From dividends and salaries to cash loans and even having personal expenses like education and entertainment paid for by the company, there is a wide variety of ways in which owners try to recoup the work and money they have put into their businesses.

The money belongs to the business from the moment it is deposited. 

We analyse the cash inflow and outflow of the business, as well as the stumbling blocks that entrepreneurs or company owners face.

Paying back the owner for money borrowed to the business

You may request a loan payback from your business if you have previously extended a loan to it. As long as the loaned funds were put to use in the operation of the business, the company can deduct the interest payments it paid to you (provided interest was really charged on the loan). 

Interest generated must be reported on your tax return, but principal repayments made by the corporation are not considered taxable income. It is important to keep records of all loans, including their terms and repayments.

Paying out profits as dividends

Dividends are a way for a company to give its shareholders a share of its earnings. If the company has franking credits from income tax it has paid, the dividends might be franked, and the credits can often be used by the shareholder to lower their own tax bill. 

When a private business pays a dividend, it must give the shareholders a distribution statement within four months of the end of the financial year. This gives private companies up to four months after the end of the financial year to figure out how much their earnings will be franked.  

If any of the company’s shares are held by a discretionary trust, there are a few more things to think about. These include whether or not the trust has a positive net income for the year, whether or not it has chosen to be taxed as a family trust, and who will be able to get distributions from the trust for that year.

Paying back the share capital

A small amount of share capital is often enough to start a private business. But if a company has a bigger share capital balance, it might be able to give some of the share capital back to the shareholders. Whether or not this is possible depends on the company’s bylaws, and there are also some corporate law problems that need to be dealt with. 

From a tax point of view, a return of share capital will usually lower the cost base of the shares for CGT reasons. This means that when the shares are sold in the future, there could be a bigger capital gain, but there might not be a tax bill right away. Still, there are some rules about honesty in the tax system that need to be thought about. Most of the time, these rules are more likely to be triggered when a company keeps gains that could be paid out as dividends.

Shareholder loans, payments and settled debts: Using money from the company

Some rules in the tax law (called “Division 7A”) talk about what to do with money that is taken out of a company. Division 7A is a tricky piece of tax law that is meant to stop business owners from getting money in a way that gets around paying income tax. 

When owners take money out of a company’s bank account, the money is often deducted from a shareholder’s loan account in the financial statements. However, Division 7A makes sure that any payments, loans, or forgiven debts are treated as dividends for tax purposes unless there is a loan agreement in place that meets certain strict requirements. Most of the time, these ‘deemed’ payments can’t be franked.

If you have taken money out of the company bank account, you can avoid this “deemed dividend” by making sure the loan is fully paid back or put under a “complying loan agreement” before the company’s tax return for that year is due or the actual date it is filed, whichever comes first. To be a complying loan agreement, the agreement must have minimum yearly repayments over a set time period and a minimum benchmark interest rate, which is 4.77 percent for 2022-23 at the moment. 

For example, if your company pays for your kids’ school fees or if you take money out of the company bank account to pay down your personal home loan, if you don’t pay this amount back or set up a proper loan agreement, this amount is likely to be treated as a deemed unfranked dividend. That is, you need to report this amount on your personal tax return as if it were a profit, but without any franking credits. This means that even if the company has already paid tax on this amount, you will be taxed on it again without being able to get a credit for the tax the company has already paid. This means that the same company income will be taxed twice.

When it comes to paying back loans, the rules are very strict. If a member makes a payment and then soon after gets a loan for the same amount or more, there are special rules that can be used to ignore the payment. There are some exceptions to these rules, and the situation needs to be carefully handled to avoid bad financial consequences.