Nick Bruining: Bankruptcy risk for individuals, small businesses with this huge change to ATO interest rules

D-Day is looming for thousands of Aussies who owe the Australian Taxation Office unpaid tax.

A change in the rules is likely to cost many small businesses and sole traders thousands of dollars in extra tax.

While the move is likely to bring in millions of dollars in revenue for the Government, it could trigger a significant number of bankruptcies.

The very nature of a tax debt means many caught in the net won’t be able to rearrange their affairs to minimise the damage.

From July 1, the interest charged on money owed to the ATO will no longer be tax-deductible. With the current annual interest rate a whopping 11.17 per cent, a $100,000 debt will cost you a non-tax-deductible amount of $11,700 a year.

The general interest charge — known as the GIC — is set on a quarterly basis.

The move was announced as part of the 2023–24 Mid-Year Economic and Fiscal Outlook.

The Federal Government announced tax law would be amended to deny income tax deductions for ATO interest charges, starting on or after July 1, 2025.

H&R Block director Mark Chapman said the greatest impact would be on individual taxpayers, including those involved in a small business.

“Many mum-and-dad taxpayers can get caught up in the GIC if they owe personal tax and haven’t settled it by the due date or they have entered into an ATO payment plan,” Mr Chapman said.

“In most cases, they are still accruing GIC daily. It will also affect sole traders or property investors who miss their BAS (business activity statement) or income tax payments.”

Chartered accountant Phillip Sieber said many of his clients would be affected.

“Times are tough and many people are effectively using the ATO to help fund their business,” Mr Sieber said.

“By not paying tax — including PAYG instalments and GST — they are using that money to keep the doors open. Making the GIC non-deductible is just another expense and a new layer of pain.”

That could lead to some businesses failing and people forced into bankruptcy.

One strategy may be to borrow funds to pay out the money owed to the ATO. Potentially, you could claim the interest from the loan as a tax deduction.

But Mr Chapman warned how the loan was established and documented would determine whether the strategy worked.

“You can’t simply borrow the money to pay out the tax debt and claim a deduction. The law says the debt must be used for assessable income-producing purposes for it to be tax-deductible,” he said.

Any arrangements need to be properly structured and documented, and both tax experts recommend seeking professional advice before employing the strategy

“The other reality is that for many, they won’t be in a position to borrow the additional money to pay out the tax debt,” Mr Sieber said.

“The reason they owe the ATO money in the first place is because they’re already stretched to the maximum.”

People who owe money to the ATO and are incurring either the GIC or the shortfall interest charge have been urged to seek professional advice in the lead-up to the July 1 deadline.

While the tax-deductibility rules won’t be changing, qualified tax agents may be able to provide strategies to reduce the impact.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association.