A company in financial trouble can affect a lot of people, and the closer to liquidation, the more hazardous for the directors.

One big concern lies in 'director loans' .

What is a Director Loan?

Usually this is a result of a director paying personal expenses from the company bank account, borrowing from the company, or drawing money that is not accounted for as a salary.

If not classified as a wage, and PAYG tax remitted to the ATO, then the amount is recorded as an asset on the Balance Sheet as a 'Director Loan Account'.  It is then recoverable as a debt due to the company, and is immediately repayable on demand.

So, What's the Problem?

If the company is solvent and the directors are also shareholders (or associates), the loan falls under the Division 7A provisions of the Tax Act.  This requires a loan agreement to be put in place and the loan plus interest be repaid over 7 years (to prevent the ATO taxing the loan as a deemed, unfranked dividend).

But, if the company has financial troubles or worse, is in liquidation, the loan amount is recoverable from the director by the Liquidator.  If a judgment is obtained, the director can be bankrupted.  That's the problem!

Is there a Solution?

It's best to take care in accounting for payments made to or on behalf of a director.  Once recorded though, ensure a Division 7A Loan Agreement is executed and followed up each year (or it could be taxed by default as an unfranked dividend).

There are a few ways to deal with the loan:

- Offset the loan against any amounts owed to the director by the company

- Repay the loan

- If the company has Franking Credits declare a dividend and credit the dividend to the loan account.  It is still income received but the franking credit will assist with the tax payable

- Credit a bonus or extra salary against the Loan account rather than draw the cash.  Again, that is income received but PAYG has been paid.

A caution .  Never just make it 'disappear' off the financial statements.  There can be serious legal consequences and the loan would still be recoverable.

What's next?

This is an issue for every year ;  the Tax Office looks for Division 7A loans and the Agreement for repayment.  In the drive to get the best tax outcome it is worthwhile to spend an extra few minutes and see how a loan problem can be fixed, especially if there is a concern about the company's solvency.

Division 7A is an important tax matter.  It is not an afterthought or something that can be ignored.

As we carry out tax planning for the end of the year we also consider loans and solvency, and seek to address any concerns early.  However, if you have any concerns now about solvency and there either are or could be director loans, please call us soon.