By Emma Petroulas, Nudge Accounting
Warning: This article gets a bit technical. But it talks about a very important question. One that small businesses ask a lot, and one which they often struggle to get a response which makes sense.
One question I often get asked is “my company is now making a profit, so what’s the best way to take money out?”. Unfortunately it’s not a quick or an easy question to answer. There’s no “best” way for every small business owner. It really comes down to your own situation and some of your own preferences.
There are three ways that you as the business owner can take money out of your company:
(1)Pay yourself a salary
One way to take money out of your company is to pay yourself a salary, so essentially you are now an “employee” of your company. Although you may be a Director, the same rules here apply whether you’re a Director or an employee.
As an employee, tax will need to be taken out of your salary on pay day. A good tool to work out how much tax to take out is to use the ATO Tax calculator
As an employee, there are also other on-costs you need to consider. The two main ones are superannuation and workerâs compensation insurance. Generally speaking (although, there some exemptions), your company will need to pay superannuation when you earn at least $450 per month. The current rate of superannuation is 9% and will increase to 9.25% from 1 July.
A Worker’s compensation policy insures your company against any claims to compensation for injuries in the workplace. Worker’s compensation insurance may need to be paid when you are classified as an employee. Different states have different rules so check the guidelines that your state has around this.
(2)Pay yourself a Dividend
The second way for you to take money out of the company is to pay yourself a dividend. A dividend is effectively a distribution of profits from the company to its shareholders and is paid out in proportion to the different company shareholders. What this means is that if you and a friend each own 50% of the company, then the dividend should be paid out in that proportion.
One of the great things about the tax system in Australia is that when a company pays tax on its profits and they are distributed to shareholders as dividends, the shareholders can receive a credit for this tax already paid. The payment of these profits with tax credits is called a franked dividend.
Explaining this a bit further, for a dividend to be franked, the company needs to have enough “franking (tax) credits” to cover the dividend amount. This means that the company needs to already have paid tax on the dividend amount it is paying out to you.
As an example, let’s say your company is able to pay out a $7,000 in dividends. This can be seen as:
|Let’s say your company makes $10,000 in profit this year||$10,000|
|Tax on companies is 30%||($3,000)|
|The profit after tax is calculated as||$7,000|
If there is at least $3,000 in the company’s franking (tax) account, then the dividend can be paid out to you as a franked dividend. Some examples of how an amount could be in a company’s franking account include; if the company paid PAYG instalments during the year or if they prepaid some tax before year end.
So how does this look for you personally? The franked dividend of $7,000 that you receive is grossed up by the $3,000 to reflect the company tax paid and included as $10,000 of dividend income in your income tax return (this is the effectively the same profit as the company).
And by receiving a franked dividend, you will get the benefit of the $3,000 tax already paid by the company in your own personal tax return. This means that the tax you are liable to pay in your personal tax return will be offset by the $3,000 in tax already paid by the company.
Forgetting to gross-up the dividend is a common mistake small business owners make when completing their personal tax return.
(3)Borrow money from the company
The final way to take money out of the company is as a loan. This essentially means you are being loaned money from the company. The thing to remember here though is that your loan is a “balance” and takes into account both money you have taken out of the company as well as money you have put in. What we generally find with our start-up clients is that to start their business, they normally put in a fair bit of their own money. Let’s say you put in $20,000 to start your business. Using this scenario, you can take out up to $20,000 tax free before triggering any loan amount owing by you to the company.
If you want to take money out of the company and you now owe the company money, you need to be careful as there may be serious tax consequences around this. If you don’t have a formal loan agreement in place, you may have to pay tax on that amount not only through the company but in your personal tax return as well (that’s a bad position to be in). If you do have a formal loan agreement in place, you may be required to pay interest to the company. This is what is known in accounting language as “Division 7A loan repayments”. Generally speaking, we try to avoid Division 7A loans as the ATO sees it as a tax deferral mechanism. We try to avoid these situations by doing one of the first two options discussed above. As well as charging interest, a minimum repayment needs to be paid every year so that the loan is repaid within 7 years (effectively like a normal bank loan).
In working out how to take money out of your company, it’s important to chat with your accountant. Maybe one way will suit you best, or maybe it’s a combination.
Disclosure: This article is not intended to replace in any way professional accounting and legal advice.