Things to know about your company and its profits

Sally Preston

A private company can be an effective structure for running a business, acting as trustee of a trust, holding investments, or sitting within a broader family or group structure. However, a company is a separate legal and tax entity. That separation is useful, but it also means owners need to be careful when money or assets move between the company, shareholders, directors, family members and related entities.

Company basics

Most private company structures involve a proprietary limited company, commonly shown as “Pty Ltd”. Unlike listed public companies, these companies are usually privately owned and controlled by a small group of shareholders or related parties.

Two important roles are the director and the shareholder. Directors are responsible for overseeing the company’s affairs and complying with their obligations under the Corporations Act 2001. Shareholders own the shares in the company and may receive dividends when profits are distributed.

Because the company is separate from its owners, company funds should not be treated as private funds. Payments to shareholders, directors or associates need to be properly characterised, documented and reviewed for tax consequences.

Company tax and dividends

Companies generally pay tax at either the base rate entity rate or the general company rate. From the 2021–22 income year onwards, a base rate entity is taxed at 25%, while other companies are taxed at 30%. To qualify as a base rate entity, the company must have aggregated turnover below $50 million and no more than 80% of its assessable income can be base rate entity passive income.

Base rate entity passive income includes items such as rent, royalties, interest income, corporate distributions and franking credits, net capital gains, gains on qualifying securities, and certain trust or partnership amounts that are traceable to passive income. This means an investment company or a company with a high proportion of passive income may not qualify for the lower company tax rate even if its turnover is below the threshold.

Dividends are payments of company profits to shareholders. Before paying a dividend, directors also need to consider the Corporations Act requirements, including whether the company’s assets exceed its liabilities, whether the payment is fair and reasonable to shareholders as a whole, and whether the payment would materially prejudice the company’s ability to pay creditors.

For tax purposes, a dividend can be assessable when it is paid, credited or distributed. This is important because a shareholder may be taxed on a dividend even if the amount has been credited to a loan account rather than physically paid into their bank account.

Franking credits can attach to dividends where the company has paid tax and has sufficient franking credits. Shareholders generally include both the cash dividend and the franking credit in assessable income and may then be entitled to a tax offset for the franking credit.

The franking rate can be a trap where a company moves between the 25% and 30% tax rates. The maximum franking rate for a distribution is worked out under specific rules and may not simply match the company’s current year tax rate. This should be checked before declaring dividends.

Where more than one franked dividend is paid in a franking period, the benchmark franking rule can also require consistency in the franking percentage. Before dividends are declared, the company should check prior dividend payments and its franking account balance.

Individuals may be entitled to a refund of excess franking credits, but companies are generally not. If a company receives excess franking credits, the excess is usually converted into a tax loss rather than refunded.

Why company structures can be useful — and where they can be less favourable

Companies can offer limited liability, allow profits to be retained for working capital or reinvestment, and provide a practical structure for introducing or changing owners. Where shares are held by a discretionary trust, there may also be flexibility in how dividends are distributed within the wider family or group structure.

However, companies are not always the most tax-effective structure. A company cannot access the 50% general CGT discount, losses are generally trapped in the company, and extracting profits from the company can create tax issues if not done properly.

Division 7A

Division 7A is an integrity rule designed to prevent private company profits being extracted tax-free by shareholders or their associates. It can treat payments, loans and forgiven debts by private companies to shareholders or their associates as unfranked dividends unless an exception applies.

The rules are broad. They can apply to direct loans, payments of personal expenses, transfers of property, use of company assets, forgiveness of debts, and arrangements involving trusts or interposed entities. They can also apply where the company pays an amount to another party on behalf of a shareholder or associate.

Common examples include an undocumented loan from the company to a shareholder, a company paying private expenses for a director or family member, a payment to a trust connected with the shareholder, or private use of an asset owned by the company.

Some amounts are excluded from Division 7A, including amounts repaid before the company’s lodgment day for the relevant year, payments that are otherwise assessable under another provision, certain arm’s length payments, complying Division 7A loans, certain employee benefits that are dealt with under the FBT rules, and payments or loans to companies in limited circumstances.

The ATO publishes the annual Division 7A benchmark interest rate. For companies with a 30 June year end, the rate is 8.37% for the 2026 income year and 8.77% for the 2027 income year.

Where a loan is put on complying Division 7A terms, minimum yearly repayments need to be made on time. If repayments are missed, a deemed unfranked dividend can arise.

Bendel and corporate beneficiary UPEs

The High Court’s 2026 Bendel decision means a corporate beneficiary’s unpaid present entitlement is not, by itself, a Division 7A loan merely because the company does nothing in respect of the entitlement. This is a significant change from the ATO’s previous long-standing administrative view.

However, Bendel does not mean corporate beneficiary arrangements are risk-free. The ATO has warned that other rules can still apply, including Subdivision EA where trust funds are used for the benefit of shareholders or associates, and section 100A where the entitlement forms part of a reimbursement agreement.

For private groups, the practical step is to review the trust deed, distribution resolutions, accounting records, loan accounts, use of funds and any historical sub-trust or Division 7A loan documentation before deciding whether changes should be made.

Common private company traps

·       Using the company bank account for private expenses

·       Leaving director drawings unresolved until after year end

·       Failing to put complying loan agreements in place on time

·       Missing minimum yearly repayments

·       Declaring dividends without checking franking capacity

·       Assuming Bendel removes all risk from corporate beneficiary arrangements

·       Failing to review trust distributions to corporate beneficiaries after Bendel

Practical checklist

☐ Review shareholder and associate loan accounts before 30 June

☐ Identify personal expenses paid by the company

☐ Check whether loans need to be repaid or documented before lodgment day

☐ Calculate minimum yearly repayments

☐ Review franking account balances before declaring dividends

☐ Review corporate beneficiary UPEs and related trust dealings

☐ Check whether any Bendel-related changes are appropriate before altering existing arrangements

☐ Document commercial reasons for any inter-entity arrangements

Need help?

Smart Solutions Tax Advisory can assist with Division 7A reviews, dividend planning, franking account issues, company tax rate reviews and corporate beneficiary arrangements.

Disclaimer: This article contains general information only and should not be relied on as tax or legal advice.

References / Useful links

ATO Division 7A loans: Loans by private companies | Australian Taxation Office

ATO Division 7A benchmark rate: Division 7A – benchmark interest rate | Australian Taxation Office

ATO Bendel DIS: Bendel case – Decision impact statement (DIS) | Australian Taxation Office