Owning a family company comes with its own set of responsibilities, especially when it comes to receiving payments from the company. It is crucial to understand the tax implications and treat these payments correctly. Failure to do so can result in unintended tax consequences. In this article, we highlight some important tax traps that family companies should be aware of and emphasise the need for professional advice to navigate these complexities.
Treatment of payments
Any payment from a company, other than a return of the original capital, is generally considered a dividend. This classification holds true regardless of how the payment is otherwise classified. It is vital for company owners and their associates, such as spouses, to understand the implications of receiving payments from the company.
The issue of loans
If a family company provides a loan to an owner or an associate, it is treated as a taxable dividend unless specific requirements for a “complying loan” are met. These requirements include imposing a market rate of interest on the loan. Additionally, if the company forgives the loan, it is also considered a deemed dividend, subject to certain conditions.
Trust distributions
When a family trust resolves to distribute income to a beneficiary company, commonly known as a “bucket company,” but the amount is not actually paid to the company and remains in the trust, the Australian Taxation Office (ATO) treats it as a deemed dividend. The ATO’s approach to this matter is currently a contentious issue, making it essential to seek professional advice to understand the implications fully.
Loans made by shareholders or directors
Family companies may also encounter situations where shareholders or directors lend money to the company and subsequently forgive the debt. While a complete forgiveness of the debt should trigger a capital loss for the shareholder or director, the tax laws are more nuanced. A capital loss arises only to the extent that the debt is incapable of being repaid by the company. There is debate as to whether any capital loss should be available at all, even if the company cannot repay the debt.
Consequences for the company
In addition to the tax implications for shareholders or directors, there are consequences for the company itself when debt forgiveness occurs. While no immediate taxable gain arises from the release of the company’s obligation to repay the debt, there may be restrictions on future tax deductions, such as carry forward tax losses and depreciation. This can significantly impact the company’s ability to claim tax benefits, particularly if it continues to operate.
Conclusion
Owning a family company requires a thorough understanding of the tax implications associated with receiving payments, making loans, and forgiving debts. Treating the company as a personal bank without considering the serious tax consequences can lead to adverse outcomes. Seeking professional advice is crucial to ensure compliance and mitigate potential risks. Family companies should always consult with their advisers to navigate the complexities of tax law and make informed decisions that align with their long-term goals.
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