How Do I Pay Myself From My Company or Trust?

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…

This Differs Between a Company and a Trust.

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.

Here’s a few concepts you’ll need a basic understanding of

Loan

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agreement between you and the company (or between a relative of the shareholder and the company if the funds were not withdrawn for the shareholder directly).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 significant 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for the year, this reduces the balance owed back to the trust and you’re loan account is left at the net amount (cash withdrawn – Distribution).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

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.

Wages or a Salary

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.

Directors’ Fees

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

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

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 30^th of June. It is important to ensure these decisions are consistent with the clauses in the trust deed.

How We Recommend Getting Money Out of a Company

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.

How We Recommend Getting Money Out of a Trust

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.

At the end of the day, you need to know you’re doing it right

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 🙂

Business Structuring Made Easy! Part 5: Family Trusts

A trust is a structure wherein a Trustee (either an individual or company) carries on the operations of the Trust on behalf of the beneficiaries. The actions of the Trustee are governed by the Trust Deed, which details the rights and obligations of all parties. Trusts are a common structure choice for family businesses as it enables the various family members to become beneficiaries of the Trust that is operating the business. While the trust is not a separate legal entity it is a separate entity for tax purposes. The trustee must apply for a Tax File Number (TFN) for the trust and lodge an annual income tax return.

If a company trustee is used, the trust offers all the same asset protection benefits as using a company structure, along with the additional benefits of using a trust. A trust that has individuals acting as trustees exposes the trustees (the individual, or individuals) to same levels of business risk as a sole trader.

Broadly speaking there are two common types of trusts that you will encounter when making your business structuring decision: Fixed Trusts and Discretionary Trusts.

Click Here to Download our eBook “Business Structures Made Easy”

Discretionary Trusts

A Discretionary Trust is the most flexible form of business structure for a family trust. No single beneficiary has a fixed interest in the trust’s property or the trust’s income. The trustee has complete discretion in the distribution of funds to each beneficiary. This makes the Discretionary Trust (with a corporate trustee) a strong and flexible option for a family business. The family members are protected from business risk and the trustee has the discretion to distribute the income in the most effective way possible.

It is important to remember that all of the benefits offered by a discretionary trust for a family business make it a poor choice for businesses where more than one family or group is involved, as neither group of beneficiaries retains a fixed entitlement to property or income.

Advantages of a Discretionary Trust:

Flexibility with income and capital distribution;
Broader Tax planning opportunities;
Access to Small Business CGT concessions;
50% 12 month CGT discount;
Asset protection (if a corporate trustee is used)
Can pay salaries and wages as well as superannuation;
Less regulatory requirements than trading as a company.

Disadvantages of a Discretionary Trust:

Distributions must be in accordance with the Trust Deed;
Risk of resettlement if changes are made to trust members or trust property without giving consideration to the rules outlined in the trust deed;
Losses cannot be distributed;
More of an investment to establish and maintain when compared to Sole traders or partnerships;
Trustees can be personally liable for some debts of the trust (if individual trustees are used).

Fixed (Unit) Trusts

Fixed (or sometimes called “Unit”) Trusts are recommended when more than one family or group is involved in the business operation. The interest in the trust is divided into units, similar to shares in a company. The Trustee distributes income to the beneficiaries in accordance with their respective holdings in the trust. This is the key point of difference between Fixed and Discretionary Trusts: The units remove the Trustee’s discretion concerning the distribution of income.

Advantages of a Fixed (Unit) Trust:

Fixed Interests provide protection where more than one family or group in involved in the business;
Asset protection (where a corporate trustee is used);
Access to Small Business CGT concessions;
Access to 50% 12 month CGT discount;
Easy to raise capital by issuing additional units;
Can pay salaries and wages as well as superannuation;
Less regulatory requirements than trading as a company.

Disadvantages of a Fixed (Unit) Trust:

Sale of units can be a CGT event and attract stamp duty;
Not as flexible as a Discretionary Trust;
Trustees can be personally liable for some debts of the trust (if an individual trustee is used).

So should you use a family trust?

Business owners looking to shift their business operations into a trust structure can experience a number of benefits. We strongly recommend anyone interested in setting up a trust seek professional advice before doing so. Given the additional requirements of using a trust, we work closely with all clients that use this structure to ensure all their obligations are satisfied and it is used in the most efficient manner possible.

For more information about trusts or other structuring options please refer to our other articles in this series, or contact us for more a business structure review.

CGT Main Residence Exemption – Tips, Tricks, and Traps

Under ordinary circumstances the sale of a property would attract Capital Gains Tax (CGT). However, you can avoid paying CGT if you sell a dwelling that is considered to be your main place of residence. But what is your ‘Main Residence,’ and how do you know if the exemption applies?

Is the Property I’m Selling my Main Residence?

Generally speaking, your main residence is your home. A few examples of factors the Australian Taxation Office (ATO) considers relevant in identifying your main residency are:

Whether you and your family live there;
Whether you have moved your personal belongings into the home;
The address to which your mail is delivered;
Your address on the electoral roll
The connection of services and utilities (for example, phone, gas, or electricity);
Your intention in occupying the dwelling.

Please note there is no minimum time a person has to live in a home before it is considered to be their main residence

In order for the Main Residence CGT exemption to apply, the property being sold must include a dwelling. A dwelling is anything that is used wholly or mainly for residential accommodation. Examples of a dwelling are:

a home or cottage;
an apartment or flat;
a strata title unit;
a unit in a retirement village;
a caravan, houseboat or other mobile home.

A mere intention to construct or occupy a dwelling as your main residence – without actually doing so – is not sufficient to obtain the exemption. You must physically occupy the dwelling.

Can I Have More Than One Main Residence?

You can only ever have one main residence at any given point in time unless you’re selling your old main residence and buying another. In this case you’re entitled to an overlap period of six months as long as:

1) the new property will be your main residence after the sale of the old property;

2) you lived in the old property for at least three continuous months in the 12 months prior to sale; and

3) it wasn’t used to produce rent in this same 12 month period.

Can I Earn Rental Income from My Main Residence?

While you can only have one main residence at any point in time you do not need to live in the dwelling for the entire holding period for it to continue to qualify for the exemption. If you own a property which is currently your main residence you can move out of the property for up to six years. During that time you can earn rental income on the property and claim a tax deduction for expenditure as you would with a normal investment property. Providing you re-occupy the building before the end of the six period and do not dispose of the property within the same financial year that the property was earning rental income you can still qualify for the full exemption.

Does the Main Residence Apply to Property Renovators?

The simple answer is yes! If you purchase a property, occupy the dwelling while undertaking renovations and then sell the property only to move into another dwelling and repeat the process, any profit you make on the sale of each property is generally tax exempt.

Can I Subdivide My Block of Land and Apply the Main Residence Exemption to the Proceeds from the Sale?

As discussed, the main residence exemption requires a dwelling to exist on the property that is sold. If you have a large block of land and subdivide the land so that you can sell off a part of the unused land, there is typically not a dwelling on this parcel. Therefore, any profit on this sale would attract Capital Gain Tax.

However, it is important to note that if the reverse situation applies and you purchase the neighbouring block of land to obtain a larger back yard, the main residence exemption will apply to the sale of your main residence and the adjoining block provided both properties are sold together and the total area of land does not exceed 2 hectares.

What if I Can No Longer Live in My Main Residence?

The main residence exemption can also apply where the owner is no longer able to reside in the dwelling, because they have lost the ability to live independently and require full time care. This ensures that property owners who spend extended a period in hospital, must relocate to a residential care facility, or who relocate to live with a care giver can still access the main residence exemption when they sell the property to pay living and medical expenses.