If you operate your business through a company, it is vital that you understand the methods you can use to get funds into your personal name. You can’t just withdraw money from the company bank account and transfer it into your personal account. These are the company’s profits, and you must identify the method you are using to bring them into your personal name or risk adverse tax consequences.
There are four ways you can bring funds from your company into your own name:
Wages
If you wish to receive a regular source of income, you may wish to declare a wage to yourself. Usually, the company’s payroll will be processed on a regular basis (weekly, fortnightly or monthly). Using your gross wage, the business will calculate tax and superannuation and you will be paid the net wage into your personal name. This wage will be declared in your personal tax return alongside any other personal income you receive.
Your wages will be a deduction to the company.
Directors’ fees
Directors’ fees are like wages, they are effectively compensation for services performed as a company director. They must still be processed through payroll, have tax withheld on them and super calculated on them. A company cannot declare director’s fees and avoid its tax and superannuation obligations.
Director’s fees are typically ad hoc rather than regular payments to directors or may be more regular payments made to directors who do not work in the business. Like wages, directors’ fees are a deduction to the company and will be considered part of the director’s personal income.
Dividends
The director of the company or an entity they control may be a shareholder of the company. A dividend is a payment out of the company’s profits to its shareholders that brings money out of the company and into the shareholder’s name.
Once a dividend is paid it becomes income in the shareholder’s name. The dividend may be franked, that is it will have a ‘franking credit’ attached to it based on the tax already paid by the company on these profits. Alternatively, a dividend may be unfranked (no tax has been paid by the company on these profits) or partially franked (some tax has been paid by the company on these profits).
You will pay tax at your marginal rates but if the company has already paid tax on the dividend, that is, the dividend has a franking credit attached to it, you do not have to pay tax on the dividend. If the marginal rate of tax you pay is lower than the company rate of tax, you may even receive a refund if you receive a franked dividend.
Remember, dividends must be paid proportional to your shareholding.
Loans
If you transfer company money into your personal account without declaring wages, director’s fees or dividends, you are creating a loan. In the worst case scenario you have now created a non-complying Division 7A loan which results in unfranked dividends being deemed and declared in your own personal name for income tax purposes.
Division 7A of the Income Tax Assessment Act 1997 (Cth) does not stop companies from lending or advancing money to their shareholders, but it does lay down some very strict rules for recording these loans and ensuring these transactions are compliant.
A company will breach Division 7A if:
- It lends money or transfers property to shareholders or a shareholder’s associate for less than its market value;
- It loans money to shareholders or a shareholder’s associate without a formal credit agreement;
- The loan is not fully repaid by the financial year’s tax return lodgement date; or
- It relieves the shareholder, or their associate of debt owed.
Unless a complying Division 7A Loan Agreement exists, these transactions will form part of the shareholder’s assessable income and be subject to income tax at the shareholder’s marginal tax rate. The money will be treated as an unfranked dividend to the shareholder which basically means you will be paying an excessive rate of tax on this money.
You will need tax advice and legal assistance in entering and drawing up a complying Division 7A loan. As a form of distribution of money from a company, loans are only used in very specific situations.
How we can help
If you think there may be some Division 7A issues lurking in your company structure, then contact us on 1300 654 590 or by email.
The information contained in this post is current at the date of editing – 15 July 2024.
