Page 1 of 5 Liable if you do – Liable if you dont Introduction

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Page 1 of 5 Liable if you do – Liable if you dont Introduction Powered By Docstoc
					                               Liable if you do – Liable if you don’t


Directors may be exposed to personal liability when their companies are wound up. The most
common exposure is through personal guarantees granted to creditors, but exposure is possible
through Insolvent Trading and Part 5.8B claims (for loss of employee entitlements). To be
exposed to other types of claims, a director would have had to have entered into some
transaction that is void because it was uncommercial (section 588FB) or was unreasonable
(section 588FDA).

Historically directors had little to no exposure to a company’s outstanding tax debts. To
compensate, section 221P of the Income Tax Assessment Act (ITAA) gave the Australian
Taxation Office (ATO) a priority over other creditors. In 1993 the ITAA lost that priority but
received the automatic liability provisions and could make directors personally liable for a range
of outstanding tax debts. This is done through the process of issuing Director Penalty Notices.

The common factor is that most of the recovery provisions and potential exposures are aimed at
‘directors’. Whether a person is, or was at some time, a director of a company and liable under
one of these provisions (particularly to the ATO) is wider than most people believe.

Who is a director?

Section 9 of the Corporations Act defines a director in two broad groups:

     (i) those people appointed as directors regardless of their title; and
     (ii) those people who are not formally appointed but act in the position of a director; or
             whose directions the directors of the company are accustomed to follow.

Finding people that have been appointed as directors is pretty straight forward. Their names will
be on the company register and company documents. Identifying the second group is more

This second group falls into two broad categories which are generally differentiated by knowledge
and intent. One category includes people acting as ‘shadow directors’ through nominees or other
appointed directors. Examples are the (usually bankrupt) husband controlling a company through
his wife who has been appointed as the director, or the non-resident person standing behind the

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'man-of-straw' director located in this jurisdiction. These people know that they are acting as the
guiding hand - they just want to distance themselves from the company.

The other category is those people whose activities unintentionally make them directors. They are
sometimes called de facto directors and are generally surprised when they are summonsed for
public examinations or receive demands. Their activities were not designed to make them
directors or hide their involvement in the company, they just crossed the statutory line between
acting as a director and not.

To be caught under this definition, these people must have acted in the position of a director by
taking on some of the usual tasks of a director, or have had the appointed directors continually
act in accordance with their instructions. Both of these contemplate some active involvement in
directing the company, albeit unintentionally. The more an advisor does to lead the company – as
opposed to giving advice and letting the directors decide whether or not to follow it– the more
likely he or she will be a director.

An often quoted case of an advisor who crossed that statutory line is DFC of T v Austin (1998) 16
ACLC 1. Austin was a past director but continued with tasks and dealings with certain parties
after his resignation. The court found that he was a ‘director’ under the extended definition.

Director Penalty Notices

The mechanics that create personal liability for outstanding taxes are pretty straight-forward.
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 ITAA.

If a director fails to cause the company to pay its tax or to 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.
This occurs whether or not the company is insolvent at the time. 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:

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This provision applies to anyone who falls under the definition of a director at any time from when
the tax was deducted to when it was payable. Anyone becoming a director even on the day
before the tax is due for payment will be liable for the penalty, even though they were not
directors when the tax was incurred or accrued or ‘deducted’. Conversely, people resigning as
directors during this period do not escape liability.

Although the liability exists, the ATO must follow a specific procedure in order to collect the
penalty. Section 222AOC only makes the director liable for the penalty, it does not allow for its
collection. 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 [Director Penalty] notice...”. The ATO must issue a Director Penalty Notice (DPN) to
the director under section 222AOE before it can collect the penalty.

The director may avoid having to pay the penalty if, within 14 days from the date that the DPN
was posted by the ATO (not received by the director - DCT v Meredith [2007] NSWCA 354), they
ensure that:

        (i) the liability has been discharged; or
        (ii) an agreement relating to the liability is in force under section 222ALA; or
        (iii) the company is under administration within the meaning of the Corporations Act ; or
        (iv) the company is being wound up.

If the director does not do one of these four things within the 14 days, the ATO will be able to
commence collection proceedings personally against the director. Most directors of companies
unable to pay the tax debts will appoint a liquidator or administrator of the company.
Unfortunately some do this on day 15.

Sometimes the company has the capability to pay the outstanding tax debt to the ATO and satisfy
that liability. This in turn satisfies the penalty owed personally to the ATO. But, if the company is
later wound up, the director’s exposure to that debt may not end there.

Section 588FGA – A Second Exposure

The ATO is not immune to demands from liquidators for the return of preferential payments.
Indeed actions for the recovery of preferences against the ATO are common because the ATO is
a creditor in the vast majority of liquidations, the amounts involved are often significant and they
have a strong collection policy.

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Often the ATO cannot defend the claim because it became aware of the company’s insolvency
through its collection process. To compensate, special amendments were introduced to the
Corporations Act that place a statutory liability on directors to indemnify the commissioner if any
amount is successfully clawed back by a liquidator. This is set out in section 588FGA:

          588FGA(1).. if the Court makes an order under section 588FF against the Commissioner
          of Taxation because of the payment of an amount in respect of a liability under any of the
          following provisions of the Income Tax Assessment Act 1936 ..
          (2) 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

The commissioner can require any person who was a director (under the extended definition) at
the time that the payment was made by the company to the ATO to indemnify them for the 'loss
or damage' if the court orders that an amount be repaid to the liquidator. That loss or damage can
include interest on the claim and costs on top of the amount of the original preferential payment.
This is what happened in the Austin case and is the reason that some directors now oppose
applications for recovery made against the ATO.

This process captures each person who was a director 'when the payment was made', even if
they were not a director when the original tax debt was incurred, or resigned between when the
payment was made and the liquidation. Directors can once again become liable to the ATO even
if the company pays all of its tax debts before liquidation.

Double Jeopardy

This could lead to an interesting position. Directors of insolvent companies may end up with
personal exposure for both:

    1. debts that remain unpaid at the time of the liquidation (Insolvent Trading), and
    2. debts that were paid to the ATO before the liquidation.

Directors of companies with cash shortages face a dilemma. Who does he pay if there is not
enough money to pay everyone, but he rightly or wrongly believes the shortage will soon correct

There is no risk of personal exposure if he pays trade creditors and the company is later wound
up and the creditor has to return that money to a liquidator. This will also reduce the amount of

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any possible insolvent trading claim, as they are based on debts that remain unpaid at the time of
the liquidation.

The same is not true if he uses that money to pay the ATO. Directors that cause the company to
pay a tax debt to avoid personal liability under a DPN or a repayment agreement may face a
personal debt at a later date if the ATO is ordered to pay money back to the liquidator. This does
not create a great incentive to pay the ATO if there is any doubt of insolvency.

A practical issue for directors and their advisors arises when a tough decision has to be made
between a company paying the ATO - a debt due on one hand - and the company being placed
into administration or liquidation on the other. If a decision is made to pay the ATO and trade on,
there is a real risk that the directors can become personally liable for the tax debt plus costs if
ongoing trading is not successful. But the safe alternative is to admit defeat and appoint external

Both Michael Peldan and Michael Griffin are partners in the Brisbane office of Worrells Solvency
and Forensic Accountants, Official Liquidators and Registered Trustees. Michael Peldan can be
contacted on 07 3225 4370 or Michael Griffin can be contacted
on 07 3225 4360 or

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