Examining director loan accounts amidst ATO’s ongoing debt enforcement measures – Insolvency/Bankruptcy

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.