When a business becomes profitable, many business owners pay themselves in different ways, often unaware of the tax consequences that those payments can have on their business and personal finances.
Many business owners pay themselves by:
- Paying out a regular amount as salary, withholding the appropriate taxes and remitting the tax withheld to ATO, or
- Taking any amount whenever they want and having their accountant take care of the financials at year-end.
Paying yourself a salary will result in higher income tax obligations which can affect your cashflow while distorting the financials of your business for purposes of valuation. On the other hand, taking cash from your own business (as most small and medium business owners do) can trigger the heavier tax impact of Division 7A.
How Division 7A Can Affect You
As a rule, profits that a business earns are owned by the company, not by the individual owners, regardless of the personal efforts that led to those profits. Profits that remain at the end of the year may be distributed to the owners or shareholders in the form of dividends that are subject to dividend taxation.
When a business owner pays himself from the company profits, they run the risk of triggering Division 7A which is a section of Australia’s income tax law. Under Division 7A, all payments to shareholders are generally treated as dividends, subject to dividend taxation without the benefit of franking or deductions. Consequently, a Division 7A application usually leads to higher tax obligations of up to 76% of the amount paid. This law is intended to prevent private company owners from taking business profits while avoiding payment of appropriate dividend taxes.
Division 7A is a complicated law that is constantly amended to address relevant situations. If you intend to pay yourself during the taxable year, it’s important to discuss all your options and the potential consequences with your tax accountant. This may mean making adjustments in the amount of wages or salaries your business will pay you as your business grows. Ideally, you should be receiving a salary that the market usually pays to employ someone who performs the type of work or role you perform.
If you are conducting business via a company structure, you may pay yourself a dividend at the end of the year or an employee bonus during the year. When making any of these payments to yourself and other shareholders, ensure that the payments are properly recorded in the books of the company. Talk to your tax accountant about making these payments and make it a habit of including these payments when tax planning at the beginning of the taxable year.
The tax and accounting professionals at ATP Tax Accountants have been helping Western Sydney business owners for years, maintaining financial records for them and providing them with sound financial and taxation advice that promote business growth, allowing owners to focus on running their businesses. Call us today at 1-300-829-484 or email us to learn more about how we can help you.