Debt consolidation for sole traders

A sole trader is not a separate legal entity. You trade under an ABN, the profit is assessed at individual income tax rates, and the obligations belong to you personally. A supplier invoice, an unsecured business loan and an outstanding tax balance are all your debts in the same way a personal credit card is.

That has one clarifying consequence and one uncomfortable one. The clarifying part is that there is no director penalty notice regime in play, because there is no company and no directors. The uncomfortable part is that the Australian Taxation Office does not need one. It can pursue a sole trader directly, including by garnishee of a bank account or of money owed to you by your customers, and ultimately through bankruptcy proceedings.

So there is no separation to protect and no structure to unwind. The whole picture is one balance sheet, which makes the planning simpler even when the numbers are not.

The pattern repeats across trades, consultants, allied health practitioners and owner-operators. It is rarely one bad decision. It is usually a good year followed by a tax bill that arrives after the money has already been spent on the business.

• PAYG instalments. Once you have lodged a profitable return, the Tax Office generally puts you onto instalments based on that prior year. A quieter year still carries the earlier year’s instalment rate until it is varied.
• GST on lodged business activity statements. The GST collected was never yours, but it does pass through the same account as everything else.
• The income tax assessment itself, which for a sole trader lands as a personal liability.
• Unsecured business loans and merchant cash advances taken to bridge a gap, often with daily or weekly repayments.
• Credit cards used for stock, materials or fuel, which then never clear.
• Superannuation guarantee for any employees or eligible contractors, which is a separate and serious obligation.

A salaried applicant hands over two payslips. A sole trader hands over the last two individual tax returns and the matching notices of assessment, and the lender works from the taxable income on those documents. Some lenders will consider a single year where the business is established and the trend is clear.

The number on the return is rarely the end of it. Lenders will add back certain items that reduced taxable income but do not represent cash leaving the business on an ongoing basis. Which items are accepted varies by lender, and getting this right is often the difference between a decline and an approval.

• Depreciation, because it is a non-cash deduction.
• Interest on any debt that is being refinanced or cleared by the new loan, since that expense will not exist afterwards.
• One-off or non-recurring expenses, where they can be evidenced as genuinely one-off.
• Additional superannuation contributions above what is required.
• Certain lease or hire purchase payments, treated according to the lender’s policy.

Add-backs are a lending concept, not a tax one. Nothing here changes your tax position, and the deductibility of anything is a question for a registered tax agent rather than a broker.

An outstanding tax balance is not automatically fatal to a loan application, but it does have to be addressed rather than mentioned in passing. Most lenders will want one of three things: the balance cleared at settlement from loan proceeds, a formal payment plan with evidence that it has been adhered to, or a clear explanation supported by documents.

There is a second reason to move early. The Tax Office is able to disclose certain business tax debts to credit reporting bureaus where the criteria are met, which generally involve an ABN, a debt above a threshold amount, an overdue period, and an absence of engagement with the Tax Office about it. The specific threshold and periods should be checked at the source rather than assumed, because they are set by legislation and administrative practice that change. Once a debt is reported, it is visible to every lender you approach.

Engagement is the protective factor in almost every version of this. A balance being actively dealt with reads very differently to a balance being ignored, both to the Tax Office and to a credit assessor.

Integrated client account

The account that generally carries activity statement liabilities such as GST and PAYG. An income tax assessment usually sits on a separate account, and lenders ask which one the balance is on.

General interest charge

The charge applied to an overdue tax balance, compounded daily. Its deductibility treatment has changed in recent years, so confirm the current position with a registered tax agent.

Payment plan

A formal arrangement to pay the balance by instalments. Evidence that the instalments have actually been met is the part lenders want to see.

Garnishee notice

A direction to a third party, such as your bank or a customer who owes you money, to pay the Tax Office instead of paying you.

Business tax debt reporting

The disclosure of certain business tax debts to credit reporting bureaus where the legislated criteria are met. Check the thresholds and periods at the source, because they change.

For a sole trader, the money is mixed by nature but the record-keeping should not be. When business debt is refinanced into a loan secured by the family home, the resulting account can become a blend of home purchase debt and business debt with no clear line between them.

The practical answer is a split. Ask the lender to place the business portion in its own sub-account so that the balance, the interest charged and the repayments on that portion are separately identifiable for the life of the loan. It costs little to set up at application and it saves considerable argument later.

Whether interest on that portion is deductible depends on the purpose the borrowed funds were applied to and on the rules as they apply to your circumstances. That is a tax question. Take the split loan statements to a registered tax agent and let them make the call. A broker who tells you a loan is deductible is a broker guessing with your money.

1. 01

   Get the true total

   Log into ATO online services and print the account balances, then list every other debt with its balance, limit, rate and repayment. Guessing at this stage produces a plan that does not hold.

2. 02

   Talk to your accountant about lodgements

   If returns or activity statements are outstanding, start that work now. It runs in parallel with a finance application and it widens the lender options considerably.

3. 03

   Establish what security exists

   Owned property, business premises, plant and vehicles. This determines whether the answer is a refinance, a business facility, or a combination.

4. 04

   Keep the Tax Office engaged

   A payment plan in place and being met is a materially better position than silence, both while the application runs and if the timing slips.

5. 05

   Structure the loan before you sign it

   Splits, term and repayment set deliberately. The five minutes spent here shapes the next several years.

6. 06

   Fix the cause

   A separate tax account funded from every payment received is the single most effective habit a sole trader can adopt. Consolidation buys the room to build it.