Tax: directors of companies used to be isolated from company tax debts. Not any more, says Michael Pelden.
The ATO is the most common creditor in insolvent estates, whether personal or corporate. The ATO is seen as an easy and cheap source of short-term funding when cash flow tightens, and an easy creditor to delay, usually without penalty. Tax debts are commonly the last to be brought up to date when cash starts to become available.
Directors of companies used to be isolated from company tax debts. Historically the ATO was a priority creditor in liquidations for outstanding group and PPS (prescribed payments system) debts. This priority compensated the ATO for the lack of access to the directors personally. However, this regime changed in 1993 and since then the gloves have come off.
The old 221P priority provisions went out, and the ATO became a non-priority unsecured creditor alongside all other creditors in the liquidation. But they also picked up provisions that allow collection of some tax debts personally from directors of companies. While the existence of these provisions is generally well known, some of the detail, and potential exposure, is not.
Since June 1993 the ATO has had the power to collect outstanding deducted taxes (now deducted amounts under the PAYG provisions) by making directors liable for a penalty in the same amount as the unpaid tax. These provisions create a separate parallel liability to the ATO in the name of the director, or more than one separate parallel liability if there is more than one director. Each director becomes separately liable for the full amount of the penalty.
While the provisions currently only apply to outstanding PAYG, usually this is one of the two largest amounts of tax owed by companies when they are wound up. At this stage GST is not caught under this regime, but one would think that the government will change that position at some stage in the future.
The creation of the penalty
The mechanics that create the penalty are pretty straightforward. Directors are under a positive obligation to cause the company to pay deducted or withheld tax or take other specified remedial action by the time it is due for payment. This is set out in section 222AOB of the Income Tax Assessment Act 1936 (ITAA).
222AOB(1)
The persons who are directors of the company from time to time on or after the first deduction day must cause the company to do at least one of the following on or before the due date:
comply with its obligations in relation to deductions (if any) and amounts withheld (if any) whose due date is the same as the due date
make an agreement with the Commissioner under section 222ALA in relation to the company's liability
appoint an administrator of the company under section 436A of the Corporations Act 2001
begin to be wound up within the meaning of that Act
If a director fails to cause the company to pay its tax or take other action before the tax is due, they automatically become liable for a penalty in the amount of the tax that has not been paid. The ATO does not need to issue any notices or take any action to create the penalty; it simply relies on section 222AOC.
222AOC(1)
If section 222AOB is not complied with on or before the due date, each person who was a director of the company at any time during the period beginning on the first deduction day and ending on the due date is liable to pay to the commissioner, by way of penalty, an amount equal to the unpaid amount of the company's liability under a remittance provision in respect of deductions or amounts withheld.
This provision captures anyone who was a director at any time from when the tax was deducted to when it was payable. People becoming directors even on the day before the tax is due for payment will be liable for the penalty, even if they were not directors when the tax debt was incurred or accrued or deducted. Conversely, people resigning as directors during this period do not escape liability.
There is some good news. The ATO must follow a specific procedure to make the amount collectable. The word collectable is used on purpose, as section 222AOC only makes the director liable for the penalty; it does not allow for collection of the penalty. This is expressed in section 222AOE(1):
The Commissioner is not entitled to recover from a person a penalty payable under this Subdivision until the end of 14 days after the Commissioner gives to the person a notice ...'
This is where directors may avoid personal liability, but strict time limits apply. Section 222AOE dictates that the ATO must issue what is known as a director's penalty notice (DPN) to the director to make the penalty collectable.
The DPN must set out and specify all of the details of the liability and state the person receiving the notice is liable to pay the penalty, but that it will be deemed remitted if the director takes one of the four options set out in the no-tice within 14 days 'after the notice is given'. The four options are:
the liability has been discharged
an agreement relating to the liability is in force under section 222ALA
the company is under administration within the meaning of the Corporations Act 2001
the company is being wound up.
The 14 days is a strict time limit. The ATO has no discretion to extend the period. It may be possible to ar-gue that the notice was not received for a few days after it was issued, but positive evidence will have to be given proving the actual delivery date of the notice. Generally, once the ATO proves that the notice was posted, the deemed delivery provisions in the relevant Acts will be upheld if there is any doubt and little evidence. Directors must act within the 14 days.
If the company is solvent, it should pay the tax. Directors of companies that could not pay the tax usually decided to appoint voluntary administrators as this could be done within a few days, and the ATO may not be the only creditor making demands. Unfortunately some directors reach that realisation on day 15.
The danger areas
DPNs do not have to be served in the same way as legal proceedings. The Tax Office only needs to give notice and this can be done 'by leaving it at, or sending it by post to, an address that appears from [ASIC or ATO] documents to be, or to have been within the last seven days, the person's place of residence or business'. Directors and their advisers need to ensure that address details are up to date, or the notice may be issued and expire without the director even being aware of it. [DCT v Woodhams (2000) 199 CLR 370]
The four choices may be more limited than they first appear:
It generally takes longer than 14 days to wind up a company in the court, and the Act requires that the company is in the process of being wound up to comply with the DPN, as opposed to preparing to be wound up to comply with section 222AOB. Making the application to court to wind up the company is not sufficient. Until 1 January 2008 a creditor's voluntary liquidation (CVL) took about nine days or so to arrange (at least seven days notice had to be given to creditors). Recent changes to that legislation now allow the directors' and members' meetings to be easily held within the 14-day period, so winding up the company may be possible under a CVL.
222ALA agreements may take longer than 14 days to negotiate and execute. Directors may not even be aware that this option exists until they receive the notice and then may not understand what it means. There is no certainty that the ATO will accept any proposal made by the company.
Risk for new directors
One of the less known parts of this division is the liability that may attach to directors appointed after the due date for payment of the tax. They may agree to be appointed as a director with no knowledge of the outstanding tax, and 14 days later be personally liable for tax debts that were incurred and became payable well before their appointment. New directors have 14 days to make the company comply with section 222AOB or they too will be added to the DPN mailing list. Simply resigning within the 14 days does not remove this liability.
222AOD(1)
if after the due date, a person becomes, or again becomes, a director of the company at a time when section 222AOB has not yet been complied with
and at the end of 14 days after the person becomes a director, that section has still not been complied with; the person is liable to pay to the Commissioner, by way of penalty, an amount equal to the unpaid amount of the liability referred to in subsection 222AOC(1).
Once new directors become liable for the penalty under this section, a DPN can be issued. Obviously people contemplating becoming company directors should satisfy themselves that all relevant tax liabilities are up to date.
Remittance of liability
The only other good news is that section 222AOG extinguishes the liability for the penalty, not just the ability to collect the penalty, if one of the four options set out in the DPN is taken within the 14-day time period. Actions taken after the 14 days may affect the company, but will not affect the personal liability of the director for the penalty.
if a penalty is payable by a person under this subdivision
section 222AOB, 222AOBAA or 222AOBA (whichever relates to the penalty) is complied with at a time when the Commissioner has not yet given the person a notice under section 222AOE, or within 14 days after the Commissioner gives the person such a notice; the penalty is remitted because of this section.
Once the director's penalty notice expires, the only way to remove the liability for the penalty is to pay it.
Even though the ITAA creates separate parallel liabilities for each director and retains the one in the name of the company, they are connected to the extent that a reduction or satisfaction of one reduces or satisfies the others. But to receive the benefit under section 222AOH, the money has to be paid or applied to the discharge of one of the parallel liabilities
This means that if, at a particular time:
an amount is paid or applied towards discharging one of the parallel liabilities
because of section 222AHA, one of the parallel liabilities is discharged to the extent of a particular amount;each of the others that is in existence at that time is discharged to the extent of the same amount
The directors, if more than one, can each make part payment of the penalty and receive the benefit of the other part payments. But any amount not paid may form the basis of collection or bankruptcy proceedings against all directors.
It is not uncommon to find that the company has very limited funds by the time that DPNs are issued, and the di-rectors have already invested all of their available money into the company to keep it afloat to that point. In these cases, by the time that the DPNs are issued no one has any money to pay them.
Defences to an expired DPN
Section 222AOB sets out a positive obligation for directors to take some action, but they may simply not be able to do so. Directors in that position may be able to rely on the statutory defences set out in section 222AOJ. These defences fall into two categories:
that illness or some other good reason stopped the director from taking part in the management of the company. It is a defence if it is proved that, because of illness or for some other good reason, the person did not take part in the management of the company at any time when: (a) the person was a director, (b) the directors were under the obligation to comply with subsection 222AOB(1) or 222AOBAA(1).
that the director took all reasonable steps to make the directors comply with the notice, or that there were no steps that the person could have taken. Directors of single director companies will have a hard time relying on this defence. It is also a defence if it is proved that: (a) the person took all reasonable steps to ensure that the directors complied with subsection 222AOB(1), 222AOBAA(1) or 222AOBA(1) (whichever is relevant), (b) there were no such steps that the person could have taken.
Essentially if the director was unable to do anything for reasons beyond his control (illness), or they made every effort to have the company comply, but could not take them by themselves (being a minority director), they may be relieved from the liability. But the onus of proving these defences lies with the person trying to rely on them.
Repayment agreements with the ATO
One of the four options available to directors under sections 222AOB and 222AOE is to have the company enter into a formal written repayment agreement under section 222ALA of the Act.
Section 222ALA states that the agreement must be to pay 'specific amounts, on specific days' and for the purpose of 'discharging one or more specified liabilities'. This amount of detail is important.
The courts recently considered the terms of an agreement that was meant to have been a 222ALA agreement. That particular agreement included terms for the payment of tax liabilities that were not subject to section 222ALA, and it did not adequately specify that payments were for discharging one or more specified liabilities. The directors argued that they had entered into a section 222ALA agreement and this complied with the DPN issued to them. The Court and the Court of Appeal held that the agreement did not comply with section 222ALA because of these irregularities, and therefore did not satisfy the terms of the DPN. [Paola v DCT (2007) NSWCA 108]
222ALA(1)
The Commissioner may make with a person a written agreement under which the person is to pay specified amounts, on specified days, for the purpose of discharging one or more specified liabilities of the person, each of which is:
a liability under a remittance provision; or
a liability to pay an estimate.
This case emphasised the need for the agreement to strictly comply with the terms of section 222ALA, otherwise the protection sought may not be achieved.
A complying 222ALA agreement satisfies the terms of a DPN and effectively remits that penalty. This eliminates one obligation, but creates another. Section 222AQA creates a new positive obligation for directors to 'cause the company to comply with the agreement'.
The position of directors is no worse than the position they were in before. There is still a potential for personal liability for the debt, but at least while the agreement is in force the company and its directors have some time to meet these commitments.
But entering into a 222ALA agreement only provides relief from personal liability while the terms of the agreement are being fulfilled. If the company defaults, the directors are personally liable for the unpaid balance of the agreement.
They are in the same position as if the DPN had expired, subject to a reduction in the amount owed due to payments that have already been made.
222AQA(2):
If the company contravenes the agreement by failing to pay a specified amount on or before the specified day, or by contravening a special condition, each person who was a director of the company at any time during the period beginning on the day when the agreement was made and ending on the day of the contravention is liable to pay to the commissioner, by way of penalty, an amount equal to the balance payable under the agreement.
There are also statutory defences to recovery under a breached 222ALA agreement. These are similar to the defences against DPNs.
It is a defence under section 222AQD if:
'because of illness or for some other good reason', the director did not take part in the management of the company during the relevant period, or
if the director took all reasonable steps to ensure that the company complied with the agreement, or there were no steps that could have been taken. Again, directors of single director companies will have a hard time relying on this defence
These defences are only available to a director if 'it is also proved that, at that time, the person had reasonable grounds to expect, and did expect, that the company would comply with the agreement'. If the director cannot provide that proof, the defences will not be available.
Summary
Most directors are aware that they can become personally liable for some unpaid tax liabilities. The positive obligations set out in the Act and DPNs provide a range of options to protect directors from that personal liability, but realistically by the time that the notice is issued and advice has been sought, the options can be limited either to paying the debt or entering into voluntary administration or voluntary liquidation.
New directors may not be aware that they too may become liable for past tax debts.
Often the ATO provides some breathing space by not issuing DPNs immediately after the tax is due. This may allow a 222ALA agreement to be explored or the company to be wound up. But section 222ALA agreements remove one liability and create another, hopefully more manageable, obligation. They do not entirely remove the prospect of personal liability.
Michael Peldan is a partner at Worrells Solvency and Forensic Accountants, Official Liquidators and Registered Trustees.
