This is a question often asked of lawyers. There are many tax risks a person is exposed to when they agree to become a company director.
Below is an extract from a paper I presented at a Legalwise Seminar "Business Clients: 20 Answers To Their Most Asked Questions" in Perth on 21 November 2019.
- Risk of breaching directors duties if taxes are not paid
Directors have an obligation to act in good faith and in the best interests of the Company and to act with reasonable care and diligence. This includes ensuring the company's tax affairs and tax compliance matters are managed diligently.
Accordingly, a director must ensure that a company of which he or she is a director complies with its tax payment obligations. Failure to do so can result in the director being in breach of his or her legal duties as a director, which may attract penalties under the Corporations Act 2001. This could include civil penalties, compensation proceedings and criminal charges. Seek our advice as needed.
- Risk of personal liability under Director Penalty Notices
Division 269 of Schedule 1 of the Taxation Administration Act 1953 (Cth) (the TAA) sets out the Director Penalty Notice (DPN) regime. Under Division 269 directors are required to ensure that the company complies with its Pay As You Go (PAYG) withholding and Superannuation Guarantee Charge (SGC) obligations. If a director fails to ensure compliance, the Commissioner of Taxation can recover personally from the director a penalty equal to the company's outstanding PAYG and SGC obligations.
What is PAYG withholding?
By law a company must withhold tax from salary, wages, commission, bonuses or other allowances the company pays to an individual as an employee. Tax legislation also requires a company to withhold tax in other scenarios, including:
- payments to company directors and officer holders;
- payments to workers under a labour-hire agreement;
- payments under certain voluntary agreements; and
- payments to suppliers where an ABN has not been quoted in relation to a supply.
Broadly, these laws are known as the PAYG withholding regime. Withheld tax amounts must be paid to the ATO.
What are SGC obligations?
By law a company must also pay compulsory superannuation guarantee amounts to its employees. The Superannuation Guarantee (Administration) Act 1992 (SGAA) requires that employers pay a fixed percentage of an employee's earnings into the employee's superannuation fund. This is the superannuation guarantee (SG) amount. A Superannuation Guarantee Charge (SGC) is imposed on employers who fail to pay the required SG amount i.e. the SGC is the shortfall plus interest (usually 10% per annum) and administration costs (usually $20 per employee per period). The SGC must be paid by the employer to the ATO each quarter.
Personal liability under Director Penalty Notices
The DPN regime allows the ATO to impose a personal penalty on directors who fail to ensure a company complies with its PAYG withholding and SGC obligations.
In summary, if a company has an outstanding PAYG withholding or SGC debt then the ATO can send a DPN to a director giving that director 21 days to:
- cause the company to pay the debt; or
- put the company into liquidation; or
- put the company into voluntary administration; or
- come to a payment arrangement with the ATO.
Requirements for a valid DPN
Section 269-25 of the TAA sets out the requirements for a DPN to be valid. The DPN must:
- set out what the ATO thinks is the unpaid amount of the company's PAYG withholding or SGC liability;
- state that the director is liable to pay to the ATO, by way of penalty, an amount equal to that unpaid amount because of an obligation the director has or had under Division 269 of Schedule 1 of the TAA; and
- explain the main circumstances in which the penalty will be remitted.
Notably, the DPN does not have to be physically received by a director for it to be valid, as long as there was effective delivery as defined in the TAA.
Avoiding personal liability under a DPN
After a DPN is issued, the ability of the director to avoid paying the penalty personally is relatively limited. If the unpaid PAYG withholding or SGC amount was reported to the ATO within three months of the due date, then the personal penalty can be remitted (cancelled) if:
- the company pays the outstanding debts;
- an administrator is appointed; or
- the company commenced being wound up,
within 21 days of the DPN being given.
Importantly, the penalty on the director may not be remitted if instead a payment arrangement is agreed with the ATO (as referred to above). The ATO can commence proceedings against the director at the end of the 21 day period.
So, a DPN cannot be ignored and must be dealt with promptly. To be clear, the 21 days runs from the date of issue, not the date of receipt.
Prior to 2012 it was sometimes possible to wind up a company at any time to avoid paying the penalty in a DPN. Amendments to the TAA in 2012 removed this ability. Essentially, the 2012 amendments make directors automatically personally liable for PAYG withholding and SGC amounts that remain unpaid and unreported three months after the due date for lodging a tax return. A DPN issued in relation to such debts is a so-called "Lock down DPN". A director who receives a Lock down DPN cannot cause the DPN penalties to be remitted by placing the company into voluntary administration or liquidation.
So, directors must be diligent in ensuring a company keeps it tax returns up to date and lodged. Adopting a tactic of failing to lodge returns will not work. Even if the company cannot pay a PAYG withholding or SGC debt, directors must still lodge the return anyway. If they do not do so, automatic personal liability will be imposed and that liability will not be able to be remitted if a Lock down DPN is issued.
Defences to liability under a DPN
A director may avoid personal liability under a DPN if a statutory defence is applicable. Broadly, a director may avoid personal liability if the director can show that:
- because of illness or some other good reason, the director did not take part in the management of the company at the time when the company incurred the PAYG withholding or SGC or obligation; or
- the director took all reasonable steps to ensure the company complied with its PAYG withholding or SGC obligation, by ensuring one of the following things happened:
- the company paid the amount outstanding;
- an administrator was appointed to the company;
- the directors began winding up the company; or
- in the case of an unpaid SGC liability – the company treated the SGAA as applying in a way that could be reasonably argued was in accordance with the law, and took reasonable care in applying that Act.
The TAA allows for defences to be raised within 60 days from notification – that is, 60 days from when the DPN is issued. Again, a DPN cannot be ignored and must be dealt with promptly.
A DPN defence must be submitted to the ATO in writing, clearly articulating which defence the director is seeking to rely on. It should provide all the necessary information and supporting documentation to substantiate the defence. We can assist in this regard.
The illness defence mentioned above has a number of limbs that must be satisfied. These are discussed in the case of Deputy Commissioner of Taxation v Snell  NSWDC 159. A detailed discussion is beyond the scope of this article. For present purposes, it is sufficient to observe that it can be difficult to substantiate the defence, as there must not be any evidence that the director took part in any aspect of the management of the company at any time during the relevant period. It is not enough to show that the director did not take part in managing the tax affairs of the company.
Also, medical evidence will be required in support of the proposition that the director could not have reasonably been expected to take part in the management of the company due to the illness.
Reasonable Steps Defence
Section 269-35(2) of the TAA provides that a director is not liable for the penalty in a DPN if the director took all reasonable steps to ensure that one of the outcomes referred to above happened.
In determining what reasonable steps could have been taken, regard must be had to when, and for how long, the director took part in the management of the company as well as all other relevant circumstances. The ATO will consider what a reasonable director in that position during the time the director was subject to the obligation would have done. The assessment is an objective one. Directors who are "too busy" or simply devote their attention elsewhere will not be able to rely on the defence. A lack of attention to details or ignorance of the company's financial position will also not be enough to establish the defence.
Liability of new directors versus previous directors under a DPN
Directors recently appointed to the position are given a grace period to comply with their obligations under section 269-15 of the TAA. A director who is appointed after the due date for a PAYG withholding or SGC liability can become personally liable for the amount if after 30 days the liabilities remain unpaid.
This means that as soon as a director is appointed, they should review the company's PAYG withholding and SGC liabilities, and ensure any amounts which remain unpaid are paid within the 30 day period. They should also check to ensure all outstanding tax returns have been lodged. If they find outstanding PAYG withholding or SGC liabilities or returns, they should seriously consider resigning.
A retired or former director can also be given a DPN. Resigning as a director does not allow a director to escape liability. The courts have confirmed that the ATO can impose liability on persons who were directors at the relevant time when the PAYG withholding or SGC obligation accrued. There is a continuing obligation on directors to ensure the company complies with withholding tax obligations, and this obligation can persist despite the director ceasing to act in the role. Specialist tax advice should be sought by directors in such situations.
- Risk of personal liability for unpaid GST
Proposed legislative amendments may result in directors being exposed to personal liability for unpaid GST. The Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 introduced into Parliament in 2019 will, if enacted, allow the ATO to collect estimates of anticipated GST liabilities from company directors personally in certain circumstances. The amendments will allow the ATO to collect unpaid GST from directors in the same way as PAYG withholding and SGC can be recovered, as discussed above. Directors should keep an eye on the progress of this proposed legislation.
- Risk of personal liability for tax debts incurred while insolvent
Directors can be personally liable for debts incurred by a company where the company trades while insolvent. This is because one of the fundamental duties of a director is to ensure that the company does not trade while it is insolvent. If a company is unable to pay its debts as and when they fall due the company is insolvent.
Common signs of insolvency include:
- suppliers refusing to extend credit to the company;
- minimal or insufficient cash flow;
- problems paying suppliers and other creditors on time;
- difficulty in meeting loan repayments on time;
- difficulty in keeping within bank overdraft limits; and
- legal action being taken, or threatened, by creditors over money owed to them.
In certain circumstances, directors may be liable for debts incurred by a company when it is insolvent. This could include tax liabilities incurred by the company while trading insolvent. There are various penalties and consequences of insolvent trading, including civil penalties, compensation proceedings and criminal charges. A detailed consideration of these issues is beyond the scope of this article. Seek specialist advice from us as needed.
- Risk of personal liability as a Public Officer
A company carrying on business in Australia is obliged to appoint a "public officer" to act as the company's representative and official point of contact for the ATO.
A public officer must be appointed by the company within three months of the company commencing business in Australia or deriving income from property in Australia. It is an offence to fail to appoint a Public Officer. There must always be a person who holds the position of public officer.
Generally, the board of directors will choose who is appointed as a public officer. The power will normally be contained in the company's constitution.
The public officer must ensure that the company meets its obligations under the ITAA, and they can be held liable for penalties which are imposed on the company for failing to comply with the ITAA. Similar provisions are found in the SGAA.
As can be seen from the above, there are many tax risks involved when accepting an appointment as a company director. Diligence on the part of the director is required if personal liability is to be avoided.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.