Directors beware the risks of personally guaranteeing company ATO debt when a director penalty notice expires
It was recently reported in Accountants Daily that the ATO (Australian Taxation Office) is increasingly using data-matching tools to identify which directors have the assets to meet Director Penalty Notices[1]. In that article, my NSW colleague, Jeremy Mudford, was quoted as saying “In the first half of 2024, around 30,000 DPNs have been issued”.
With the volume of DPNs being issued by the ATO rising significantly, it is important for directors to understand the personal ramifications in the event that the 21-day period expires, and the Company is not in a position to pay the liability associated with the DPN. From this, the ATO can commence proceedings against the director to recover the director penalty amount 21 days after the DPN has been issued.
With the Directors personal assets now being exposed to the amount of the DPN, if they are not in a position to pay it, then the Director will need to consider all the available options, including those within the Bankruptcy Act, 1966.
Bankruptcy and the family home
If a director has an interest in the family home (or any real property), and they do become bankrupt, this is where it can become available to the ATO to meet the obligations incurred by the director not acting within 21 days to remit the personal liability arising from the DPN. This is because a home is not a protected asset under the Bankruptcy Act. If there is equity in the property after paying out any proper mortgage and selling costs, the bankruptcy trustee is obliged to realise (i.e. sell) the property.
The first step in the process is for the bankruptcy trustee to determine whether there is any equity in the property. To do this, they will get the property valued and ascertain the value of any debts secured against the property (e.g. mortgages etc.) The secured debts are deducted from the property’s value and the bankrupt’s share of the equity is calculated.
When there is no equity in a property and the debts secured against the property are greater than the current property value, the mortgagees may exercise their rights and sell the property.
If mortgagees don’t exercise their rights, the bankrupt—and possibly other parties—can continue to service the loan. It is important to understand that the property vests in the bankruptcy trustee at the time of bankruptcy and remains vested regardless of whether the bankruptcy trustee takes action to sell the property, or when there is no equity in the property. The property also remains vested in the bankruptcy trustee when the bankrupt has been discharged from bankruptcy.
The bankruptcy trustee may review the property’s equity position periodically. They can realise any equity generated after the date of bankruptcy, even if that equity is generated by the bankrupt or another owner continuing the mortgage repayments. The Mortgage repayments attributed to the bankrupt’s share are deemed to be rental payments to use and occupy the property.
Where the bankruptcy trustee is the only owner, they can put the property up for sale. Where there is a co-owner, the bankruptcy trustee will usually take the following approach:
1. Give the co-owner the opportunity to buy the estate’s interest in the property.
2. Invite the co-owner to join the bankruptcy trustee on agreed terms to market and sell the property.
3. Ask the court to appoint a ‘statutory trustee for sale’ over the co-owner’s interest to force a sale of the property, if there is no agreement to sell the property with the bankruptcy trustee.
The appointment of a statutory trustee forces the sale of the home, even if the co-owner is solvent and has not contributed to the bankruptcy in any way. While the court will often try to soften the effect of such an order by allowing the co-owner time to relocate, the outcome is that the property will be sold.
The impact of the doctrine of exoneration on the owners interest in the property
The principle of the doctrine of exoneration changes respective interests in real property ownership, depending on the conduct of one or more of its owners. For instance, when a director is the joint owner of real property, borrows funds and secures them against the real property and uses these funds for the Company’s working capital. In applying the doctrine, each owner’s interests in the property’s equity are adjusted.
This can have a significant impact for a bankruptcy trustee particularly where, despite a bankrupt being a registered owner of real property with equity, they have no interest in that equity because they previously borrowed additional funds and secured them against the property. It frequently applies where a person has borrowed against the family home held jointly with someone else to fund a business, and the person who has benefited from the funds is subsequently faced with bankruptcy.
The doctrine applies where a number of parties are registered owners of real property, but where borrowed funds secured against it are used for the benefit of some owners, but not all. For instance, Steve and Robin (husband and wife), own their family home as joint tenants. The house is worth $400,000. They bought the house with a joint loan secured by a mortgage on the property. They owe $100,000 under the mortgage.
Steve is the director of a Company which ran a business that Robin had no financial interest in. For the benefit of the Company, Steve borrowed $200,000 with a loan secured against their home. Steve becomes bankrupt and the bankruptcy trustee is now required to consider what, if any, interest they have in the real property.
Firstly, the doctrine does not affect the mortgagee’s rights. The mortgagee is entitled to the balance of the original loan to purchase the property of $100,000 and the subsequent loan of $200,000. Leaving aside the sale costs, $100,000 remains as the surplus sale proceeds.
In determining whether the doctrine applies, each party’s intentions are considered. In this instance, because the business loan of $200,000 was solely for Steve’s benefit to advance to the Company, the doctrine applies, and the allocation of the equity is adjusted in Steve’s favour (such that Steve has accessed a portion of his equity in the family home). The allocation of equity and adjustment, would be as follows:
The balance of the original mortgage of $100,000 is applied first against the sale proceeds of $400,000, leaving a balance of $300,000.
Theoretically, the $300,000 is split equally between Steve and Robin, resulting in a split of $150,000 each.
But because the $200,000 business loan, which was advanced to the Company was solely for Steve’s benefit, this is applied only against his interest in the property, which means his $150,000 allocation is extinguished.
Therefore, all of the remaining equity in the real property (the $100,000) is entirely owned by Robin, and Steve in fact owes Robin $50,000, and she can prove in his bankrupt estate for this amount.
This scenario means that the bankrupt estate would receive nothing from the sale of the real property. This is compared to the outcome if the doctrine were not to apply, where the surplus funds, of $50,000 each, are split equally between Steve and Robin.
With the significant rise in DPN’s being issued by the ATO, Directors need to be aware of the risks in not acting within the 21 days. Failure to act appropriately means the directors are essentially personally guaranteeing the Company’s debts to the ATO. If the Company cannot meet these obligations, the Directors personal assets are available to pay Company liabilities.
[1] https://www.accountantsdaily.com.au/business/19720-ato-targeting-dpns-at-directors-with-high-value-assets#:~:text=%E2%80%9CIn%20the%20first%20half%20of,to%20deal%20with%20the%20ATO
