It’s common for business owners to invest money into the business to get their business started and sustain it until it has the ability to survive on its own. A recent case outlines the risks associated with taking money out of a company without taking into account the tax implications.

A case before the Administrate Appeals Tribunal (AAT) was a loss for a taxpayer who tried to blur the lines between his business expenses and personal expenses. The taxpayer was a director and shareholder of a private company that ran a business. Over the past few years, he made withdrawals and paid personal expenses out of the company bank account, but the amounts were not considered the assessable income.

After an audit, the ATO assessed the payments and withdrawals as either:

  • deemed dividends under Division 7A, or
  • ordinary income assessable to the taxpayer

Division 7A possesses rules aimed at circumstances where a private company provides benefits to shareholders or their associates in the form of payment, loan, or by forgiving a debt. If Division 7A is triggered, the beneficiary of the benefit is considered to have received a deemed unfranked dividend for tax reasons.

The taxpayer attempted to convince the AAT that the withdrawals he made were actually repayments of loans that he had initially lent to the company. Thus, these withdrawals should not be subject to taxation as ordinary income. Alternatively, the taxpayer argued that the payments given to him were a loan, and under Division 7A, there was no deemed dividend because the company didn’t have any “distributable surplus”. This is a technical concept that limits the deemed dividend under Division 7A.

The ATO found a few issues regarding the quality of the evidence given by the taxpayer and concluded that the taxpayer failed to prove that the ATO’s assessment was excessive. It relied on various factors, including:

  • The taxpayer produced various iterations of his financial affairs and tax return.
  • He could not clearly explain how he could fund the original loans to the company, especially given he had declared tax losses in several years around the time when the loans were made.

While the taxpayer had tried to explain that some of his loans to the company were taken from his brother, the AAT considered this was unlikely given the brother’s own tax return showed modest income.

So, how should a contribution from a company owner to keep a business running be treated? It is based on the circumstance, but for small start-ups, the common avenues are:

  • Structure the contribution you make as a loan to the company, or
  • Arrange for the company to release shares, with the paid amounts being treated as share capital.

To make a decision on which is the best approach, it is important to consider a range of factors, including the ease of withdrawing funds from the company later, commercial issues, and regulatory requirements. The way you use money for the company also impacts the options that are available to subsequently withdraw funds from the company. However, the key issue to remember is that if you take funds out of a company, then there will be some tax implications that need to be carefully managed.

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