A tax debt can become a cause of concern for mainstream banks in Australia and this is especially true for business and commercial loan applications. And yet, many business owners as well as their accountants view a tax liability as “normal”, especially in uncertain or challenging economic times. That is, until they apply to a Big 4 bank for a loan and potentially get application declined. In this piece, we are going to be look closely at how a tax liability changes your chances of approval.
What is a tax debt?
A tax debt is a liability owed to the Australian Tax Office for any income tax, PAYG tax withholding, or GST payable arising from your Business Activity Statement. It’s normal for a tax debt to arise when you lodge your relevant compliance paperwork or reporting to the ATO, and there are no issues if you pay your tax liabilities immediately or within a reasonable time. It’s when these tax debts linger, or are put on ATO Repayment Plans or, even worse, not paid at all do they cause a concern for a mainstream bank.
An ATO Repayment Plan is an arrangement to pay back your tax debt over a period of time, set up by your accountant and agreed to by the ATO. Like any other debt outstanding, a repayment plan has a monthly instalment and an interest rate applied to the outstanding amount.
1. How does a bank know about a tax debt in the first place?
The bank finds out about a tax debt due to the information collected during the Credit Approval process. This is especially so for a commercial or business loan application. The two main documents that reveal a tax debt are:
- Firstly, your Income Tax Account (ITA) – which shows your income tax payable, for either yourself or your business; and
- Secondly, your Integrated Client Account (ICA) – which shows your lodgement history, as well as the tax payable for taxes other than your income tax, such as GST and PAYG withholding tax.
The bank may also see regular payments to the ATO via your bank transaction history, prompting further questions.
In addition to this, in late 2019 the ATO obtained powers to report any tax debts to Credit Reporting Agencies, thereby giving the ATO to openly disclose your tax liabilities in your Credit Report. While this has not happened yet at the time of recording this video, the ATO has begun issuing letters to unresponsive taxpayers, warning that they will start marking their credit file if they do not begin to cooperate.
2. Knowing a Tax Deb exists, what does this mean for your loan application?
Now, knowing tax debts exist, what does this mean for your loan application? I will start by saying that most mainstream Bankers and Credit Officers, hate Tax Debts.
The reason for this, is that it raises questions about your character in relation to your readiness and willingness to repay a loan.
While there may be good personal or business reasons for having an ATO Debt, such as managing your cash flow during uncertain times, or using your funds for an investment opportunity that is simply too good to miss out on, bankers tell me all the time – “If a client can’t pay their taxes, what makes you think they are going to repay their loan?”
I know this is a bit judgmental, but this is a common response I hear all the time from the bank when encountering an ATO debt.
In extreme cases, the ATO even has powers to freeze your bank account to make sure the tax office and any vulnerable parties such as employees are repaid first, ahead of any other creditors.
These “garnishing powers” make a bank’s position less secure, and lowers the likelihood of being repaid if something goes wrong with the loan. It’s for these reasons that a bank is more willing to decline a loan application than take on a borrower with an outstanding Tax debt.
3. Knowing a tax debt is viewed negatively, what can you do about it?
I recommend three courses of actions.
a) Clear the ATO debt before you submit the loan application
If you have the funds available, the first option is to clear the ATO Debt before you even submit the loan application. Alternatively, you can request to have the tax debt cleared as a condition of Formal Loan Approval.
Most clients that we help advise us that if a bank is willing to approve their loan, they are happy to cooperate and pay out ta tax debt in full – a situation where all parties win.
b) Explain the nature of the tax debt and factor it into the loan servicing
A second course of action is to explain the nature of the tax debt, often with the support of an accountants letter, and request that the repayments associated with the tax liability are factored into loan servicing.
We find this to be a less effective and more uncertain approach, as it lowers a client’s borrowing capacity to make the loan amount less meaningful, or in the extreme case, the deal totally unworkable.
This is due to the short term nature of ATO repayment plans, which are typically 12 months, which results in larger loan repayments that places a drag on a business’s cash flows for loan servicing.
c) Seek the loan from an alternative lender who is more comfortable with tax debts
The third course of action, is to seek a loan from a lender that is more comfortable with tax debts.
These are typically non-bank lenders who are still willing to approve a loan, as long as they understand that the tax issues are not ongoing, and there is a pathway for the tax debts to be fully repaid.
As this is a more sensitive and technical topic, we strongly recommend you seek the advice from your accountant, before taking any of these courses in relation to your tax debts.
We hope this has been useful in understanding how a tax debt may affect your loan application.
Speak to a Broker
Thank you for reading and it was a pleasure to present this series of finance tips for business owners.
As your finance broker, our job is to help you secure the finance that you need. So if you are a business owners, start-up founder, entrepreneur or a self-employed sole trader, we are more than happy to have a chat with you to discuss your requirements and find a solution for you.
If you have questions or comments on this topic, you are more than welcome to get in touch with Tommy Lim () or the SF Capital broking team.