Directors’ Loans Explained

In this episode, Mai and Lee unpack one of the most misunderstood areas of running a company: director’s loans. While many business owners see this account in their financials, very few truly understand how it works, or how costly it can become if handled incorrectly.

Mai breaks down what a director’s loan actually is, why it exists, and how it’s often used to record personal spending through the business. More importantly, she explains how Division 7A rules come into play, and why they’re designed to stop business owners from accessing company funds without paying the right amount of tax.

In this episode, Mai talks about:

• The purpose of a director’s loan and why it appears in your accounts
•  How Division 7A applies to money taken from your company
•  What happens when a director’s loan becomes a deemed dividend
•  How unpaid balances can significantly increase your personal tax liability
•  Why treating your business like a personal ATM creates problems
•  When and how you can use a director’s loan to manage short-term cash flow
•  What a Division 7A loan agreement is and when it should be put in place
•  How to structure your income (wages vs drawings) to manage tax effectively
•  Why timing plays a key role in when and how you pay tax

This episode is a reminder that understanding how you take money out of your business is just as important as how you make it. When used correctly, tools like director’s loans can provide flexibility and control, but without the right advice, they can quickly turn into one of the most expensive mistakes a business owner makes.

If you’d like a copy of Mai’s Director’s Loan Compliance Checklist, DM the word Loan on Instagram at @the_maiharris.

You can also submit questions or topic ideas via the Ask Mai link at the top of the show notes.

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Disclaimer

The advice contained in this presentation is general in nature only and should not be acted on without first seeking professional advice.

Your personal circumstances have not been taken into account, and you should consider the appropriateness of the advice to your individual needs.

Transcript

Welcome And The Big Question

Speaker 0:02

Hello and welcome back to the podcast My Accounting Advantage. My name's Lee Woodward, hosting with Mai Harris, our wonderful accountant, sharing the world and wealth of knowledge. Mai, welcome back. Thank you, Lee. It'll be a cracker this one. Episode 10. What your accountant hasn't told you about director's loans. Take us into this.

What A Directors’ Loan Really Is

Speaker 1 0:25

So directors' loans um play a big part in a lot of businesses that has companies. So I'm sure every one of business owners who have companies would come across, you know, their question, oh, let's post this transaction to your director's loan. And a lot of people go, Well, what is it? And why does it exist?

Speaker 0:52

Why does it exist?

Speaker 1 0:54

Well, it exists so that people can allocate, well, not people, your accountant will allocate your personal expenses to that account, being, you know, it's a it's like a loan from the business to you. It's called Division 7A.

Speaker 1:14

Division 7A. Yeah. People are going, what is Division 7A?

Speaker 1 1:18

Yeah, so Division 7A is an anti-tax avoidance rules. It's designed to stop business owners from taking money or using company funds without paying the right tax.

Speaker 1:31

So having a jet ski on the PL is not meant to be there.

Speaker 1 1:37

No. Um, that's why if you pay for the jet ski from the business bank account, yes, it will be allocate the cost of it will be allocated straight into director's loan account.

Speaker 1:50

Mm-hmm. Continue on.

Speaker 1 1:52

Yeah, so basically um it's, you know, quite a mystery to a lot of business owners. And we haven't been told how we should use it as a tool instead of um, you know, you you're fearful about having the balance there. What you can do with director's loans is to plug the hole in in your cash, in your cash flow. So for example, if you have um, you know, cash in the business and um your business is doing well, you can utilize that cash to uh uh fix your short-term cash flow issue that you may have in your personal life and you, the business owner, and um, you are allowed to do that, but you do have to pay that amount back before um the tax return is due for lodgement. Yeah. So if you pay it back before the lodgement due date, you won't be penalized for it. So it could be a um, you know, short-term cash flow tool that you can

Deemed Dividends And Costly Tax Traps

Speaker 1 3:00

use.

Speaker 3:00

Where does it go wrong? You've obviously you have to take over being in your world, something's gone wrong and you're taking over that assignment. So they've changed accountants and then you're looking at the books and you're thinking, wow, well, what's some of the go-wrongs that have happened there?

Speaker 1 3:16

Yeah, uh there there were a lot, actually. So um often uh we have a look at the balance sheet and that's where the director's loan sits. So if there's a debit loan in in the balance sheet, it means that you have drawn out a lot of cash from the business. What does it mean? It means that you haven't paid tax on that cash. Because there's two ways to take out um cash from a company. Number one is through wages. If you're taking wages, you pay PAYG withholding tax on that, or you take a dividend. And with dividend, you would have paid the company tax upfront before you can take franked dividend from the business. But what if um the company uh didn't have enough um franking credits to pay dividend, and you've taken the money out? That could be something that you didn't think of. Yeah, it will be uh classified as deem dividend. What does deem dividends mean?

Speaker 4:20

Never heard of that. I'm I'm fascinated.

Speaker 1 4:22

Okay. So deem dividends is basically means that you've taken the money out, you haven't paid tax, it's deemed that you have taken the income from the business. The balance could be assessed, meaning add on to your taxable income. And say if the balance of your um director's loan is $100,000 and you haven't paid that back by the time the company lodged its tax return and you don't have frank enough franking credits to pay frank dividend, well then that is deemed to be an unfranked dividend, which means that it does not have tax credits attached to it. So it gets assessed on top of your other income. So if your income was to be $120,000 and you have a director's loan balance of $100,000, that gets added on top. So now you your taxable income is $220,000, which means that you have to pay a substantial amount of top-up tax.

Speaker 5:27

Top-up tax, more tax. More tax. And I think people just get in the habit of, I'll just take this, I'm just paying myself for this, I'm just doing this, I'm just doing that. As if it's a credit card they never monitored, and then suddenly they're in trouble.

Speaker 1 5:41

Yes, that's right. So you need to educate yourself. What can you do in terms of um taking the money out of the business and make plans to pay that back before the lodgement due date? And it's okay. Don't be fearful about, you know, um taking money from the business, but you need to be aware that it might just to fix your short-term cash flow issues, like you've got an unexpected tax bills under your personal name, or you need um fast cash to uh plug a hole and or do some repairs and maintenance at home and you were the business owner, you can use the um, you know, the funds from the business. And a lot of owners don't realize they've they they're fear, like they've very fearful about taking the money from the business. And if you actually know that, oh, I can actually fix my short-term cash flow problems by using excess cash from the business, what are the processes that I have actually have to

Using Division 7A As A Cash Tool

Speaker 1 6:48

follow? Division 7a loan can be a tool for you. If push comes to shove and you can't pay that back, all you have to do is put a Division 7A loan agreement in place with the company itself. Your accountant should be able to advise you on that one. And um it just means that you put in a loan agreement, what and then they'll work out the minimum loan repayment for you over seven years, and then that's manageable as well. So you don't need to stress too hard. That might be an option for you if you can't get finance under your own name and you have excess cash in the business, you can access it, you can borrow it. That's control for you.

Speaker 7:33

That's pretty

Pay Yourself Well Without Overpaying Tax

Speaker 7:34

powerful. Question I have for you for our different stage of listeners. My Accounting Advantage is really such a powerful tool in the taxation space, and people don't do enough tax planning, they don't even know they need a strategic tax plan, they think I've just got to pay my taxes. It's a sad thing, but this podcast is bringing light into this topic. In a business owner's life, should they pay yourself first, otherwise you you'll be last to get paid, and they take a salary from the business. Some people take an enormous salary from the business and they say, you know, but uh that's what I earn. Yeah, but you you're paying an enormous amount of tax on that.

Speaker 1 8:15

One go, yeah.

Speaker 8:16

In one go. At what point do you realise I could have a minimum wage and then use the credits, or what's your view?

Speaker 1 8:24

Yes. So my view on that is typically when you have a company, your tax is fixed at 25% more than the that's the company tax rates. Um, where you should set your wage as a business owner is up to say $130,000, which is um which means that your average tax rate is equal to the company tax rate, 25%. If you um set the wage over that 130, yeah, you're creeping up over the the 25 average tax, which means that you know you you are you're actually um not benefiting from from the 25% fixed tax rates. And but what if you want more money, more than $130,000 a year? That's when you actually utilize the funds through director's loan arrangement. So what we can do is, you know, you can um take money out and um we allocate that extra cash that is um above your wage to the director's loan. That will be, you know, controlled under the company that you your your wage is fixed, your tax is fixed, and then any excess cash that you take from the company is allocated to the director's loan and will be managed by your accountant. And how it will be allocated in the director's loan is will be a strategy, another strategy that your accountant will provide you. It's all about timing. You pay tax now or you pay tax later. But sometime you're better off paying tax later by doing this because you can control the amount of tax that you'll be paying.

Speaker 10:19

Very, very powerful episode today. And I think everyone should reach out and get that assessment done and make sure they understand, yeah, you're working, but are you working within the guidelines the

Key Takeaways And Checklist Offer

Speaker 10:32

best way possible to get the best return for your efforts? Mai what's your closing words today?

Speaker 1 10:38

The closing words today is to understand what are the tools um out there that is available to you as business owners. And you know, sometimes you don't know what you don't know. So ask the right questions. If you actually would like our um director's loan compliance checklist, do DM the word loan. We will email it over to you. Yeah, if you want to em DM me on my Instagram, it's the_ maiharris.

Speaker 11:13

Mai, another brilliant week. Thank you for joining us, and I look forward to next week.

Speaker 1 11:18

Thank you, Lee. I'll be there.