Taking Money from Your Company the Right Way - Understanding Division 7A

Today, let's delve into one of the most misunderstood tax concepts for company owners, Division 7A.

To set the scene, here's a call I often get:

Business owner: “Hi Kelly, I want to take $100,000 out of the company to renovate my house.”Me: “Great. How do you plan to take it? As wages, a dividend, or maybe through a documented loan agreement?”Business owner: “I don’t know. It’s my company; I own 100% of it. The money’s there. I just want the $100,000.”

On the surface, this sounds simple, but here’s the catch: the way you take money out of your company matters immensely for tax purposes, and doing it incorrectly can result in adverse consequences.

Understanding Division 7A

Company Money vs. Personal Money

One of the biggest misconceptions business owners often have is failing to distinguish between company money and personal money. Even if you’re the sole director and 100% shareholder, the Australian Taxation Office (ATO) views company money as separate from your personal finances.

• The tax rate difference: Your company might pay tax at 25%, but you could be taxed at 47% on your personal income.

• If you enjoy personal benefits from withdrawing company money without proper documentation, the ATO isn’t going to let it slide. They’ll want 47% tax paid on it, not the 25% company tax.

This disconnect is exactly why the tax rules under Division 7A exist.

What Is Division 7A?

Division 7A is a set of tax rules designed to prevent company shareholders, directors, and associates from withdrawing money from their companies tax-free.

If you were to take $100,000 from the company without following proper processes, the ATO could classify that withdrawal as an unfranked dividend. What does that mean?

• Unfranked dividend: The $100,000 counts as assessable income in your personal tax return.

• No franking credits.

• No tax deductions.

This can lead to a disastrous tax situation, something you’ll want to avoid at all costs.

How To Take Money Out the Right Way

Thankfully, there are legitimate and compliant ways to access money from your company. Here are your options:

1. Salary and Wages or Dividends. These are the two most straightforward and tax-efficient methods.

• Salary and wages: The money is taxed like any other personal income.

• Dividends: You may benefit from franking credits depending on your company’s tax situation.

2. Documented Loan Agreement. If neither salary nor dividends suit your tax profile, money can also be taken as a loan, but this must comply with strict Division 7A rules.

Division 7A Loan Requirements:

• Documented loan agreement: The loan must be formalised with proper documentation.

• Specified loan term:

  • Unsecured loans have a maximum term of 7 years.

  • Secured loans (e.g., those against property) can have a term of up to 25 years.

• Interest charges: Interest must be paid to your company at the ATO-set rate (8.77% for FY 2025).

• Minimum annual repayments: You’re required to repay principal and interest each year over the loan term.

• Timing: The agreement must be signed off before the lodgment date of your tax return for the year in which the loan was taken.

Even if a single step is missed (e.g., failing to document the loan properly or delaying repayments), the ATO can declare the whole loan amount as an unfranked dividend, with dire tax consequences.

While Division 7A loans can be a useful tool for tax planning, they should not be abused or allowed to accumulate unchecked. Here’s why:

• Snowballing repayments: Year after year, repeated loans can create a growing debt pile. Minimum repayments will increase, and interest charges will balloon.

• Long-term tax inefficiency: Without proper management, this can create financial and tax headaches.
  

Navigating Division 7A rules and ensuring compliance requires expertise. Accountants play a vital role in:

• Structuring withdrawals from your company.

• Documenting loan agreements correctly.

• Ensuring tax efficiency while avoiding adverse consequences.

Understanding Division 7A is crucial for business owners to avoid costly mistakes when managing the flow of money between their company and personal finances. If you have concerns or questions, the GrowthMD team is here to help, and we can guide you through the complex tax landscape, ensuring you stay compliant while optimising your tax position.