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Directors Penalty Notice & Security Deposit
There has been much huffing and puffing in recent months about the government “crackdown” on phoenix activity but so far very little has made it as far as the law books – two exceptions are security deposits that can be demanded by the ATO from targeted sectors, and some amendments to directors penalty notice rules.
Introduction

On 1 July 2010 amendments to the taxation laws came into effect, following a proposals and consultative paper issued by the Australian government in November 2009 entitled ‘Action Against Fraudulent Phoenix Activity’.

That paper addressed many proposals but very few have been legislated so far.  The ones that did make it through are aimed at addressing phoenix activities and the current director’s penalty regime, specifically the rewrite of Part VI of the Income Tax Assessment Act (“ITAA”) 1936. 

We feel that there are already provisions within the current taxation and corporation legislation to effectively manage the activity of directors who wish to either engage in phoenix activity or breach their duties as directors.  However these provisions are not actively pursued by ASIC or the ATO. 

We question whether the new provisions are effectively designed to protect the ATO’s position rather than the community as a whole from the effects of phoenix activity, and hence the focus on changes to taxation law rather then tightening the provisions already provided in the Corporations Act. We also think these changes may adversely affect economic activity in the SME sector.

Changes to the Act

The changes implemented in Part VI of ITAA 1936 can be broken down into three broad areas:

  • Division 1 – General rules about collection and recovery of Income Tax;
  • Division 8 – Prompt recovery of certain income tax liabilities through estimates;
  • Division 9 to 10 – Director Penalties for non-compliance.

Division 1 Changes

The major area of focus within the Division 1 changes is the expanded ability of the Commissioner to seek a security deposit from a taxpayer for future tax liabilities. Although this provision has been available to the Commissioner since 1936, the changes have expanded the provision to include all taxes administered by the ATO, as opposed to just income tax which previously was the case. Refusal to provide the security sought is a criminal offence.

The provisions have also been updated to include guidelines for the ATO about the process they need to go through, along with rights and obligations of the taxpayer. 

Division 8 to 10 Changes

There are only small differences in the rewrite of these divisions; however the changes do allow the Commissioner to assess unreported PAYG and take legal action based on those estimates. This option was not previously available to the Commissioner. There were also updates to the divisions to bring them up to current ATO protocol, for example to reflect the use of the Running Account Balance System by the ATO.

Division 9 to 10 Changes

As with the changes to the other Divisions the rewrite of the Divisions was aimed at simplifying the provisions of the Act, and it also aimed to provide Directors with a clear set of rights and obligations.

The changes also took into account recent court decisions by increasing the time a director has to respond to a notice from 14 to 21 days (from the date the notice is posted, not when it is received) and ensuring that postage is proof of service as governed by section 28 of the Acts Interpretation Act 1901 and the Taxation Administration Regulation 1976. It also makes clear that the ATO can rely on certain ASIC information, such as the registered address when dealing with a tax payer.

The company will have a period of 21 days rather than 14 days to either comply with its tax obligation, appoint a voluntary administrator or wind the company up – again, allowing more time and in this circumstance, bringing the time limit in line with the time for a creditors’ statutory demand (although that of course runs from the date of receipt by the company and not the date of posting).

The division has also seen a redefining of what a business is, with references to ‘carrying on a business’ in section 213 have been changed to ‘carrying on an enterprise’ to reflect the widened application of the provisions to other taxes, including the goods and services tax.

The provisions have been amended so that entering into an instalment arrangement will not remit the director’s obligations under the DPN – this changes the position previously as an arrangement to pay the tax would bring the DPN to an end.

The provisions have also been amended to make it more difficult for a director to rely on the defence that the director did not take part in the management of the company as a result of ‘illness or other good reason’ - it is now a requirement that the director show it would have been unreasonable to expect the director to have taken part in the management of the company at that time. This overcomes a number of decisions where the ATO was unsuccessful in DPN proceedings where directors have relevantly relied upon an extended illness or even, in one case, the illness of their wife to say that they were not involved in management.

Effect of Changes
The changes to Division 1 are the most significant and although the ATO has given assurances that this provision will only be used in limited circumstances where the ATO assesses that the risk is significant, the wording of the legislation allows for a very broad definition of the public interest.
 
We believe that the provision of a security deposit will increase the burden on small business and act as a disincentive to start a new business. We understand that there is a need to protect the community from phoenix activity, but we believe the provisions are already available and not fully utilised. This change only protects the ATO and not all creditors.  It effectively gives the ATO a priority over other creditors, which was foregone in the major changes to the Corporations insolvency legislation in 1993 by ensuring that moneys outstanding to the ATO are paid in full before other creditors receive any money outstanding – and that will include employee creditors.
 
It is an axiom of capitalism that economies grow by people taking risk. Consequently risk is assessed in the market place and accounted for in margins. Sometimes these risks result in mistakes been made and insolvency ensues. This may result in a company going into external administration, with the directors having in the past the opportunity to start business afresh, hopefully learning from their mistakes and having another go – all success stories in the business world proudly admit to having had failures in the past!  Let us hope that the process of identifying the companies that are required to put up deposits will not create a deterrent to the entrepreneurs among us and a resultant stagnation of our economy. This impost on working capital could be disastrous for the SME market.

We are also doubtful that the requirement for a security deposit will be a strong deterrent to a company determined to avoid its taxation liabilities – it will just be another impediment to doing business, and one that will no doubt be funded from future tax liabilities! However it is likely to be a huge impost on the honest entrepreneur. 

The changes to Division 8 – 10 are largely cosmetic; however directors should now be aware that the ATO is now able to assess unreported PAYG if a company has not lodged the required information.

Once again the changes to Division 9 – 10 relate largely to administrative changes, however the widening of the definition of a business allows the ATO to spread a wider net when issuing directors’ penalty notices. There is also more onus on the directors to ensure that repayment arrangements are complied with to avoid personal liability for the taxation debts.

Conclusion
We are doubtful that the changes are an effective method for reducing the occurrence of phoenix activity; however directors should be aware of their new rights and obligations under the Act. Specifically:
 
  • The ATO’s ability to request a security deposit on setting up a new business;
  • The ATO’s ability to assess unreported PAYG;
  • The expanded definition of a business in relation to Directors Penalty Notices;
  • Ongoing personal responsibility for unpaid debts even when repayment arrangements are entered into.

So far, the changes are only in relation to withholding taxes although it has been proposed that the DPN legislation be extended to all of a company’s taxation liabilities.  We will keep you posted with any amendments that come through.

If you have any concerns as to whether these changes will affect you or your clients, you should seek independent professional advice without delay.  Speak with your accountant or taxation advisors, or call our offices for assistance. 

Written by Anthony Bagala & Justin Ward