Welcome back to Sapphire Bay’s insights series into Division 7A – shareholder loans.
This is the second instalment of the Division 7A series, which explains in simple, practical terms these rules for business owners.
In the first article of our Division 7A series, we explained the rules and how they operate, and we discussed ways we commonly see the ways the Division 7A rules applying, often inadvertently to the intentions of the business shareholder.
In today’s feature article, we will explain practical measures you can implement to avoid inadvertently triggering the Division 7A rules and will give our best 5 tips to implement.
And in the third and final article in the series, we will explain how to apply the rules for your strategic benefit for those occasions when it makes sense to utilise company assets for other non-business related items.
So, let’s dive into today’s feature article to discuss practical measures to ensure you don’t inadvertently trigger the Division 7A rules.
At a glance
Managing Division 7A challenges involves considering your mindset and personal cash management.
See your business as a distinct entity to yourself
Ensure you are managing your personal affairs appropriately so you are not tempted to dip into business funds on an ad hoc basis
Think big picture about your overall affairs and make sure you it is streamlined and efficient in the way you hold your business and investment assets
Ensure you keep accurate records and ensure any use of funds is appropriately documented
If you do require funds from your business, be strategic and deliberate in how you access business funds
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Article
Division 7A challenges occur often, especially amongst small and medium sized businesses where the owner is actively involved in the operations.
However, with the right mindset and perspective, along with strategic money management and excellent financial record keeping, it is an issue that should be managed without concern of inadvertently triggering the rules.
In fact, where shareholders have these fundamental practices mastered, Division 7A can be a source of strategic advantage for you and your business and we will cover this off in Article 3.
In the meantime, in this article we will address how to avoid Division 7A issues inadvertently arising for you and your business, specifically by addressing the following 5 factors:
Your mindset – namely, viewing your business and its assets as distinct from you
Personal cash management
Thinking big picture about your affairs – namely how you hold your business and personal investment assets
Keeping excellent financial records
Being strategic when utilising business funds
5 Success Factors to Manage Division 7A in your business
Factor 1 – A business owner’s mindset; seeing your business as distinct from you personally.
This is probably the biggest cause of Division 7A inadvertently applying and, more broadly, something which holds the business back: owners who see the business as an extension of themselves.
We see this particularly in smaller businesses, especially where the owner is very active in the business and either has no team or a very small team around them.
We understand that emotionally many business owners see their business this way. But when it comes to the logistics and the way the business is operated, it needs to be seen as a distinct entity to the shareholder.
Therefore, money in the business, belongs to the business and should be kept for the business only. Don’t use it to pay for personal expenses.
The same applies to business assets, including the business’s ability to service loans and provide guarantees.
We note that as businesses grow and bring in third party stakeholders (e.g. employees, other investors, creditors etc), this type of mentality diminishes, however, the earlier this mindset is removed, the better it will be for the business.
If nothing else, we have found businesses with owners that have this perspective perform better, grow faster and deliver more profit to owners than those whose owners do not have this mindset.
Factor 2 – Personal cash management; poor personal cash management frequently leads to Division 7A challenges.
Division 7A is often inadvertently triggered when the business owner is in need of financial resource and draws on the business assets.
We have spoken already about mindset and how you should view your business as separate to you, but further to this, you should ensure you have excellent personal cash management for yourself also.
Failure to manage their personal cash affairs is what leads many business owners to raid business assets. Despite the best intentions to pay this back, very often it is forgotten or another separate financial challenge necessitates an additional draw on company resources.
Having excellent financial management for your personal affairs will therefore mitigate the need for you to draw on business resources. It will also put you in good stead to effectively manage your business.
As a rule of thumb, you should see yourself as the CEO of a publicly listed business. No competent CEO would ever dream of touching business assets for their own personal use.
This example clearly demonstrates the level of distinction you need to have with your business. As the operator of a business, you need to see yourself as a caretaker of it.
Factor 3 – Think big picture about your overall affairs.
Many family groups have loans between entities and mortgages and other debts. These need to be considered holistically.
Astute thinkers look at the big picture and conceptualise how parts fit together to create an outcome.
Where to start? First, identify all your group’s deductible and non-deductible debts, bank loans, credit loans and unpaid distributions.
Second, put these components to work by cleaning them up or reorganising your affairs where possible - certain items may be able to be offset or repaid (if correctly documented) to potentially reduce future liabilities. The right move now with this exercise might pay handsome future dividends.
From time-to-time, take a step back, look at the big picture and remind yourself what it is you’re trying to achieve for your business and yourself (including your investments, succession planning and your legacy).
Factor 4 – Keep excellent financial records.
Keep accurate records that explain all transactions, including payments to and receipts from associated trusts and shareholders and their associates.
This is a fundamental step, not just for Division 7A related matters, but in order to build and grow any effective, measurable business.
This suggestion is straightforward and, in today’s day and age, with so many tools available to assist, there really is no excuse to not have this in place.
Your accountant can help to make sure your records are excellently maintained.
Factor 5 -Be strategic when utilising business funds
We get it: there are going to be times when you need additional funds from your business.
Examples could include withdrawing funds to purchase investment assets for your own personal investments (e.g. buying shares, property, or even other businesses), or needing funds for personal / lifestyle expenses.
When this occurs, be strategic in the manner you take out funds, either as:
distributions,
a short term loan to repaid prior to the tax filing date, or
a strategically implemented Division 7A complying loan.
Obviously, it goes without saying that you of course need to ensure that your business has the capacity to handle the removal of funds. Otherwise, you may need to consider another financing option for whatever it is you need the money for.
We discuss when you should consider utilising each of your options to your benefit in Article 3 of our Division 7A series. But you should also seek professional advice to make sure you are implementing the most advantageous arrangement for your specific affairs.
The Closing Word
These 5 simple tips will mean you reduce the risk of inadvertently triggering the Division 7A rules and avoid an unintended tax bill in your personal income tax returns.
In Article 3, the third and final article in our Division 7A series, we will the advantages and disadvantages of your options when withdrawing money from your business, as well as discuss strategic uses of the Division 7A rules to keep your money working harder for you.
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Sapphire Bay Partners is always delighted to help. We love working with dynamic, proactive clients and helping their businesses grow.
If you would like assistance, feel free to reach out to us.
Tel: + 61 3 9563 4666
Email: letstalk@sapphirebay.com.au
Important Information
This is general information only so it doesn’t take into account your objectives, financial situation or needs. Sapphire Bay Partners is not giving you advice or recommendations (including tax advice), and there may be other ways to manage finances, planning and decisions for your business.
Carefully consider what’s right for you, and ask your lawyer, accountant or financial planner if you need help. Alternatively, feel free to reach out to Sapphire Bay Partners for assistance or referrals to an appropriate professional. We’re always happy to help!
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