Getting Funds Out of a Company Tax Effectively

Getting Funds Out of a Company Tax Effectively

Making the Most of Your Company’s Retained Earnings

Many business owners find themselves in a situation where their company has built up significant retained earnings. The challenge? Accessing those funds in a way that minimises tax exposure. If not planned correctly, drawing money from your company can lead to excessive tax liabilities. Let’s explore your options for extracting funds tax-effectively.

Option 1: Paying Yourself Dividends

One of the most straightforward ways to take money out of your company is through dividends.

How Dividends Work

A dividend is simply a payment made by a company to its shareholders from its profits. Dividends can be franked or unfranked:

• Franked dividends come with attached tax credits (franking credits) from tax already paid by the company, reducing the tax you need to pay personally.
• Unfranked dividends do not have any tax credits attached, meaning they are fully taxable in your hands.

Understanding Franking Credits

Franking credits are tax credits attached to franked dividends, representing the tax the company has already paid on the profits being distributed.

For example, if a company has paid tax at the 30% rate, and declares a $100 fully franked dividend:

• The shareholder receives $100 in cash and a $43 franking credit.
• The shareholder’s total taxable income includes $143 ($100 + $43 franking credit).
• If the shareholder’s tax rate is 47%, they owe $67.21 in tax but receive a $43 credit, leaving a top-up tax of $24.21.

If the shareholder’s tax rate is lower (e.g., 30%), they may pay no additional tax or even receive a refund if their tax rate is lower than the company tax rate.

Franking credits ensure that company profits are not taxed twice—first at the company level and again at the full personal tax rate.

The Tax Considerations

When you receive a fully franked dividend, you’ll still need to pay “top-up” tax if your marginal tax rate is higher than the company tax rate.

For example:

• If your company paid tax at 30%, and your personal tax rate is 47%, you’ll need to pay an extra 17% in tax after franking credits.
• If your company qualifies for the lower 25% tax rate, this increases your top-up tax liability slightly.

Key takeaway: Franked dividends can be a tax-efficient way to withdraw funds, but it’s important to plan carefully to avoid unnecessary tax burdens.

Option 2: Dividends for Non-Resident Shareholders

If you or your family members are non-residents for tax purposes, tax treatment on dividends differs:

• Franked dividends paid to non-residents generally do not attract withholding tax.
• Unfranked dividends are subject to a 30% withholding tax, though this can be reduced under certain international tax treaties.

If you’re planning a move overseas, it may be worthwhile to extract profits as franked dividends before leaving Australia to avoid withholding tax.

Option 3: Timing Your Dividends Wisely

Timing matters when it comes to dividends. Paying dividends strategically over multiple years can help you:

• Spread out the tax impact instead of paying a large lump sum tax in one year.
• Take advantage of lower tax brackets in years when your income is lower (such as during retirement).
• Bring in additional shareholders (e.g., family members) to share in dividends and distribute taxable income more efficiently.

Planning dividends with future income projections in mind can create significant tax savings over time.

Option 4: Using Div 7A Loans (Shareholder Loans)

Instead of withdrawing money as dividends, some business owners choose to take a loan from the company. However, this is heavily regulated under Division 7A of the tax law.

The Basics of Div 7A Loans:

• Any loan to a shareholder must be properly documented and structured as a complying loan agreementwith interest and repayments.
• If not properly structured, the ATO will treat the loan as an unfranked dividend, making it taxable in full.
• If used correctly, these loans can allow you to defer tax and smooth out cash flow.

7-Year vs 25-Year Loan Terms

Under Div 7A, loans must be repaid within either:

• 7 years, if the loan is unsecured.
• 25 years, if the loan is secured by a registered mortgage over real property.

The key difference is the repayment burden:

• A 7-year loan requires higher annual repayments, which may put pressure on cash flow.
• A 25-year loan spreads repayments over a longer period, making it easier to manage, but requires the borrower to have sufficient real estate security to support the mortgage.

Which loan term is best?

• If you are using the funds for personal or lifestyle expenses, a 7-year loan may be the only option unless you have real estate to secure a longer-term loan.
• If the funds are being invested in income-generating assets (such as property or shares), a 25-year loancould be preferable since interest may be tax-deductible and repayments are more manageable.

When do Div 7A Loans make sense?

• If you need funds temporarily and can repay them within the required time frame.
• If you can meet the minimum loan repayments annually.
• If the loan is used for investment or business purposes, making the interest tax-deductible.

Div 7A loans can be useful, but they require careful planning to ensure they don’t trigger unintended tax liabilities.

Option 5: Selling Your Shares (Capital Gains Tax Considerations)

Rather than drawing profits from the company, another option is to sell your shares. This can be a particularly useful strategy if:

• You are looking to exit the business and realise its value.
• You want to reduce direct involvement in the company while accessing your wealth.
• You are eligible for Capital Gains Tax (CGT) concessions, making the transaction tax-efficient.

Tax Considerations & Risks

• If you’ve held your shares for more than 12 months, you may be eligible for the 50% CGT discount (unless shares are owned by a company, which doesn’t get this discount).
• Small business CGT concessions may apply, potentially reducing or eliminating tax on the sale.
• However, selling shares means you lose ownership of the business and its future profits.
• Finding a buyer can take time, and the value of your shares is subject to market conditions and company performance.

When might selling shares be preferable?

• If you want a clean break from the business and immediate access to funds.
• If the business is at its peak value and you wish to capitalise on the high valuation.
• If you need liquidity but don’t want to affect company cash reserves.

Careful planning is needed to structure the sale effectively to minimise tax and maximise financial benefits.

Final Thoughts

Withdrawing money from your company can be done in various ways, but each method has different tax consequences. The best approach will depend on your personal tax situation, future financial goals, and business plans.

The key strategies to consider include: ✅ Paying franked dividends to use available franking credits. ✅Spreading dividends over multiple years to manage tax liability. ✅ Considering loans under Div 7A (but ensuring compliance). ✅ Exploring capital gains tax benefits if selling shares. ✅ Evaluating whether liquidation makes sense. ✅ Using salary and superannuation contributions effectively.

Before making any decisions, it’s essential to get tailored advice to ensure you’re maximising your after-tax cash flow while staying compliant.