Can Directors Take Cash Out of Their Business?

For directors and shareholders, withdrawing money from a business involves more than a simple transfer of funds. 

The Australian Taxation Office (ATO) has strict rules about how money can be taken from a company. If you do not follow these rules, you may face serious tax problems. This can include double taxation, which nobody wants!

Understanding the correct methods to extract cash from your business is essential to maintain compliance and avoid costly penalties. 

Here are the three primary methods directors should consider:

1. Director’s Salary, Wages, or Fees

One of the most straightforward methods is to pay yourself a salary or director’s fee. This effectively treats you like any other employee, and your earnings will be subject to PAYG withholding and superannuation obligations.

However, you need to understand the tax implications of this approach. Once your income surpasses $125,000, the marginal tax rate on your personal income will exceed the corporate tax rate, which could lead to increased tax liabilities.

If your salary exceeds the corporate tax rate threshold (currently 25% for base rate entities), each additional dollar you draw could be taxed at up to 47%, depending on your total income. Therefore, drawing an excessively high salary may not be the most tax-efficient option. 

Key consideration: Remember that taking a salary also reduces the company’s taxable income, which may be beneficial in certain scenarios. We recommend that as a director, you ask yourself, “How much would it cost to employ someone to do my job?”, and pay yourself a market-based wage that aligns with your position and level of effort.  

2. Shareholder Dividend Payments

Dividends are another popular method for shareholders to access company profits. Unlike a salary, dividends do not impact the company’s taxable income but instead are distributed from retained earnings. 

A key advantage of paying dividends is the benefit of franking credits. If your company has already paid tax on its profits, you may receive franking credits to offset the tax you owe on dividend payments. This effectively prevents double taxation and provides a more tax-efficient way to access profits.

However, there are critical conditions for dividend payments. 

Firstly, the company must have retained the available earnings, and secondly, the company must maintain a positive net asset position after the dividend is paid. Directors should know that paying dividends from a company with negative net assets could lead to significant legal and financial risks, including insolvent trading claims.

Key consideration: Dividends are taxed in your personal tax return, but the overall tax burden may be reduced with franking credits. Careful timing and planning are essential to avoid cash flow issues and maximise the tax benefits of this strategy.

3. Director Loans (Division 7A)

Director loans allow you to borrow money from the company, but this approach is strictly governed by Division 7A (Div7A)of the Income Tax Assessment Act. If not managed correctly, the ATO can treat these loans as unfranked dividends, leading to unexpected tax liabilities. To avoid this, directors must adhere to the following requirements:

• Formal Loan Agreement: A written loan agreement must be in place, specifying the terms, including the repayment schedule and interest rate, which must comply with the ATO’s minimum benchmark interest rates.
• Maximum Loan Term: Loans must be repaid within seven years (or 25 years if secured by a registered mortgage over real property).
• Annual Repayments: Minimum annual repayments of both principal and interest are required to avoid Division 7A implications.

Failure to meet these conditions may result in the loan being deemed an unfranked dividend, which would be subject to income tax at your marginal rate. Additionally, the loan repayment must not result in the company breaching its financial obligations, as this could trigger legal consequences for directors under the Corporations Act.

Key consideration: Director loans can be a flexible way to access cash, but the complexity of Division 7A regulations makes it essential to ensure strict compliance. Proper structuring of the loan and ongoing monitoring of repayments are critical to avoid tax penalties.

Balancing the Three Approaches

Each of these methods offers distinct advantages and potential drawbacks. For directors, the optimal approach often involves a combination of salary, dividends, and loans to minimise tax exposure while ensuring personal financial goals are met. For instance, you might draw a reasonable salary to cover personal expenses while supplementing your income with dividend payments and, if necessary, accessing funds via a director loan.

Given the complexity of these options, working closely with your accountant or advisor is highly recommended. 

At Rockwall Partners, we help directors and shareholders structure their remuneration in the most tax-effective way, taking into account both the company’s financial health and your personal tax obligations.

Contact us today to discuss your options.