We have been asked three times in the past week, "How do I pay myself?".
This is a very valid question, and one that has a few complexities. Let me try to keep it simple...
While you can draw money out either a Company or a Trust the way we treat that money for tax purposes is very different depending on which structure you are using.
If you’re looking to take money out of a Company or Trust (an entity), a loan account can be used to record the amounts taken.
When you draw the money out of a company (but not a trust) there are rules that are commonly referred to as 'Division 7A' or 'Div 7A'. These rules require that you draw up a loan agreement between you and the company (or between a relative of the shareholder and the company if the funds were not withdrawn for the shareholder directly).
The Division 7A rules are a sigificant drawback when considering loaning money from a company to a shareholder and make this type of arrangement inappropriate as a long term strategy. In fact it is better to avoid loans from companies to shareholders at all wherever possible.
If you've got a trust and you draw money as a loan, this just sits on the balance sheet as money you owe to the trust. When the distributions are paid for the year, this reduces the balance owed back to the trust and you’re loan account is left at the net amount (cash withdrawn - Distribution).
Drawings are simply another word for loans - and with Division 7A, it provides the same problems within a company, just with a different name... As with loans, you're ok with a trust.
This is a simple way of paying out money from an entity. You essentially become an employee of your own company or trust.
Paying a wage or salary while simple, also requires that superannuation is paid on the gross figure and also that PAYG withholding tax is taken out. This can be a disadvantage depending on your age and cash flow requirements.
Like drawings are to loans, Directors' Fees are to Wages or Salaries.
The superannuation laws had previously allowed Directors fees to be paid without the need to make a superannuation contribution on behalf of the director. This was changed quite a few years ago and now there is little difference between Directors’ Fees and a salary / wage apart from the name.
Dividends are payments (or loan movements if not paid in cash) that are made from the balance of retained profits (aka retained earnings) in a company.
You may have also heard of the concept ‘franked dividends’. These are simply dividends where the company issuing them has paid the tax on them already. What happens then is that you can claim back these ‘franking credits’ when the dividends are paid to you.
Distributions are to a trust what dividends are to a company. They’re the method by which we allocate the entity’s profits to the owners of the business. We can only ‘Distribute’ from a trust.
Distributions are also paid out of current year profits, as opposed to retained profits from prior years (when paid in the form of dividends from companies).
The owners of the business (the trustees) need to make decisions about the distributions for an income year before the 30th of June. It is important to ensure these decisions are consistent with the clauses in the trust deed.
The easiest way here is to pay a salary to the owners. If not paid in cash there's no problems at all - it will simply sit on the balance sheet as owing to the owner.
What we would recommend too is considering a restructure to allow for a better flow of profits and cash from the entity.
It is also important to regularly 'empty out' the retained earnings in a trading company, so that it does not become a juicy target to be sued by creditors or disgruntled employees.
As the cash flow of the money coming out of a trust does not necessarily dictate where the tax is paid, you are fine to take money out of a trust and treat it as a loan from the trust.
We would then record the final balance owing to the trust, less any distribution of profits paid throughout the year - which would leave the net loan between yourself as an individual and the trust.
It is also extremely important to work with an adviser who has their finger on the pulse when it comes to distributions. You must work this out before the financial year ends, or you could be in all sorts of strife with the ATO when it comes tax time.
Taking money out of entities is a fairly complex area. If done without advice, it could lead to mistakes that can cost tens of thousands in tax.
When talking with your adviser, make sure you understand exactly how you can take money out in your circumstances. Even play out the practical 'to do' as well - whether raising a pay slip, paying PAYG withholding etc.
Oh, and please ask clarifying questions below in the comments section too :-)
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