Being an effective family lawyer involves knowing a deep amount about a whole range of issues that affect our clients. One of the financial structures that clients with a good amount of wealth may have set up is a corporate entity such as a company where the parties to a marriage or de facto relationship are the controllers of that company – or more specifically the directors or shareholders of that company.
The temptation that many succumb to is to intermingle this entity’s financial position a little bit too closely with their own, and use the company funds as their own personal piggybank. However that money is not technically the parties’ money yet (it’s the company’s) and tax needs to be considered and paid on it.
There are some ways to draw money out of a company – through wages or fees paid to directors, through dividend payments, or through loans to a director. All but the last option will then mean that there is likely to be some ‘top up’ tax that has to be paid to the ATO on the money received in the same year it is received. The tax implications are therefore confined to a tax year close to when the money was received.
A director’s loan however can be used to shift the timing of your tax obligations, and this is where the time-bomb in family law can be buried.
A director’s loan, or a ‘Div 7A’ loan, is a loan between a company and a party related to it, usually a director. These loans can run for a maximum of seven years although can be extended in some situations. Because it’s a loan, the funds come out and no tax is paid… yet! The loan has to be repaid in seven years, and interest has to accumulate on the loan, and the money to actually repay the loan has to come from somewhere.
What is common is that to repay the loans, a dividend will be declared by the company some time in the future (probably seven years later) to pay to the director, who immediately repays the company its loan. The money usually does not actually move anywhere, but the loans are repaid, the company is made whole, and everything is fine, right?
No, because the dividend that was declared in order to pay back the loan has to have income tax paid on it just like a regular dividend would!
Accountants commonly use the Div7A mechanism to ‘fix up’ drawings made out of a business by a director of a small business in one year, and then have to ensure that the Div7A loans are reconciled later on. This can create cash flow problems for a business, or indeed for an individual when they are left to pay tax on money that they received and probably spent seven years ago.
It can also catch up when you have been living a nice lifestyle, possibly paying for lots of private school fees for many years, but there is a separation of a married or de facto couple, and suddenly there is an (often appropriate) demand by the company to sort out its directors loans as part of the general reconciling of positions at separation.
Speak to one of our experienced family lawyers if you are concerned about how this may affect you, and we can look out for these types of problems with a careful examination of company records. Call us on 03 9614 7111 or melbourne@nevettford.com.au