One of the most commonly asked questions I get asked from company Directors is how they should remunerate themselves? As a company is a separate legal entity it's profits are the businesses, not yours. What's that now you say?!?!
Yep that's right, however, there are various ways in which you can extract the value you have created through salary and wages, directors fees, superannuation, dividends or drawings or a combination of these.
But first there are some hurdles to jump
You will need to consider:
Personal Services Income (PSI) rules: if your business income is primarily produced through your personal skills, knowledge and efforts, the PSI rules may apply. This means you’ll have to attribute the company’s profit to yourself as salary income unless you can pass the ATO tests found here
Division 7A: you cannot draw more money out of your company that what you have put in. If making a drawing leaves you owing your company money, you will need to repay it or enter into an interest-bearing loan agreement with your company, which is called a Division 7A loan. If unsecured, the Division 7A loan needs to be repaid within 7 years with interest and the principal being repaid by either cash contributions or dividends. Otherwise the sum may be treated as an ‘unfranked’ dividend, which will be assessable for tax.
Excess payments to associated persons: your company cannot pay excessive or unrealistic salaries to family members who perform little or no work for the business to avoid tax, so make sure if associated persons are working in the company that you pay them commercially (heads up that STP Phase 2 will alert the ATO of any anomalies here, so if you do this expect to get a knock knock knock on the door from the taxman-ian devil (AKA the ATO) with a please explain
Apart from the above, you are free to decide how you wish to remunerate yourself. Yes you read that right - it is a choose your own adventure! (seriously who didn't love those choose your own adventure books as a kid, ahhhh the memories, whoops I digress)
So let's consider the tax outcomes of salaries, director fees, superannuation or dividends
Tax outcomes
Salaries + Director Fees You will need to include any salary or director fees your company pays to you in your personal tax return and pay tax at your marginal rate. Your company will have PAYG withholding, superannuation, Return to Work insurance and potentially payroll tax obligations in respect of any salary paid to you. Salaries + Director Fees paid are tax deductible to the company – reducing its profits and taxable income, and the amount of company tax it pays.
Dividends Dividends paid by a company to a shareholder out of after-tax profits are taxable to that shareholder. If the company has already paid tax, and ‘franking credits’ on the dividend are available, the dividends may be franked. The imputation credits for the tax that has been paid will be passed on to the shareholder, which will reduce the amount of tax they have to pay on the dividend, ie only paying tax at their marginal rates after the dividend is grossed up and the imputation credit applied. If you as an individual are a shareholder of the company, you will be personally taxed on your dividends. But if your company is owned by a discretionary trust, the trustee will decide how to distribute the trust’s income – and may distribute it to other taxpayers in your family group, who will then be taxed on that income. The structure of shareholdings is important as it can help by splitting the companies profits with other taxpayers in your family group for potentially a better tax outcome.
Superannuation A Director may wish to pay themselves superannuation but there is a limit to how much you can deduct in the company for each person and that is $25,000. This includes superannuation guarantee on wages and any further concessional (tax deductible) contributions. Superannuation is tax deductible to the company up to the limits prescribed above (and must be paid on time to the superannuation fund in order to obtain a deduction) – reducing its profits and taxable income, and the amount of company tax it pays. Take a read of our super blog here for more info (pun intended 😉)
Drawings Drawings apply when you have previously leant money to your company – usually during the business start-up and initial growth phases. Drawings are loan repayments by your company to you, not a distribution of profits, so there will be no tax payable on repaying these amounts as long as you have not breached Division 7A (see above).
Something you should know
If you are preparing your business for sale, applying for finance, or are in any other situation where you need to maximise the apparent profit or value of your business, it might seem tempting to stop paying yourself a salary (because removing this expense from your P&L will boost the company’s reported profits, and hence the value). Unfortunately this is unlikely to be an effective strategy – directors’ remuneration will generally be ‘normalised’ to a market rate of salary as part of the due diligence process in any of these situations.
So let's wrap this baby up
Depending on the individual circumstances of you and your business, it is likely that a combination of these strategies will be most appropriate. For example, you may choose to draw a base salary to cover your ordinary living expenses, then consider whether to pay a dividend at the end of each financial year, depending on the business’s performance and your expected taxable income. (Ps. That's where we come in as we can help you to work through the most optimal strategy)
We highly recommend (we thought demand might be to harsh a word to use there 😂) you discuss your options with us to make sure your strategy works for you. We also take into account all of the above scenarios when we are recommending your structure and doing tax planning for you.
Still have questions? That's OK, feel free to make contact with one of our oh so cool not nerdy team members who can def help you!
Disclaimer: The information provided is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice