CORPORATIONS ACT 2001 – SECT 588FGA
Directors to indemnify Commissioner of Taxation if certain payments set aside
In the past a director’s liability was realistically limited to any personal guarantees they had granted. Changes to the insolvent trading provisions in the 1990’s strengthened the ability to make claims against directors by grouping all creditors claims under the liquidator. The ITAA also received the automatic liability provisions through the process of issuing Director Penalty Notices.
More recently the Corporations Act was amended to include section 588FGA. In essence it gives the ATO a right to recover from directors an amount of ‘loss or damage’ resulting from having to disgorge a preferential payment to a liquidator. The sections states:
(1) This section applies 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:
or under a provision of Subdivision 16-B in Schedule 1 to the Taxation Administration Act 1953 .
(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 order.
Interestingly the Act captures each person who was a director ‘when the payment was made’, even if they resigned between then and the liquidation, or even was not a director when the original debt was incurred. It should be noted that the company must have been insolvent at the time for the payment to the ATO to have been preferential. The Act makes them liable for the ‘loss or damage’ to the ATO – the interest and costs and the amount of the original preferential payment. This is the reason that directors are now opposing applications for recovery made against the ATO.
It raises the interesting position that directors of insolvent companies may be found to be personally liable for both incurring debts that remain unpaid, and for paying debts before the liquidation, even if the company was solvent when the tax debt was incurred.
It also raises a dilemma for directors. Take a position where the director realises that the company has a cash flow shortage. There is some money, but not enough to pay everyone. But he believes – rightly or wrongly – that things will soon correct itself. He knows that trade creditors will be more lenient with their debts than the ATO.
He will not risk any personal liability if he uses the money to pay trade creditors and, the company later being wound up, the creditor has to return that money to a liquidator. He also knows that the same is not true if he pays the ATO. He may be personally liable for an amount greater than the original payment. This is not a great incentive to pay the ATO if there is any doubt of insolvency.
It also means that directors may cause the company to pay a debt to avoid personal liability under a DPN only to have a larger debt reappear at a later date – or not depending on whether the liquidator decides to pursue the ATO for a preference.