The Government has announced a series of amendments to the director penalty provisions which are intended to introduce greater certainty, while closing off some of the existing loopholes that are presently exploited by less-scrupulous directors.
A number of these changes are contained in the Tax Laws Amendment (Transfer of Provisions) Bill 2010, which was introduced into Parliament on 17 March. Further changes have been foreshadowed in the Action against fraudulent phoenix activity - Proposals Paper, which the Assistant Treasurer released in November 2009. These measures should be welcomed by all persons who are interested in seeking fair play in the commercial sector.
Director Penalty Notices
The prime function of the recently introduced Bill is to relocate the director penalty provisions from the Income Tax Assessment Act 1936 (ITAA 1936) to Schedule 1 to the Taxation Administration Act 1953 (TAA 1953), where they will sit alongside the other recovery powers available to the Tax Office. However, the Bill also takes the opportunity to close a number of loopholes and provide a greater degree of certainty about the operation of the provisions.
For instance, there has been a great deal of confusion (at least since the 2003 Gillis decision) as to when an ordinary payment arrangement constitutes a payment agreement within the meaning of section 222ALA ITAA 1936. The Bill resolves the confusion by repealing section 222ALA and replacing it with a prohibition on the Tax Office launching recovery proceedings while the company is adhering to an ordinary payment arrangement.
It also closes off a loophole which presently enables a director to wash away his personal liability by resigning the day before the company enters a 222ALA Payment Agreement and being reappointed the day after the company defaults on an installment. This loophole enables a director to avoid personal exposure while maintaining control of the company, but without actually getting the company to remit the amounts it’s collected from employees’ pay packets.
Amendments to defences
Another measure will tighten the existing 222AOJ(2) defence, which provides a defence for directors who did not take part in the management of the company because of ill health. Worrells understands that some directors have successfully made out that defence, despite having been quite able to manage the company if they’d wanted to. Their defence has been that they (or even someone they knew) had a slight ailment and, because of that, they “did not” take part in the management of the company, even though they could have if they’d wanted to. The provisions does not say that the ailment had to be theirs.
The amended defence provision will add a requirement that directors also show that, having regard to the ill health, it would have been unreasonable to expect them to take part in the management of the company.
The vast majority of defences that have been offered by directors relate to issues of service of the director penalty notice (DPN). The landmark Meredith decision, found that the service requirement for a DPN is satisfied once the DPN has been posted, and that it is not open to a director to contest actual delivery. The new legislation will make it clear that the service provision should always have been construed in that fashion. There is, of course, an argument about who should bear the risk of a DPN getting lost in the mail.
The Government shares the same view as the NSW Court of Appeal - that the DPN is essentially a courteous reminder to the director of something that they should already know. They know the amount that their company withheld and failed to pay, and they know that they are still obliged to pay it to the Tax Office. They should also know that if they can’t pay it because of cashflow difficulties, then they should explore a voluntary administration or even liquidation, rather than continuing to commit the offence of insolvent trading.
Extension of Time Period
As an ancillary measure, the Bill will also extend from 14 days to 21 days the time after the DPN is posted during which the director has a last chance to get the company to comply with its obligations and thereby shed their personal liability.
Payment of Bond
Although not directly related to the director penalty provisions, the new Bill also provides for a beefed up Bond provision. Although rarely used (perhaps because of the puny penalty for non-compliance and because it relates only to income tax), the existing section 213 ITAA 1936 allows the Tax Office to require a taxpayer to pay a bond in respect of future income tax liabilities. The bond provision will be moved to the TAA 1953 and will allow the Commissioner of Taxation to seek a bond or security for all types of tax liabilities, and it will be backed up by a substantial penalty.
The Anti-Phoenix Proposals announced by the Assistant Treasurer have not yet been introduced into Parliament, but contain some substantial and welcome measures. We understand that the sheer volume of companies who fail to remit Pay As You Go Income Tax Withholding (ITW) on time means that Tax Office staff typically only gets to issue a DPN six to twelve months after the company first stopped paying its withholding tax. Unfortunately, that means that the director has six to twelve months of being able to ignore the solvency problems and allow the company into an ever-deeper hole of financial difficulty.
As Insolvency Practitioners who aim to help a company to survive while providing the best possible return to creditors, it is particularly frustrating to have directors come to us for help upon receiving a DPN, but only after the company’s financial difficulty has become so dire that the company is unable to be saved. Employees lose their jobs. Customers lose their supplier. And creditors often recover very little of their debts.
Automatic Liability and Collectability
We therefore welcome the Government’s proposal to introduce a three-month ‘lockdown’ of the director’s penalty. Essentially, directors will no longer be able to sit on their hands or keep their head in the sand while waiting for the DPN to finally arrive. If they are to avoid their personal liability, they will now have to take corrective action within a reasonable time after the tax liability falls due. It is suggested that three months is a reasonable time for a director to
(1) recognise that the company has insufficient liquidity to remit the withheld amounts by the due date;
(2) seek to obtain additional finance, whether from the bank, shareholders, other investors or their own personal resources to pay the overdue;
(3) seek a payment arrangement with the Tax Office;
(4) place the company under voluntary administration; or
(5) place the company into liquidation.
If a director doesn’t achieve one of those outcomes within that reasonable period, then he will remain personally liable to that unpaid amount. The good news is that he will still be able to reduce or extinguish his personal liability by even now getting the company to pay that amount to the Tax Office, or he or she may approach the Tax Office for a payment arrangement of their own.
It is hoped that this measure will prompt directors to take corrective action at the first sign of financial difficulties, and at a time when the company (and the employees’ jobs) can still be saved.
Inclusion of Other types of tax under DPNs
The final significant measure announced by the Government is the expansion of the director penalty regime to other types of tax, including GST, Excise and Superannuation Guarantee.
Undoubtedly some directors have sought to have the company pay the ITW – so as to eliminate their personal exposure – while disregarding the company’s other obligations to the Tax Office. It is surely unconscionable for a director to save their own skin while leaving their employees’ superannuation unpaid and the expansion of the director penalty regime should ensure that the directors are equally motivated to address the company’s other liabilities.
Furthermore, to the extent that the directors become personally liable, the Tax Office may collect the company’s tax liabilities from the directors – thus leaving more of the company’s assets available to address the liabilities it owes to other creditors.