A question was raised recently by an advisor whose client was the subject of an insolvent trading claim. They wanted to clarify the quantum of the claim made against the client, as it included certain amounts that he believed ‘accrued’ to the company, but were not ‘incurred’ while the company was insolvent.
Insolvent trading claims (section 588G) are made by liqudiators to seek compensation from directors of companies when they cause or fail to stop the company from incurring a debt when the company is insolvent.
The word ‘incurred’ is important because in some instances outstanding debts that become payable after the company had become insolvent were incurred some time prior to that insolvency. The most common example is a payment under a lease. Periodically amounts will become due, and if not paid may be used to wind up the company. These outstanding amounts will also be used in calculations to determine the date of insolvency.
But these payments are not ‘incurred’ when they become due for payment for time to time. They are incurred when the lease was executed and, if the lease was executed when the company was solvent, these amounts cannot form part of an insolvent trading compensation claim. Simply, they were not incurred when the company was insolvent.
The amounts in question were for unpaid PAYG liabilities. The company had withheld but not paid PAYG for some time and the amounts were significant. The question really came down to:
Are PAYG amounts ‘incurred’ by the company from time to time, or do they simply accrue due to the continued employment and become due for payment under the statute – and if the employees were engaged whilst the company was solvent, will these debts fall into the same position as lease payments?
The courts have had cause to look at this question a number of times over the years and generally come to the same result – that tax debts of this type are incurred by the company from time to time – usually when the amount had been withheld or becomes due for payment, and not when the employee is originally engaged.
The Corporations Act made the position clear in 1993 with the inclusion of section 588F, which states:
a company’s liability under a remittance provision to pay to the Commissioner of Taxation an amount equal to a deduction made by the company, after 1 July 1993, from a payment: (a) is taken to be a debt; and (b) is taken to have been incurred when the deduction was made.
The same principle applies to penalties for late payment of tax, which in themselves can be a significant amount. Are these debts incurred, or accrue by virtue of the statute? The Full Court of the South Australian Supreme Court held:
that “incurring” arose by virtue of the directors causing or permitting the company to continue to trade, knowing of its state of insolvency, knowing that there was a liability already extant, and knowing that, if unmet, that liability might well attract imposition of a penalty. By not appointing an administrator, the appellants failed to prevent the company from incurring the penalties in question. [Powell and Duncan (Noelex Yachts Aust) v Fryer & Anor  SASC 59]
Once the debt is unpaid, directors will need to appoint an external administrator in order to stop the interest accumulating while they still control the company.
Directors will have to be mindful of personal exposure if the company cannot pay its debts due to poor cash flow, and further payments are not made and late payment penalties start to accumulate.