Division 7A loan accounts appear on the balance sheets of most private companies. For advisors working with financially distressed clients, they represent one of the most serious and most commonly overlooked sources of personal liability.
The issue is not the loan itself. The issue is what happens to it when the company enters liquidation.
How Division 7A Becomes a Personal Tax Crisis
Under Division 7A of the Income Tax Assessment Act 1936, a loan from a private company to a shareholder or their associate is treated as a deemed dividend unless it is structured under a complying loan agreement, with minimum benchmark interest and a defined repayment schedule: seven years for an unsecured loan, or 25 years if secured by a registered mortgage over real property.
When a company is placed into liquidation and the director’s loan account remains unpaid, the forgiveness of that debt triggers a deemed dividend in the director’s hands. That dividend is assessable income in the year of forgiveness. In practice, a director whose company has $500,000 in creditors may also face a separate six-figure personal tax liability on a loan account they had largely ignored.
For advisors reviewing a distressed client’s overall exposure, the Division 7A loan is not a footnote. In some cases, it defines the entire personal liability picture.
What to Look for in the Client’s Books
The warning signs are not always obvious. Accumulated loan accounts frequently appear as “director’s loan account” or “shareholder loan account” on the balance sheet. Amounts may have grown over years of informal drawings, expense reimbursements, or inter-entity transfers. Related party loan accounts across associated entities add another layer.
Before any formal insolvency appointment, the adviser should be asking:
- Is there a loan account between the director and the company, and does it have a complying loan agreement in place?
- What is the outstanding balance, and can the director realistically repay it?
- Are there related party loan accounts across associated entities that compound the exposure?
- If the loan cannot be repaid, what does the resulting deemed dividend mean for the director’s personal tax position?
These questions are more productive before a liquidator is appointed than after.
The Pre-Insolvency Planning Window
The window between identifying the problem and a formal appointment is where the most useful work happens. In some cases, related party debts across associated entities can be settled on a commercial basis, documented to demonstrate that the return exceeds what a liquidator would realistically recover through debt recovery action. This changes the profile of what a liquidator inherits.
If the director’s loan account is large and cannot be repaid, the deemed dividend will crystallise regardless of other steps taken. In that situation, a personal insolvency strategy may become necessary alongside the company wind-up, and it is far easier to plan for that before the appointment than to address it after.
A Case from Practice
A Queensland-based property sales and development company came to de Jonge Read® after the ATO issued garnishee notices on all company bank accounts. The director held an outstanding Division 7A loan in excess of $1 million. A significant fall in regional property values had eliminated his capacity to repay.
de Jonge Read® settled the related party loan accounts across associated entities on a commercial basis, with each settlement documented to demonstrate it exceeded the recoverable amount in debt recovery proceedings. The company was then placed into liquidation. As anticipated, the forgiveness of the director’s loan triggered a substantial personal tax liability.
A Part X Personal Insolvency Agreement (Part X) was then implemented for the director, covering the liquidator, secured lenders, and the ATO. By demonstrating that equity in the family home would be eroded by the sales of seven regional properties, an offer was structured that creditors accepted as superior to the return available in a bankruptcy scenario. The director retained his family home and his real estate licence.
Acting Before the Appointment Is Made
Once a liquidator is appointed, control shifts and the planning window closes. Directors can no longer influence how the company’s affairs are structured, and the personal tax liability has already begun to crystallise.
If a client’s company is approaching insolvency and there is a director loan account on the balance sheet, early advice changes the options available. de Jonge Read® works alongside advisors at this stage: reviewing the full personal exposure, identifying what pre-insolvency steps are available, and helping map a strategy before the appointment is made. To discuss a client situation in confidence, contact de Jonge Read® on 1300 765 080.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies. Contact us now on p. 1300 765 080 | ua.moc.arjd@ofni
Did you know?
Phoenixing is another name of business restructure. Read more about business restructures and when this can be an option for you.
