxation on the funds earned. The amount a company can issue will depend on the company’s retained earnings and franking credit balance. Remember to report these dividends as income.

5. Reimbursement: Shareholders or directors can withdraw previously contributed funds if they were contributed as a loan. This means you can take back the money initially used to start your business. Lending money is a tax-free transaction, so the return of this money is also tax-free.

6. Treat it as a Division 7a loan: If you need to take a large sum of money out of the company, you can do so by treating it as a loan. This must be done through a loan agreement and the minimum yearly repayment must be made.

It’s important to note that if you take money out of the company without following these guidelines, the ATO may treat it as an unfranked dividend, which will be assessable income and subject to tax. By following these guidelines and complying with Division 7A, you can avoid penalties and ensure that your withdrawals from the company are done in a legal and tax-compliant manner.

What are the minimum yearly repayments required for a Division 7A loan?

The minimum yearly repayments required for a Division 7A loan are calculated using the benchmark interest rate and the loan amount. The benchmark interest rate is set by the ATO and changes each financial year. The loan amount and interest rate must be included in the company’s accounts for the income year in which the loan is made.

What is the common way to avoid deemed dividends when providing loans to shareholders in compliance with Division 7A?

To avoid this deemed dividend, a common approach is to execute a complying loan agreement. This requires a minimum annual repayment of principal and interest over a term of up to seven years. Instead of repaying the loan in cash, the company declares a fully franked dividend each year equal to the required repayment. This results in a “top-up” tax liability for the client, as they must pay the difference between the company’s tax rate of 30% and their personal tax rate of up to 46.5%.

Another alternative is to have a loan agreement that meets the requirements as described in Division 7A, this will also avoid deemed dividends. It’s important to note that the rules are complex and it’s best to consult with a professional to ensure compliance.

What is the alternative way to avoid paying extra taxes on money taken out of a company and how can it be beneficial?

There is a way that some people choose to avoid paying extra tax on money they take out of a company. Instead of paying back the money to the company, they sell assets to the company for the same amount of the loan. This way, they don’t have to pay extra tax and they don’t have to pay interest on the loan. Additionally, they can take advantage of any tax breaks that come with selling assets.

However, it’s important to talk to a tax expert before doing this to make sure it’s the right choice and that it follows the rules set by the government. This alternative approach can be more beneficial for some people’s specific case, but it’s important to ensure compliance with the relevant laws.

What other factors should be considered when dealing with Division 7A and payments made by a private company to shareholders or associates?

It’s important to note that Division 7A does not apply to payments made by the private company to shareholders or associates in their capacity as employees. Instead, fringe benefits tax (FBT) may apply. Additionally, Division 7A does not apply to normal dividends or director’s fees that are already subject to income tax.

Can a Division 7A loan be forgiven?

Division 7A loans are treated as a benefit provided by a private company to a shareholder or associate. If a private company forgives a Division 7A loan, it can be treated as a dividend for income tax purposes, making it assessable income for the shareholder or associate. However, a Division 7A loan can be forgiven if the company can demonstrate that it is a genuine loan and that it has a loan agreement in place with the shareholder or associate, and that the company has made the minimum yearly repayment required under the agreement.

Why should you be concerned about Division 7A?

If a private company makes a loan to a shareholder or associate and it is not repaid or placed under a complying loan agreement before the due date for the company’s income tax return, the loan may be treated as a dividend by the Australian Taxation Office (ATO). This means that the loan will be subject to income tax and may result in additional tax liabilities for the shareholder or associate.

What are the consequences of not complying with Division 7A?

If a private company does not comply with Division 7A, payments or benefits provided to shareholders or associates can be treated as unfranked dividends for income tax purposes, resulting in the shareholder or associate having to pay income tax on the payment or benefit. Additionally, the company may be subject to penalties and interest charges.

Conclusion

Division 7A is a complex area of tax law and it’s important for private company shareholders and associates to understand the potential application of Division 7A and seek advice where necessary. The common approach to repaying Division 7A loans is to execute a complying loan agreement and make minimum annual repayments of principal and interest. However, there is a novel alternative approach of selling assets to the company for an amount equal to the loan which can be tax efficient and must be considered after consulting with a tax advisor to ensure compliance with relevant tax laws.

Don’t let Division 7A penalties catch you off guard. Contact us today to schedule a consultation and get personalized advice on how to withdraw money from your private company safely and compliantly.