Since the Global Financial Crisis, it has been very common for the Australian Taxation Office in assisting companies manage their tax obligations by entering into negotiated payment arrangements. This has allowed Directors of struggling companies some breathing space by providing sustainable cash flow management in tough times. However Directors need to beware that entering into a payment arrangement could come back to haunt them in the future by making them personally liable. This article explores recent changes to Director Penalty Notices and Directors’ Indemnities to the tax office.
Director Penalty Notices
The Tax Laws Amendment (Transfer of Provisions) Act 2010 commenced operation on 1 July 2010 which makes some important changes to the director penalty notices (DPN) regime.
In essence, the DPN is typically served on a director in circumstances where the company has fallen behind in payment of its tax withholding obligations. Failure to comply with the DPN has serious consequences for directors in that they will become personally liable for the company’s outstanding tax and any penalties if the DPN expires without the director complying with one of the prescribed options in which the DPN can be satisfied.
The key amendments are as follows;
- A DPN now takes effect 21 days from the date that it is posted to a director (and not the date in which it is received), rather than 14 days from the date that it is received as was previously the case. It is crucial that directors do
not leave it until the end of the 21 day period to seek advice on a DPN in order to avoid personal liability;
- The ATO is entitled to rely on ASIC records to obtain a director’s address, the onus therefore being on directors to ensure that ASIC records are kept up to date.
- There is now only 3 ways in which directors can be discharged of their obligations under a DPN, being as follows:
- by the company paying the outstanding tax obligation;
- by appointing a voluntary administrator to the company; or
- by commencing a winding up of the company.
- The company by entering into a payment arrangement with the ATO will no longer constitute an end to a director’s obligations under a DPN. However, the ATO cannot commence or take any further steps in existing proceedings against the director whilst a payment arrangement is in force and being complied with.
- There are variations in relation to the defense that is currently available to directors on the basis that the director “was not taking part in the management of the company as a result of illness or some other good reason”. Under the new law, a director must now also establish that such illness or other good reason “meant that it would have been unreasonable” in those circumstances to expect the director to take part in the management of the company.
A recent decision in Young & Anor v Commissioner of Taxation NSWSC 288 is a timely example of another way (in addition to the DPN regime) in which the ATO can ‘lift the corporate veil’ and make directors liable for debts owed by their company to the ATO. In this decision, a personal liability of the Director under Section 588FGA of the Corporations Act 2001 (the “Act”) was identified.
Pursuant to Section 588FGA(2) of the Act, if a Liquidator of a company recovers an unfair preference from the ATO, the ATO has the right to pursue directors of the company for certain amounts for which the ATO is liable to repay the liquidator.
The four elements of a preference claim a Liquidator must establish against the ATO are as follows;
- The company was insolvent when each transaction was entered into or became insolvent as a result of entering into each transaction;
- The ATO and the company were parties to each transaction;
- The transaction resulted in the ATO receiving more than it would have if the transaction were set aside and the ATO proved for the debt in the winding up of the company;
- The transaction was entered into during the six months ending on the relation-back day, or if after that day, on or before the day on which the winding up began.
Legal Proceedings Required to Trigger Personal Liability
The indemnity of Directors under Section 588FGA of the Act requires a court order under Section 588FF of the Act. As such, the ATO can only recover from Directors payments it makes back to a Liquidator upon legal proceedings having been commenced by the Liquidator and a court making an order under Section 588FF of the Act.
Orders are allowed to be made by consent without the necessity to make a finding after the examination of all the evidence. This however in my view questions the fairness to Directors as orders by consent could have significant consequences by automatically triggering an action for the ATO against the Directors personally under Section 588FGA of the Act. In the matter Crosbie, re Trollope Silverwood & Beck Pty Ltd (in liq) v Commissioner of Taxation (2003) 21 ACLC 1,659;  FCA 922, Finkelstein J considered whether a mere consent judgment against the Commissioner satisfied the criteria for the Director’s indemnity, and decided it did not. However Finkelstein’s approach was rejected in Wanted World Wide (Australia) Ltd v FC of T (2004) 22 ACLC 1,284, where the court concluded that s 588FF allows orders to be made by consent without the necessity to make a finding after examination of all the evidence. The court considered the practical advantages of enabling an order to be made on the admissions of the parties before the court, in order to avoid a waste of time, effort, resources and expense. The same approach was followed in Dean-Willcocks v Commissioner of Taxation (No. 2) (2004) 22 ACLC 1,034, where the Court again determined not to follow Crosbie.
The Extent of the Indemnity
Section 588FGA(2) states that:
“Each person who was a director of the company when the payment was made is liable to indemnify the Commissioner in respect of any loss or damage resulting from the order”
An order in favour of the Commissioner under Section 588FGA in respect of “any loss or damage” resulting from a court order under Section 588FF can include the costs ordered to be paid by the Commissioner to the liquidator unless it can be shown that the costs were incurred in consequence of unreasonable conduct by the Commissioner in defending the claim: Commissioner of Taxation v Sims  NSWCA 298.
However there is uncertainty as to whether the indemnity extends to covering the costs of the ATO in defending the preference proceedings. In the matter Deemah Marble & Granite Pty Ltd (In Liq) v Deputy Commissioner of Taxation  NSWSC 1126; (2004) 22 ACLC 81, the Director was ordered to pay the Commissioner’s costs of defending the preference proceedings. However, this was questioned in Sims v Deputy Commissioner of Taxation  NSWSC 305
Directors when entering into a payment arrangement subsequent to the receipt of a DPN need to be satisfied that the payment arrangement will be adhered to, as the payment arrangement with the ATO will no longer constitute an end to a director’s obligations under a DPN.
Directors also need to be cautious when entering into a payment arrangement without a DPN being issued, as they may become personally liable if the payments they make under the payment arrangement are subsequently found to be preferential payments by a Liquidator.
Hence Directors can find themselves stuck between a rock and a hard place when deciding as to whether to enter into a payment arrangement, as the payment arrangement may be crucial in sustaining the company’s cash flow (and existence) in the short term – however may also be a financial catastrophe for the Directors personally if the company is Liquidated in the future.
It is important for Directors to consider the solvency of their company when entering into a payment arrangement. The question they will need to ask is whether the payment arrangement will co-exist with the long term viability of the company or whether it is simply a ‘quick fix’, which only serves the purpose of prolonging the inevitable.
If Directors have any doubts or questions when entering into a payment arrangement, they can speak to the Hall Chadwick insolvency and reconstruction team.