DON’T Transfer money in and out of your company without a plan!
Borrowing money from your own company might seem convenient / easy / simple / a minor issue that you can rectify later but in so many cases, this practise just results in a tax, legal and administrative NIGHTMARE.
Company directors: here’s our guide to the intricacies of borrowing money from your company…
Understand the Legal Framework
Before you consider borrowing money from your company, make sure you understand the applicable legal framework. In Australia, Division 7A of the Income Tax Assessment Act 1936 plays a critical role. In short, this legislation is designed to prevent profits or assets from being distributed to shareholders or their associates in the form of loans. If you transfer money from your company bank account into your personal bank account, really it should be a wage (with tax withheld and super paid) or a dividend. A dividend is a distribution of a portion of a company’s earnings (it’s after-tax profits) to a class of its shareholders. Provided a company has available franking credits (i.e. the company has paid corporate income tax on its profits); dividends that are paid out to shareholders can be franked. Essentially what this means is that an individual receiving a franked dividend gets a credit for the company tax already paid in their personal tax return – thereby reducing their overall tax payable.
IF, you don’t comply with Division 7a, the result is what’s called a “deemed dividend.” A deemed dividend is when the entire balance of the loan must be declared as an unfranked dividend in a shareholder’s personal tax return.
Comply with Division 7A Requirements
To avoid a loan that you’ve taken from your company being treated as a deemed dividend in your personal name, you need to ensure that any loan from your company complies with Division 7A requirements. Here’s how:
- Have a formal loan agreement in place: The loan must be documented in a written agreement specifying terms and conditions.
- Understand the Minimum Interest Rate: The loan should carry an interest rate at least equal to the benchmark rate published by the Australian Taxation Office (ATO).
- Create a Repayment Schedule: Set up a clear repayment schedule within the maximum term allowed (7 years for unsecured loans and 25 years for secured loans).
Avoid Direct or Indirect Re-borrowing
One common mistake is using the funds from a new loan to repay an existing one. This practice, known as re-borrowing, can lead to the payments not being recognised as legitimate repayments under Division 7A, thereby risking the loan being treated as a deemed dividend.
Consider the Timing of the Loan
The timing of the loan can also impact its tax implications. Loans taken out close to the end of the financial year and repaid shortly after the start of the new financial year, with the intention of re-borrowing the amount, can attract scrutiny from the ATO. Does this include transferring money from your company onto your personal mortgage in order to reduce interest??
YES it most certainly does! Using company funds to pay personal expenses, even temporarily, breaches corporate governance principles. Directors have a duty to use company assets for legitimate business purposes and must act in the best interests of the company. Misuse of company funds can lead to legal consequences, including penalties for breaching directors’ duties.
Keep Accurate Records
Maintaining accurate and detailed records of all transactions related to the loan is essential. This includes the loan agreement, records of all repayments, interest calculations, and any communications regarding the loan. These documents will be invaluable in case of an audit by the ATO.
Consider Alternative Financing Options
Before deciding to borrow money from your company, consider alternative financing options that might be available, such as bank loans, personal loans, or other forms of credit. These might offer a simpler or more cost-effective solution without the potential complications of intra-company loans. Remember too, that if you’re racking up personal loans with your company, your accounting compliance costs are likely to be higher too!
To manage personal and business finances legally and efficiently, consider:
Proper Withdrawals: Legally withdraw funds through salary, dividends, or a compliant Division 7A loan with all requisite formalities. Remember too, that if you’re not drawing a wage and paying yourself super, you’re actually only cheating your self in the long-run.
External Financing: Explore personal financing options like a bank loan or refinancing strategies that do not involve company funds.
Conclusion
Borrowing money from your company is not a decision to be taken lightly. It requires careful consideration of the legal and tax implications, meticulous planning, and strict adherence to the rules. By understanding the dos and don’ts outlined in this guide, you can make informed decisions that protect both your personal and business finances. This blog post aims to provide a clear understanding of the complexities involved in borrowing money from your company and how to navigate them effectively. Always remember, when in doubt, seek professional advice to ensure compliance and avoid costly mistakes.
Should you have any queries, don’t hesitate to get in touch with our team.
