The hidden tax trap of director loans - and how to avoid it

If you run a trade business as a company, you might think of the company’s money as your own. After all, you’re the one generating the income, taking on the stress, and holding the business together, right?

Not so fast. Taking money out of your company without the proper records or processes in place can land you in serious tax trouble - especially if it gets treated as a Division 7A loan by the ATO.

What's the issue?

A Division 7A loan is what the ATO calls any payment, loan, or benefit taken from a company by a shareholder (or associate of a shareholder) that isn't classified as a wage, dividend, or properly documented loan.

If you take money from your company’s bank account without allocating it correctly, the ATO can consider it a loan - even if you didn’t mean it that way. And if that loan isn't repaid on time or doesn't follow ATO rules, it can be taxed as unfranked dividends in your personal tax return. That means extra tax, potentially at your top marginal rate.

Why is this a problem for small business owners?

Many small business owners transfer money to their personal account when needed, especially during quieter months or when covering personal expenses. While this feels harmless, it causes three major issues:

1. Unexpected tax bills: If you don’t set up the right loan structure or repay the money on time, the ATO can tax you personally on the full amount.

2. Cash flow confusion: Money pulled from the business might affect your ability to pay wages, bills, or tax obligations.

3. Risk of penalties: If caught during an ATO audit, you may face interest charges and penalties for non-compliance.

How to stay compliant (and stress-free)

1. Pay yourself properly: Set up a wage or take regular dividends. This ensures that tax and super are accounted for, and you know exactly what’s being taken from the business.

2. Document loans correctly: If you need to borrow money from your company, set up a compliant Division 7A loan agreement. This should include interest, regular repayments, and a maximum term (usually seven years for unsecured loans).

3. Keep detailed records: Use accounting software to track payments to directors, repayments, and any loans. A clear paper trail is crucial if the ATO ever reviews your finances.

4. Work with a pro: Don’t go it alone. A good accountant will not only help you stay compliant but can structure your pay in a tax-efficient way that avoids Division 7A issues entirely.

Your company’s bank account isn’t a piggy bank - and treating it like one can come back to bite you hard at tax time. Inside our Small Business Foundations Course, we guide you through everything you need to know if you want to take money out of your company - so you can avoid these costly mistakes.