Loans to shareholders (paid outside ordinary wages and dividends eg ‘drawings’) made by private companies can be deemed to be dividends unless they meet strict requirements. The ATO is focusing risk review and audit activity on loans to shareholders.
The documentation and repayment requirements are very strict. Tax planning provides an opportunity to review these issues prior to year end and also plan for dividends that you may need to declare personally to meet the minimum repayments.
We are seeing an alarming increase in the number of clients taking large drawings from their companies with no tax planning to deal with it. When they bring their historical information in to us to prepare the tax returns, it is too late to do anything about it and as a result they are left with very large tax bills.
DIRECTORS’ LOAN ISSUES
There are strict laws and regulations in place to prevent directors, shareholders and their associates of private companies withdrawing amounts from those companies for private purposes.
The only means by which a company can pay amounts to directors, shareholders or associates are as follows:
- Wages (if the person is an employee of the business)
- Directors fees
- Dividends (either franked or unfranked)
Wages and Directors’ Fees
The company may be able to pay amounts out as wages or directors fees where the person is employed in the business. It is important to note that if they are classified as employees, all entitlements relevant to other employees will also apply. E.g. Compulsory superannuation contributions will be required to be paid and the company will be required to withhold tax on the payments and declare this to the tax office. They will also need to include these amounts in their calculations for workers’ compensation insurance premiums.
Dividends
For shareholders, the company can declare and pay dividends to distribute the profits. Preferably these would be franked dividends, however this will be dependent on the amount of tax credits available in the company.
Wages, directors’ fees and dividends will need to be declared as income in the personal income tax return of the director or shareholder.
Under limited circumstances, the company may enter into a loan agreement with the director or shareholder for the amount to be repaid. Under these circumstances, the parties must have a written loan agreement (prepared by a solicitor) and the loan must be repaid within 7 years from the date that it commenced. In addition, the company is required to charge interest on the loan and there will be tax payable on this interest. Also the director or shareholder is required to make a minimum repayment each year as calculated by the tax office.
Failure to comply with these regulations can result in severe penalties being imposed on the company, directors, shareholders or associates. This may result in them being liable to pay significantly higher amounts of tax than they would otherwise be liable for..
It is important that clients contact us to discuss their circumstances prior to withdrawing any amounts from their company for personal purposes.