You’re finally your own boss, and in its early days, the business needs upstart funds. Such as a loan to a business, to sustain it until it finds its own feet. But you can’t move funding sources in and out like in a bank account, and the ATO can chase you up on your tax return if you don’t structure it correctly.
Depending on the situation, generally treat a contribution from a company owner as:
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A loan to the company, or…
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Paid through share capital, by setting up the company to issue shares.
Other factors to consider are: commercial issues, regulatory requirements and the ease of withdrawing funds from the company again.
A “loan” to a business repaid wrong
If you want to take funds out of a company at a later point, there will likely be some implications to your tax return.
Such as a case before the Administrative Appeals Tribunal (AAT): a shareholder and director of a private company lost an argument regarding the money he withdrew from his company impacting his assessable income. Because he was blending private and company expenses, he could not prove that he had loaned money to the company, which was later repaying him.
Over several years, he made withdrawals and paid personal private expenses out of the company bank account. But the amounts were not considered assessable income in his tax return.
Following an audit, the ATO assessed the withdrawals and payments as either:
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Ordinary income assessable to the taxpayer, or…
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Deemed dividends under Division 7A.
Division 7A deals with situations where a private company gives benefits to its shareholders or their connections as a loan, payment, or forgiving a debt. If Division 7A applies, the ATO considers the person receiving the benefit, for tax purposes, to have received a deemed unfranked dividend.
Poor arguments for the case
The taxpayer tried to convince the AAT that the withdrawals were repayments of loans he originally advanced to the company. So the money he pulled out shouldn’t be assessable as ordinary income.
On the flipside, he also argued that the payments were a loan to him. Meaning, there was no deemed dividend under Division 7A, because the company did not have any “distributable surplus”. This is a technical concept which limits the deemed dividend under Division 7A.
The ATO didn’t find the taxpayer’s evidence strong enough to prove that their assessment was excessive, according to him. The factors that weakened his position included:
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He produced several different iterations of his financial affairs and tax return.
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He couldn’t explain how he was able to fund the original loans to the company, since he had declared tax losses multiple years around the time he made the loans.
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His explanation that his brother assisted with the loan by borrowing him money seemed implausible. The brother’s tax return was modest at best.
Company tax regulations are complex, aimed at safeguarding the business’ functioning, as well as the shareholders and directors from direct financial risk. However, that doesn’t mean it’s liquid money. When considering a loan to a business, or moving funds, ensure you use the proper channels to avoid tax shocks.
For more information on what a company structure is good for, watch our video on business structures.
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