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Director's Liability For Unpaid Tax
Are you or one of your clients having trouble paying your tax liability?
Has the Australian Taxation Office ('ATO') recently served you or one of your clients with a notice to pay?
Are you tempted to enter into an arrangement with the ATO?
If so, then it is in your best interest to read on.

Companies often trade by utilizing either funds collected for Goods and Services Tax (“GST”) or by not remitting group tax (“PAYG”) or Prescribed Payments. Directors entering into such behaviour, even under necessity, must be acutely aware of the personal liability that may arise. The ATO has recently been cracking down on such practices by issuing notices under Section 222AOE of the Income Tax Assessment Act (“ITAA”) which may confer a personal liability on directors for unremitted taxes.

Even though, a company may be seen as a separate legal entity to the individual, there are circumstances where directors can be made liable for the company’s tax debts (including penalties). Prior to 1993, the ATO in a liquidation scenario held some priority over certain creditors in relation to outstanding group tax. However, legislation was amended to reduce the priority status of the ATO, but at the same time provisions were made which allowed the ATO to gain the power of creating a personal liability by way of penalty for directors.

The ATO has various legislation at its disposal for the recovery of outstanding tax liabilities. These include normal commercial debt recovery procedures together with special legislative powers afforded to it via the ITAA. These collection procedures have the ability to greatly impact upon the:

  • Ongoing viability of a business; 
  • Personal assets of directors; and 
  • Floating charge security held by financiers. 

Directors Personal Liability

Directors’ personal liability may arise where the Commissioner of Taxation issues a Director Liability Notice (“DLN”) under Section 222AOE of the ITAA to the directors at a time when the company has failed to remit tax. This notice instructs the company’s directors to act within fourteen (14) days of receipt of the DLN to cause the company to enter into one of four stipulated events. These events are:

  • Pay the liability or estimated liability as indicated in the notice; or 
  • Enter into an repayment agreement with the ATO in respect to the liability or estimated liability (these agreements are pursuant to Section 222ALA of the ITAA); or 
  • Appoint an Administrator to the company (pursuant to the Corporations Act); or 
  • Wind up the company (the Courts have provided that the mere fact that an application to wind up the company has been filed, or is pending, is not sufficient to satisfy this event). 
A director who receives a DLN should act immediately and not underestimate the time required to undertake any of the above events. The 14 day period is an extraordinarily short period of time and may directors may be very reluctant to make the decision. However, if the served company does nothing, then the ATO may recover the tax liability or estimated liability from each company director. This liability is both joint and several amongst the directors. Directors who have resigned may also be liable if any portion of the debt arose and was unpaid whilst they were a director. Further directors may also be responsible for debts incurred prior to their appointment if during their appointment there was unremitted tax debts.

There are very few ways or means for directors to avoid this type of exposure. Two defences are prescribed under the legislation, but they may provide little benefit or assistance. The defences are:

  1. The director establishes that he did not take part in the management of the company at any time while a director because of ill health or some other good reason. 
  2. The director took all reasonable steps to ensure that one of the four actions referred to above was taken, or alternatively there were no such steps that the director could reasonably have taken in all the circumstances. 

Option 2 – Repayment Arrangements

In the recent past, the quick fix has been for directors to enter into repayment arrangements with the ATO. In certain cases, these arrangements are not commercially sound and are not supported by the company’s ability to repay the tax debt and continue to meet all its other liabilities as and when they fall due leaving the company with continuing problems.

In such instances, we have seen the ATO seek personal indemnity by way of security over, either the company’s or the director’s property to safeguard its position and ease ny future recovery process.

If a company is not able to meet the repayment arrangement, any director, between the entering into the arrangement and the subsequent default, may become liable to pay a penalty that equates to the company’s outstanding tax liability. The ITAA automatically imposes a penalty and the ATO is not required to send notices indicating any breach. This failure may also assist any future liquidator in presenting insolvent trading claims against directors.

If a repayment arrangement has been entered into with the ATO and the company subsequently is wound up (for whatever reason), the ATO may be pursued under Section 588FGA of the Corporations Act by the liquidator as these payments may have been received in priority to other creditors. Such payments could be deemed preference payments and the impact of a liquidator successfully recovering same is that the company’s directors may be liable to indemnify the ATO for any losses/damages incurred from having to disgorge some of the monies previously paid.

Further, Gould v FCT (98ATC4946) suggest that even full compliance with the requirements of Section 222AOE may not automatically absolve directors of liability for unpaid tax.

In Gould it was held that notwithstanding compliance by the director with the requirements of Section 222AOE that he was still liable to pay a penalty equal to the amount of the outstanding tax in accordance with Section 8Y of the Taxation Administration Act and a reparation order may be sought under Section 21B of the Crimes Act 1914.

With the ATO’s ever increasing focus on collection and the build up of resources of the area to implement those collections, there is the strong likelihood that over the next twelve (12) months there will be increases in the number of directors that will have direct exposure to Director Liability Notices and the inherent personal liability that could attach to same, if not handled in the correct manner.

The moral to take away with you is:

  1. Act immediately upon receipt of a Directors Liability Notice; 
  2. Seek advice as to the available options; 
  3. Fully consider the sustainability and consequences of the option you choose.
If you have any questions on this or may be faced with advising someone with a DLN then please feel free to contact us on (02) 9633 3333, so we can help with evaluating all of the options.

By David Petrina

Independent Associate Member of Walker Wayland Australasia Limited, a network of independent accounting firms
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