Entrepreneurs often invest their personal funds into kickstarting and sustaining their businesses until they become self-sufficient. However, a recent case underscores the importance of understanding the tax implications associated with withdrawing money from a company for personal use.

A recent case brought in front of the Administrative Appeals Tribunal (AAT) serves as a cautionary tale for those who blur the lines between personal and business expenses. In this instance, a taxpayer, who was both a shareholder and director of a private company, consistently withdrew funds and covered personal expenses from the company’s bank account without recognizing these amounts as assessable income.

Following an audit, the Australian Taxation Office (ATO) determined that these withdrawals and payments should be treated as either ordinary income assessable to the taxpayer or deemed dividends under Division 7A. Division 7A outlines rules designed to address situations where private companies provide benefits to shareholders or their associates in the form of loans, payments, or debt forgiveness, triggering tax implications such as deemed unfranked dividends for the recipient.

The taxpayer attempted to argue before the AAT that these withdrawals were repayments of loans originally extended by him to the company, or alternatively, that they constituted loans to him and were not subject to Division 7A’s deemed dividend provisions due to the absence of a “distributable surplus” within the company.

However, the AAT found issues with the taxpayer’s evidence, particularly regarding the origin of the funds and their repayment. The taxpayer’s failure to provide consistent and plausible explanations, coupled with discrepancies in financial documentation, led the AAT to uphold the ATO’s assessment.

This case underscores the importance of carefully managing financial transactions between business owners and their companies. For entrepreneurs seeking to inject capital into their companies, there are common avenues to explore, including structuring contributions as loans to the company or issuing shares with the amounts paid treated as share capital.

The choice between these options depends on various factors such as commercial considerations, ease of fund withdrawal, and regulatory compliance. It’s crucial to remember that the method of injecting funds into the company will impact the available options for subsequent fund withdrawals. 

Above all, business owners must be mindful of the tax implications associated with taking funds out of the company and ensure they are managed effectively.

For any question you might have relating to this matter, please contact Bates Cosgrave on 02 9957 4033.