Director loan account? Personal exposure, explained

If you’re a company director, you may have taken money from your business informally – as loans or drawings.

These transactions are recorded in what’s known as a director loan account. Access to these funds may have been useful when managing personal expenses and cash flow. But it can also create personal exposure, particularly if your company faces financial difficulty.

This article explains what a director loan account is, how an overdrawn balance creates personal exposure, and – importantly – what happens to it if your company enters liquidation.

Read our full guide: Are directors liable for company debts? Know your risk

What is a director loan account?

A director loan account is an accounting record that tracks money movements between you and your company – meaning money drawn out, money put in, and any interest or adjustments.

Any amounts you take from your company need to be properly classified and recorded – for example, as salary, dividends or a loan. Depending on the situation, you may also need shareholder approval before your company lends you money or provides another financial benefit.

A director loan account can be either:

• In credit: Your company owes money to you (e.g. you lent the company money or have unpaid salary), creating a credit balance on your loan account.  

• Overdrawn (in debit): You owe money to the company (e.g. you’ve drawn more than your salary or agreed entitlements). This is sometimes called a debit loan account.

If your director loan account is in credit, you're a creditor of your company. If it's overdrawn, you're a debtor of your company – a situation that can create personal exposure. In some cases, an overdrawn director loan account may represent an unsecured loan from the company to you.

Under director loan account rules in Australia, some loans where a company lends money to a director or their associates may also be caught by Australian tax law, including Division 7A (often referred to as ‘Div 7A’) of the Income Tax Assessment Act 1936.

Overdrawn director loan accounts and personal exposure

So why is it that a director loan account may become a personal exposure?

Essentially, if you have an overdrawn director loan account, you owe money to your company. If your company becomes insolvent, that debt remains an asset of the company – and a debt owed by you personally.

If your company enters liquidation, this debt doesn't disappear. The liquidator has a legal duty to recover the money owed, which goes toward paying your company's creditors. This is separate from any personal liability you may have for insolvent trading while the company was unable to pay its debts.

Division 7A tax rules: the double whammy

Is your director loan account managed under a complying Division 7A loan agreement? In other words, is it properly documented and charged at the required interest rate – the Australian Taxation Office (ATO) benchmark – and subject to minimum yearly repayments?

If not, this is where director drawings tax can become an issue. The ATO can treat the overdrawn amount as a deemed, unfranked dividend for tax purposes – triggered if it isn't repaid or put under a complying agreement by your company's tax lodgment day. This can have personal tax consequences, meaning you may have to pay tax on the amount treated as a dividend.

The kicker is that this can happen at the same time as the liquidator demanding repayment of the same amount as a company asset. This means you're taxed on money you also still owe back.

One word of caution: If you attempt to repay your director loan account shortly before your company enters liquidation, the liquidator may challenge the repayment as an unfair preference, depending on the circumstances.

What happens to director loan accounts in liquidation

Whether you choose to enter a creditors’ voluntary liquidation or are wound up by a court, here’s how a director loan account is dealt with by a liquidator:

Account is overdrawn (in debit) 

• Take control – The registered liquidator takes control of your company’s assets and liabilities.

• Identify the debt – They identify and quantify the overdrawn director loan account balance (a company asset) from your company’s books.

• Demand repayment – They may write to you demanding repayment of the outstanding amount. Any money recovered can be used to help pay the company’s creditors.

• Start legal proceedings – If you fail to repay the debt, the liquidator can start legal proceedings to recover it.

• Enforce the judgment – If the court finds you owe the money, the liquidator can obtain judgment for the debt. If unpaid, it can be enforced against your personal assets – including your bank accounts, home or investments.

Unfair preference risk

If you repaid some or all your director loan account in the six months before liquidation (or up to four years for related parties), the liquidator may recover those repayments as an unfair preference under s588FA of the Corporations Act 2001 (Cth) (the Act).

Unfair preference claims stop any one creditor, including you, walking away paid in full while others get little or nothing. Even a genuine repayment can potentially be unwound if your company was insolvent when you made it, or became insolvent because of it, and the other requirements for an unfair preference are met.

Account is in credit

• You become an unsecured creditor – Your company now owes you money like any other creditor. 

• Lodge a proof of debt – You're entitled to formally claim the amount owed. 

• Wait in line – You're paid only if funds remain after secured creditors and employee entitlements are settled. Often, nothing is left for unsecured creditors.

Knowing what happens to a director's loan account on liquidation can help you take action before the choice is out of your hands.

Overdrawn director loan account? What to do 

The sooner you understand your director loan account position, the more options you have available – so act early.

First, have your director loan account balance confirmed by your company accountant. Knowing exactly what your loan balance is, how much you’re overdrawn and whether a complying Division 7A loan agreement is in place will give you a clearer picture of your exposure so you can explore your options.

Three options depending on your situation:

1. Repay the overdrawn balance (if you have the personal funds available) – But note the potential unfair preference risk if your company is already insolvent when repayment is made; get advice first

2. Negotiate with the liquidator (if liquidation has already begun) – Liquidators can sometimes agree to a structured repayment arrangement rather than immediate lump-sum recovery.

3. Seek insolvency and tax advice together – Given the Division 7A and liquidation law overlap, if you have significant director loan account exposure, you should speak to both an insolvency practitioner and a tax adviser.

If you’re unable to meet the demands for an overdrawn director loan account after exploring all your options, personal bankruptcy can be used as a last resort. While it’s a big step, it can provide a reset when debts have become unmanageable.

Read our full guide: Are directors liable for company debts? Know your risk

Clarify, get advice, act

Many directors don’t fully appreciate the personal exposure that can come with director loan accounts. It’s often only when insolvency looms that they seek clarity and understand the extent of the risk.

An overdrawn director loan account is a real personal exposure, but knowing your position – including how much you’re overdrawn and whether there may also be tax implications – puts you in a better position to seek the right advice and deal with it.