Once upon a time, before you started a business, you most likely were working for someone else and you were paid a wage – be it weekly, fortnightly, or dare I say monthly. Even though we couldn’t wait to be paid soon enough, it showed us discipline! Discipline in the sense that you saw how much you earnt and how much you could spend before the next pay day.
This article is written for those directors who run their businesses through a company structure and aims to explore the repercussions of using a business’ money for personal use in an insolvency scenario.
My company’s money is my money!
For those starting out in business (especially through a company), the directors (usually being the owners) are required to sacrifice a lot of their lifestyle for the sake of growing and running their business. In some cases, there is a lot of sentimental attachment to their business, and for good reason – for some, it’s their blood, sweat and tears poured into a business. Because of this, the lines between business and personal are blurred and a director may use the company’s money rather than their own personal funds when purchasing non-business related items.
However this is not the best way to look at it and next we will see why!
Why can’t I spend my company’s money on me?
For starters, diverting money from the business’ needs and focusing it on your own, limits the money available to grow your business let alone trade it! It also denies you any business opportunities that may arise (i.e. buy stock in bulk at a reduced price, expanding business operations, buying machinery, taking over a competitor, etc). Similarly, taking funds away from the business also puts pressure on a business from keeping it afloat, especially during the tough times or the quiet times when there aren’t enough savings to meet significant liabilities (such as taxation liabilities, suppliers, wages, etc.) when they arise.
The key here is to take a respectable wage (when appropriate) and properly account for it as a wage. After you pay the appropriate tax, you can spend your money however you like!
When directors start to use the company’s money as if it was their personal spending account, it creates what we call in the accounting world – a “Loan Account”.
Why are loan accounts so important?
For those that run their businesses through a company structure, remember that a company is a separate legal entity – it can own assets, it can sue and be sued, etc. The same goes for its money – those funds belong to the company, not you. At some point, your company is going to have to be repaid the funds that you took out to begin with … exactly like a bank would when it lends money.
So now you may be thinking to yourself that taking funds out of the Company doesn’t sound so bad, right? Wrong! There are two issues that can arise here:
- If your company is trading and it lodges an income tax return, the Australian Taxation Office will look at Division 7A – this is an article in itself but in summary, this can have taxation implications and may affect your ability to distribute profits with franking credits;
- If your company goes into liquidation, a liquidator is going to call on that loan account being repaid.
With regard to the taxation implications on these loans, directors should see their tax professionals to discuss how it impacts on their personal and company tax position. However, this article will emphasise on the liquidation scenario and why it is important for directors.
Loan accounts in a liquidation
From my experience as an insolvency accountant, there are serious implications for a director and their personal financial position. I touched on this in an early article – 5 reasons why small businesses fail – where businesses have been used to pay for: personal holidays; lavish lifestyles; mortgage repayments and even a burial plot.
What is the worst case from all of this? A liquidator (who becomes an officer of the Company, like you as a director) may decide to sue you to recover the loan – the worst case and possible outcome is bankruptcy proceedings are initiated against you.
Care should also be taken as to what is paid from a Company’s funds. The following are some real life examples that I have come across that highlight the seriousness of loan accounts:
- The director contributes to the mortgage repayments on a personal property from company funds – this is extremely serious as it means that your company has an interest in the property (regardless of whether it is the family home or an investment property). In a liquidation scenario, a Liquidator could lodge a caveat and even sue the property owners for the repayments or the market value of the Company’s interest;
- The director purchases a car for their partner with the company’s funds even though it is not used in the business – the company owns that vehicle;
- The director makes the lease repayments under a finance facility (hire purchase, chattel mortgage, etc) with the company’s funds, then the company has an interest in that financed asset, or at the very least – the equity on that facility (i.e. the market value of the asset less the payout);
- The director uses a company credit card and makes non-business related purchases (i.e. travels overseas, goes on a spending spree, gambling, etc) then the director is indebted to the company.
Another implication that might not be so direct is when a director takes out finance in their personal capacity but uses the company’s assets as collateral or the company guarantees the repayment of the debt – if that bank/financial institution recovers the company’s assets in order to repay its debt facility, the loss of those assets could be applied towards a loan account that again, a Liquidator would seek to recover!
To wrap this up, directors should remind themselves not to spend their company’s money on personal choices and that at the end of the day, the company’s funds belongs to the company until it is properly accounted.
Furthermore, directors should be cautious of the taxation consequences as well as the potential liquidation consequences of loan accounts should they ever find their company in liquidation.
The last thing any director wants is a liquidator pursuing them or their assets resulting in personal exposure that can arise from a loan account. A liquidation isn’t the most pleasant experience for directors as they deal with the repercussions from a failed business and coupled with other obligations like finance, personally guaranteed debts and penalty notices – this can at times be overwhelming for a director, both emotionally and financially.
Finally, if you have any concerns, you should always consult your tax accountant or legal professional!