Director Loans …..A Timebomb!

Director Loans …..A Timebomb!

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I hate it when clients take loans from a company to be given to a director. They are, in technical terms, called Div 7A loans. It is likely you have been told to use a bucket company to take these loans or simply taken them out of the business and not paid taxes on them.

Why do I hate them so much?

Well, it exposes asset protection (completely), and I am not sure the tax benefits are worth the stress. And oh…. they must be paid back anyway. And you must pay interest on it. Also, repayments come from post-tax income which means in most cases they are not tax deductible.

So, what sounds great may not always be great.

Accountants love it because they get to tell their clients that they will pay less tax this year. And clients love that. Accountants also tell their clients that, in the background, they will do witchcraft that will make the tax go away. But unlike real witchcraft, it’s not permanent, which means it’s more like a magic trick—it all looks fantastic, but it is all show.

I generally only tell clients to take Div7A loans if it solves a problem – set it against a home loan, for example, or even investments such as a deposit. But to take it out and spend it on lifestyle. Nope.

But because accountants tell their clients they can do that, they do, and eventually, it all catches up, and you have an even bigger problem.

Often, we take over new clients and find they have taken massive loans from their businesses. Some are as high as $500,000. I have some that are even more than that.

Here’s the issue.

  • The loans must be repaid within 7 years if there is no security attached. The interest rate set by the ATO was just over 4%, so not too bad. But that changed this year to over 8%, and that has become a problem.If you have taken a loan from your business of $200,000, you have to repay over $38,000 just to keep up. That is over $4,000 more expensive than last year. Over 7 years? That is an extra $28,000 to be found from your piggy bank. If it is sitting in your offset account, you can find it. If, on the other hand, you have been having a lot of Thai food in Thailand, the piggy bank may be a bit empty.So, if you have to repay $38K and don’t have it? Not to worry, most accountants will say. We will just increase your pay, but don’t physically take it out, and that is used to repay the loan. But as we all know, more income (salary or dividend) means more taxes, which, in my opinion, defeats the purpose in the first place.

 

There’s more.

  • If the business has given you a loan, it means you owe it money. If your company gets into financial trouble or, cannot pay its debts, or has money owing to the ATO, they can ask you to repay it. What if you don’t have it because it is sitting in someone else’s till in Thailand? Well, your house investments or other assets could be on the line.One of the many reasons businesses that should be in liquidation cannot go into liquidation is because there is so much money owed by the director to the business, and it cannot be paid back.
  • It could cause issues with banks, too. If you want to borrow, they may take these repayments and interest as servicing costs, which means borrowing more money may, in the bank’s eyes, look risky.

 

As I said, if you are a client, we will have already spoken to you about how to deal with your Div7A loan. With the rate of interest so high and expected to remain high we do need to now ask if it is worth it, and it may also be worth paying back the loans quicker.

I always tell clients to work out what they want personally, what keeps them awake at night, and then do the things that give them a good night’s sleep with the minimum amount paid in taxes.

Tax planning is not about always paying the least in taxes. It is about paying the least in taxes and having a good night’s sleep. Some business owners can deal with $500,000 loans, whilst others (like me) will never do it because it is a hassle I do not need further down the line. It is about balance and what you want. It is not about what your accountant wants. It’s always about what you want.

If you would like to discuss Div7A loans in more detail, please email Hitesh at hitesh@wowadvisors.com.au or Ros at ros@wowadvisors.com.au or call 07 3161 9548.