Examining director loan accounts amidst ATO's ongoing debt enforcement measures

Is your director client vulnerable to repayment demands from a liquidator?

The Australian Taxation Office (ATO) has made it widely known that numerous small businesses have outstanding tax debts, a significant portion of which accumulated during the pandemic. During this period, government support programs led the ATO to pause debt collection efforts to prevent widespread insolvency among small businesses. However, post-pandemic, small business tax debts continued to rise annually by 17%, totalling $50.2 billion by June 30, 2023, with $33.4 billion owed by small businesses.

In addition to mounting debts, the ATO's issuance of letters in 2023 to notify small businesses that previously written-off debts are now being pursued for payment adds further financial strain on these businesses and their directors.

Increased debt enforcement activity by the Australian Taxation Office

To address this growing debt problem, the ATO has intensified its debt enforcement activities to reduce the outstanding debt. Director Penalty Notices (DPNs) are a popular tool being used for this purpose. Since resuming recovery actions in 2022, the ATO has issued 40,000 DPNs and plans to issue another 30,000 this year. This heightened enforcement has placed many directors at risk of personal liability for their company's debts.

Issuing a DPN is one way the ATO seeks to compel a director to comply with tax and superannuation obligations. 

There are two types of DPN:

1. Non-lockdown
   Upon the director receiving a non-lockdown DPN the director may avoid personal liability if within 21 days they either:

   a)      Cause the company to pay the debt in full, or
   b)      Appoint an administrator under section 436A, 436B or 436C of the Corporations Act 2001, or
   c)      Appoint a small business restructuring practitioner under section 453B of that Act or
   d)      The company begins to be wound up within the meaning of the Corporations Act 2001.

2. Lockdown
   A lockdown Director Penalty Notice (DPN) from the Australian Taxation Office (ATO) is a legal notice that holds a director personally liable for a company's unpaid tax debts, specifically related to GST, PAYG withholding and/or Superannuation Guarantee Charge (SGC) obligations. Unlike non-lockdown DPNs, which offer directors options to avoid personal liability, a lockdown DPN restricts these options, requiring prompt action from directors.

Division 7A loans - impact on directors

The ATO's increased enforcement activities have led to a rise in companies entering liquidation. Consequently, there has been a notable increase in director loan accounts on company balance sheets, commonly called Division 7A loans. This trend likely stems from directors of financially distressed companies opting to withdraw funds through director drawings instead of recording wages as expenses.

This appears to be a strategic attempt to prevent further increases to the company’s tax liability where the company cannot currently afford to pay its tax obligations based on the cash resources of the company.

We encourage advisers to implore directors to be mindful of the impact of these director loan accounts owed to the company, as a liquidator is tasked with investigating company affairs and to protect, secure, and realise the assets of the company including loans owed by directors. 

We find directors may not have the funds to meet the repayment of the loan account and in these circumstances we consider each case on its merits and seek to recover the debt on the most commercial terms possible, in some instances where the debt is in excess of $100,000 the Liquidator requires approval to settle the debt from creditors or the Court.

Directors of financial stressed businesses need advice

It is difficult for directors to navigate their way through financially stressed businesses. If you have clients in these situations, please reach out to your local Worrells Principals for advice to help your client navigate through these financial tough times and relieve the burden they are likely to be experiencing.  

Worrells Principals will guide your client through their unique set of circumstances with a genuine focus on how  they are impacted.