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

A recent case brought before the Administrate Appeals Tribunal (AAT) serves as a cautionary tale for those who blur the lines between personal and business expenses within their company.

The individual in question, a shareholder and director of a private company, had been making withdrawals and covering personal expenses directly from the company’s bank account over several years. These transactions were not initially treated as taxable income.

Upon audit, the Australian Taxation Office (ATO) assessed these withdrawals and payments in one of two ways:

• As ordinary income for the taxpayer.
• As deemed dividends under Division 7A of the tax code.

Division 7A is designed to address situations where private companies provide benefits to shareholders or their associates in the form of loans, payments, or forgiven debts. If triggered, Division 7A treats the recipient as having received a deemed unfranked dividend for tax purposes.

The taxpayer attempted to argue before the AAT that the withdrawals were repayments of loans he had extended to the company originally, and thus should not be considered ordinary income. Alternatively, he contended that the payments constituted a loan to him, and there was no deemed dividend under Division 7A because the company lacked a “distributable surplus.”

However, the AAT found flaws in the evidence presented by the taxpayer, concluding that he had failed to substantiate his claims. Among the factors considered were the inconsistencies in his financial records and his inability to explain the source of the original loans, particularly during years when he declared tax losses.

Although the taxpayer asserted that some of the loans to the company originated from borrowings from his brother, the AAT deemed this explanation implausible given the brother’s modest income as reflected in his tax returns.

So, how should contributions from an owner to launch a business be treated? It largely depends on the circumstances. For small startups, common approaches include structuring contributions as loans to the company or issuing shares with the amounts paid treated as share capital.

The decision on the best approach hinges on various factors, including commercial considerations, the ease of withdrawing funds from the company later on, and compliance with regulatory requirements.

The manner in which funds are injected into the company also influences the available options for withdrawing them later. However, it’s crucial to remember that withdrawing funds from a company will likely have tax implications that require careful management.

Should you please have any question in regards to above, please feel free to contact our friendly team in Pitt Martin Tax at 0292213345 or info@pittmartingroup.com.au.

The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.

By Yvonne Shao @ Pitt Martin Tax