Companies Feeling The Pressure As More Tax Restrictions Loom
The Age
Monday May 12, 2003
New regulations will increase the administrative burden for those operating under a company structure as well as reducing tax advantages.
The final nail will be hammered into the tax coffin for companies from July 1, 2004. In addition to the major capital gains tax disadvantages of operating a small business through a company, new restrictions will come into force for the 2004-05 financial year. The restrictions relate to money advanced as loans to the business by shareholders.
The capital gains tax disadvantage of operating a small business through a company can mean 50 per cent more tax is paid. Where a company sells a business the general 50 per cent exemption is lost but, if eligible, the 50 per cent active assets exemption for small business is allowed.
If the business had been operated by a partnership both exemptions would apply.
A $100,000 profit on the sale of goodwill by a company would result in a shareholder paying tax on $50,000 while a partner would pay tax on $25,000.
People have for many years been attracted to operating a business through a company because of the lower tax rate. But the lower rate is at best a tax deferral method.
When profits are taken out of a company the individual shareholder then pays tax at the applicable tax rate.
Where a shareholder tries to extract profits as a loan from a company, a section of the Tax Act can result in tax being paid at penalty rates.
The section of the Tax Act that deals with loans to shareholders is Division 7A. It was introduced to give the commissioner of taxation greater powers to clamp down on this practice.
This section ensures people who operate a business through a company do not get an unfair advantage by paying the lower company tax rate while still using the profits for personal reasons without paying any extra tax.
Under Division 7A where a shareholder owes the company for cash withdrawn from the business, and there is no loan agreement in place, the loan will be treated as an unfranked dividend. For the loan agreement to be valid interest must be paid on the loan at a commercial rate and the loan repaid in less than seven years if the company has no security for the loan.
Often when a business is first established the owners will contribute money to help fund the purchase of equipment and the operations until the business can produce sufficient cash to be self-funding.
Where the business is operated through a partnership or a trust, the owners of the business can either repay or increase the loan at their discretion. Where a company is used this will no longer be the case.
Before the new legislation was introduced shareholders could make loans to companies and have the loans treated the same as if they operated through a partnership or a trust.
The only consideration under the old law was to ensure the repayments of the shareholders loan did not exceed the amount owing to them. If this occurred the provisions of Division 7A would apply.
The new regulations will mean funds loaned by shareholders will be treated differently depending on the circumstances. Where there is a written loan agreement in place that states it will be repaid in 10 years or less the loan will be treated as it always has been. Interest can be charged if required but the loan should be registered as a secured loan.
Where there is no loan agreement in place, the term of repayment is longer than 10 years, or there is no specified repayment date, it will be treated as an at-call loan.
In this situation it will be treated as equity. If interest is charged on the loan the company will not receive a tax deduction. Instead the interest will be treated as a fully franked dividend.
In addition to this being shown as equity the company will also need to maintain a ``non-share capital account". This account will show all monies loaned to the company and repayments made to the shareholders.
Nick Connell, taxation director of the NTAA, says, ``All at call loans owing to shareholders at 30 June, 2004, must be transferred to this new account. If this is not done any repayments could be classed as unfranked dividends".
These new regulations relating to shareholders' loans do not fix any problems concerning the taxing of companies. They also are not required to close a loophole or stop a major tax advantage open to owners of a company.
What the new laws do, however, is to increase the administrative burden for small business owners who use a company and provide one more reason to try to use another tax structure.
© 2003 The Age
Share This