Running a business facing insolvency can be overwhelming, often leading owners to avoid confronting mounting challenges. This pressure creates a cycle of hope and denial, with phrases like “if we can just…” echoing until all options seem exhausted, prompting a delayed search for advice.

Unfortunately, this cycle can last longer than necessary. Many business owners reveal they have received a Director Penalty Notice (DPN) from the ATO, often long after it was issued. Common reasons for receiving a DPN include:

• Not engaging with the ATO regarding outstanding debts.
• Lacking an active payment arrangement.
• Having tax debts over $100,000.
• Owing superannuation guarantee amounts.

DPNs come in two types: “lockdown DPNs,” which hold you personally liable for tax debts, and “non-lockdown DPNs,” which give you 21 days to act. With ASIC reporting a 36.2% year-on-year increase in corporate insolvencies, the risk of personal insolvency is rising, especially as the ATO intensifies its debt recovery efforts.

What to Do If You Receive a DPN

Ignoring a DPN is not an option. Here are steps you can take:

1. Develop a Business Debt Strategy: Work with your advisor to create a strategy for addressing your business debt. This might involve negotiating with creditors, streamlining operations, selling non-core assets, or exploring funding options. If administration becomes necessary, your advisor may step in to manage the business. In cases of insolvency, you may need to appoint registered liquidators to wind up the business and negotiate with creditors.
2. Address Personal Debt: Actions taken to stabilize your business can sometimes render a non-lockdown DPN ineffective if tax debts are settled and the business recovers. However, if you have received a lockdown DPN and proceed to liquidation, remember that the DPN remains in effect. The ATO cannot act during liquidation, but they will likely pursue the debt afterward.

Act Now

Receiving a lockdown DPN means that your business’s financial problems are now personal issues. While your advisor may not be able to address both simultaneously, they should take a holistic approach to ensure you have a clear understanding of your entire situation.

If your business is on the brink of insolvency, seek advice immediately. At Camden Professionals, even if we aren’t the best fit for your needs, we can recommend other resources that may be more suitable. This is especially crucial if you’ve received a non-lockdown DPN, as timely advice can help you avoid personal liability for business debts.

If you have a lockdown DPN or are dealing with a DPN related to a business that was wound up in the past, it’s time to confront the issue head-on. As the ATO intensifies its debt recovery efforts, delaying resolution will only diminish your ability to manage the debt on your terms. Don’t wait—take action now.

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How can we help?

If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au  or arrange a time for a meeting so we can discuss your requirements in more detail.

How can we help?

If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au  or arrange a time for a meeting so we can discuss your requirements in more detail.

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General Advice Warning

The material on this page and on this website has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained on this page and on this website is General Advice and does not take into account any person’s particular investment objectives, financial situation and particular needs.

Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.

Although every effort has been made to verify the accuracy of the information contained on this page and on this website, Camden Professionals, its officers, representatives, employees, and agents disclaim all liability [except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained in this website or any loss or damage suffered by any person directly or indirectly through relying on this information.

An area that often gets small and medium sized private companies into hot water is the blurred line between the company’s money and the owner’s money. This is an area taxpayers often tend to get wrong and the ATO pays particular attention each year to this issue.

Division 7A explained.

A payment or other benefit provided by a private company to a shareholder or their associate can be treated as a dividend for income tax purposes under Division 7A even if the participants treat it as some other form of transaction such as a loan, advance, gift or writing off a debt.

Division 7A can also apply when a private company provides a payment or benefit to a shareholder or associate through another entity, or if a trust has allocated income to a private company but has not actually paid it, and the trust has provided a payment or benefit to the company’s shareholder or their associate.

Division 7A is part of the Income Tax Assessment Act 1936 and is intended to prevent profits or assets being provided to shareholders or their associates tax free.

Where a company makes a payment to shareholders* that payment would normally be treated as a franked dividend.  In some cases companies may make loans to directors subject to a formal loan agreement. In many cases directors simply take money out of their private company without treating it as either a dividend or a loan.

Where that happens and the situation isn’t rectified, the ATO will take an interest and will look to treat such payments (or loans) as unfranked dividends, which is an undesirable outcome for both company and shareholder.

*The ATO treats the definition of a shareholder to include the associates of the shareholder, including spouse, children and business partners.

What transactions are flagged by the ATO?

When applying the Division 7A Rules, the ATO will pay attention to the following:

• Paying private expenses out of company funds
• Lending company funds to shareholders without a loan agreement, possibly at no interest or a reduced interest rate
• Giving private use of company assets for free or at less than market value (such as a home owned within the company or a boat). In this case, the unfranked dividend is equal to the arms-length rental amount normally paid less any rental amount actually paid.
• Unpaid present entitlement issues, if the company is a beneficiary of a family trust, arising where a trust makes the company entitled to a distribution of income but doesn’t actually pay it. Instead the funds are retained within the trust, which therefore has continued use of the money until the company finally calls for the UPE to be paid (which sometimes never happens).

Division 7A only applies where a payment or loan is not repaid by the company’s tax return lodgement date (the earlier of the day on which the company lodges its tax return, or its due date for lodgement).

Create a Complying Loan Agreement

If your company is in a position where you may have breached the Division 7A rules, you can take steps prior to lodging your company tax return by ensuring that any money that any shareholder (or their associate) borrowed or otherwise received from the company during the year is either repaid or offset against other amounts owed by the company (for example, salary, wages or directors fees) or, alternatively, put in place a complying loan agreement. It is important that you consult with your accountant to put in place a loan agreement that includes the following features:

• The loan agreement must be in writing and;
• should identify the names of the lender and borrower
• should set out the essential conditions of the loan, including:
• the amount of the loan
• the requirement to repay the loan
• interest rate payable (which must be at least the benchmark interest rate set by the ATO)
• the term of the loan
• must be signed and dated before lodging the income tax return.

There are 2 types of complying Division 7A loan agreements:

• An unsecured loan, which has a maximum term of 7 years; or
• A secured loan, secured by a mortgage over real property (where the market value of the property is at least 110% of the loan amount), which has a maximum term of 25 years.

If you don’t rectify the situation before the company’s lodgement date, Division 7A will deem the company to have paid an unfranked dividend to that shareholder, which must be declared in the recipient’s tax return (which won’t be entitled to a tax credit) and will be taxed at the top marginal rate of 45%.

The amount of that dividend is deemed to be equal to the lesser of the amount that’s actually paid to the shareholder or their associate, or an amount which is called the company’s distributable surplus (which is basically its net assets less paid-up share capital).

Future changes to Division 7A Rules

The government is proposing to change the rules so that there will only be one type of complying loan agreement, consisting of:

• a 10-year unsecured loan (which is bad news if you currently have a 25-year secured loan, as you will have to pay the loan off far faster than you thought),
• interest rates on Division 7A loans rising by approximately 2%,
• a change in the way minimum yearly repayments are calculated,
• the “distributable surplus” rule to be abolished.

No start date has been set for the changes to Division 7A so you don’t need to take action.

Important Notes

There are some common traps to avoid.

• If you enter in a 25 year mortgage, ensure that you register a mortgage prior to lodging your tax return
• Ensure that your keep records of the amounts lent and paid so that you have accurate balances of Division 7A loans at any point in time
• Pay your loan repayments on time to comply with your loan agreement

The ATO has developed a useful Division 7A calculator and decision tool which will assist you to comply with the rules. You can access the tool here: https://www.ato.gov.au/calculators-and-tools/division-7a-calculator-and-decision-tool/

How can we help?

If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au  or arrange a time for a meeting so we can discuss your requirements in more detail.

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General Advice Warning

The material on this page and on this website has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained on this page and on this website is General Advice and does not take into account any person’s particular investment objectives, financial situation and particular needs.

Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.

Although every effort has been made to verify the accuracy of the information contained on this page and on this website, Camden Professionals, its officers, representatives, employees, and agents disclaim all liability [except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained in this website or any loss or damage suffered by any person directly or indirectly through relying on this information.