The term loan account is very broad and often used to cover multiple scenarios, which can sometimes make it difficult to grasp.
To cut a long story short and provide a top-level definition: A directors loan account represents either the money the company owes you, or money you owe the company. In a similar vein, trust beneficiary accounts, while not loans in a technical sense, are sometimes referred to colloquially as loans.
The loan account could be made up of amounts you have loaned the company or it has loaned you, expenses it has paid on your behalf (or vice versa), profits credited to you that haven’t been withdrawn, or contributions towards fringe benefits, just to name a few.
“Credit” loan accounts (these sit under the Liabilities section on the balance sheet) represent the amount that the company owes the director/shareholder. This represents what the company will repay you at some time in the future (assuming solvency).
There is no necessity for the entity to repay this loan under tax law, however it may be wise to repay the loan owing to you rather than be an unsecured creditor of the company. If you are concerned about unsecured loans and being an unsecured creditor, you may consider securing the loan with a registered mortgage or registering a security interest on the personal property securities register. Taking this action protects both you and the company, especially if the company enters liquidation at some point in the future.
“Debit” loan accounts (these sit under the Assets section on the balance sheet) represent the amount that the director/shareholder owes the entity back. This type of loan account can have some requirements associated with them under tax law. When amounts are drawn from a company and the net of the amounts drawn over the year result in a “debit loan”, specific tax law provisions kick in – Division 7A of the ITAA, commonly called “Div 7A”.
Division 7A requires minimum yearly repayments, calculated using the benchmark interest rate set by the ATO, and failure to meet these can result in the unpaid loans being treated as a deemed dividend or unfranked dividend for income tax assessment purposes.
Loan account balances, the remaining term of the loan, and any debt forgiveness must be monitored and properly documented in company records to ensure compliance and avoid adverse tax consequences. Director loans can also affect the company's cash flow, so careful planning is needed to ensure the business has sufficient funds to meet its obligations, especially in the case of small or private company settings.
When properly understood and managed, a debit loan account isn’t necessarily a cause for concern. Even though these rules are directly associated with companies, they can apply to certain types of loans between companies and trusts and also loans by a trust to related parties in certain situations (this is often overlooked!). It is important to distinguish between company funds and personal funds, and ensure all transactions are properly documented to avoid confusion and potential tax issues.
So, what do you need to do in relation to director loans?
If you are required to take action in relation to a loan account, a trusted C&N Advisor can guide you through the recommended management of the loan, which might mean actions such as repayment, creating a loan agreement or paying out profits to you through a deemed dividend.
If you're going it alone, it's essential to have a complying agreement, a clear repayment schedule, and to specify the interest rate to ensure the loan is properly documented and meets Division 7A requirements. All repayments should be made according to the agreed repayment schedule and recorded in the company records. If the loan is not repaid or properly managed by the company's lodgment day, the loan amount may be treated as income and the director may have to pay tax on it.
The key thing that you can do to ensure that your loan is managed effectively is to regularly review the transactions recorded against your loan / drawings account to ensure that they are indeed personal.
This is recommended to be undertaken regularly, so that any errors are corrected while the transaction is fresh in your memory. This can assist your advisor in managing your loan accounts when planning with you at year-end. When reviewing transactions, it is important to distinguish between genuine business expenses and personal expenses or personal use, and ensure that any use of company funds or money for personal purposes is properly documented and repaid to avoid being classified as a deemed dividend.
The company must also maintain clear loan balances and company records, including all payments, cash flow and details of any debt forgiveness, to avoid adverse tax consequences and ensure compliance with the Corporations Act.
Even a sole director must comply with all legal and tax requirements, including obtaining shareholder approval for director loans and avoiding insolvent trading (when a company incurs new debts without the cash flow to pay existing ones) to limit personal liability. When a company lends money to a director or related parties, it must be for genuine business purposes, not for routine personal use, and all such transactions should be properly documented. If personal funds are used to support the business, this financial accommodation should be documented and treated as an ordinary loan with proper terms.
It is also important to understand the tax consequences underpinning each different way to extract money from a company, such as salary, dividends, or loans. Unsecured loans carry additional risks, so consider security arrangements to protect the interests of both the director and the company. Always act in good faith and seek professional advice if there are any concerns about compliance, and note that voluntary disclosure to the ATO can help reduce penalties.
The team at Cutcher & Neale are here to help, please get in touch if you would like further assistance.