Trending Up: The Perils of a Directors Debit Loan Account

We’re seeing an increased trend of director debit loan accounts. Used wisely, they’re a useful tool.

Misused, they’re a major risk.

In fact, director debit loan accounts are the most common cause of personal liability for a director in a liquidation scenario.

This is tragic in the true sense of that word, because the harm is 100% self-inflicted.

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Some directors and their tax advisors often see it as a way to improve cashflow when things are tight, to put transactions through a directors debit loan account rather than allocate them to wages or directors fees. This avoids having to pay PAYG withholding tax, workers compensation and other reporting or tax requirements in the short term.

But the ATO are awake to this tactic and they have been cracking down on the potential tax avoidance issue via Division 7A legislative updates.

However, the biggest problem is when a company goes into liquidation and the liquidator demands that the director repay his/her loan account to the company.

All of that short-term ‘cashflow saving’ has accrued and is suddenly a serious liability.

Payable now.

The liquidator may take legal action to make a director repay the debt or even make the director bankrupt.

The potential options available in dealing with a director debit loan account once a company is placed into liquidation scenario are:

  1. The director repays or offers to settle the debt owed to the company, or
  2. Set off liabilities the Company has to the director (that are not already accounted for) against the outstanding loan account.

A word of caution

Directors and accountants must take care when accounting for directors debit loan accounts in times of financial difficulty and especially prior to a company being placed into liquidation. Transactions in the directors loan accounts that favour the director would be investigated by a Liquidator to determine if they have characteristics of unreasonable director related transactions pursuant to s588FD of the Corporations Act 2001.

At the end of the day the severity of the situation clearly depends on whether the director is in a position to repay the loan account. A liquidator would always consider the capacity of the relevant party to repay the amount claimed prior to initiating recovery action.

Take a look at any of your clients’ director debit loan accounts and assess the liability that’s accruing and the potential risk that presents. It could be time to stop ‘squirreling away’ cash by using this approach, because one day you or your clients could be faced with a sudden and serious liability.