SME company directors in the tax firing line

Directors should be aware that they are liable for any unpaid tax debts, and that they have a limited time to respond. By TERRY HAYES.

By Terry Hayes

The tax implications of being a director have become more prominent. Being a company director, even for an SME, is becoming more perilous all the time.

Company directors are personally liable for an automatic penalty equal to the amount of the unremitted or unpaid amounts where a company fails to remit to the tax office money deducted from the salaries or wages of its employees (such as pay as you go [PAYG] withholding amounts), under the tax laws.

This penalty comes in the form of a Director’s Penalty Notice, which sets out details of the unpaid amount of the liability, including the amounts withheld and the periods in which amounts were withheld, although it does not have to include the due dates of the amounts.

Court cases have confirmed that company directors have an obligation to ensure that amounts deducted from the salaries or wages of employees are remitted to the tax commissioner and not misused – as the floating capital of the company, for example.

Receiving a Director’s Penalty Notice does not have to spell a tax disaster for the director personally, but it is a call to action, and a call to act fast. Generally speaking, a director has 14 days within which to respond to a penalty notice. So simply ignoring the notice won’t make it go away!

Under tax law, directors who receive such a notice have four options by which they can avoid personal liability. They can do this by ensuring that the company, on or before the due date for payment of the penalty:

• Pays the unremitted amount to the commissioner; or
• Enters into an agreement to make payment to the commissioner and honour that agreement; or
• Has an administrator appointed; or
• Goes into liquidation.

If the director fails to do any of the above, they become personally liable for the amount unpaid.

As noted above, the tax commissioner is required to give 14 days’ notice to a director before recovering a penalty where an amount has not been remitted. Note that several court cases have confirmed that the person on whom a penalty notice is served does not have to be a director of the relevant company at the time the notice is served.

Newly appointed directors may not be immediately be aware of the existence of a penalty notice. However, they can also be penalised if none of the above options is taken within 14 days of their appointment. Directors in this position should seek immediate advice.

The law provides for the method by which a penalty notice must be served on a director. This is important to be aware of. The tax law says a penalty notice may be served on a director if he or she has a preferred address for service of notices, whether physical, postal or electronic.

Alternatively, a penalty notice can be served on a director by leaving it at, or sending it by post to, an address that appears from an ASIC return to be, or to have been within the past seven days, his or her place of residence or business. In a decision of the Federal Court in February this year (Kavanagh v Deputy Commissioner of Taxation), a director’s penalty notice was held to have been validly served where it was delivered to a house where the director in question once resided and which matched the address recorded in ASIC’s computer records (although the ASIC records did not show a street number).

Although it’s relatively clear what actions a director should take to avoid the personal liability once a notice is received, there are also various defences available under the tax law where the tax commissioner seeks to recover from a director an unremitted PAYG withholding amount. These include:

• The director can claim he or she did not participate in the management of the company because of illness or “some other good reason”;
• Taking all reasonable steps to ensure the directors complied with their duties; and
• Taking all reasonable steps to ensure the company complied with an agreement to pay the penalty, provided the director had reasonable grounds to expect that the company would comply with such an agreement.

These defences are always applicable on the facts of each case, so it’s wise to seek expert advice as soon as possible. Numerous court cases have produced what might be considered surprising results. In one case, the NSW Supreme Court held that a director’s honest belief that the company would ultimately be able to pay the unremitted amounts did not constitute taking all reasonable steps to comply with the obligations.

In a very recent case before the Queensland District Court, a woman said she was the sole director and secretary of a company, but played no active role in its management and operation, other than as a signatory to the company’s statutory returns and the company’s bank accounts. The woman said that she and her husband always both regarded the company as his business vehicle and that he ran (and his wife allowed him to run) the company as such.

The director said her husband took responsibility for ensuring the company paid its trading debts and taxation and liabilities as and when the company could. She said she never asked him about the details of the business or the company’s tax position and was content to entrust him with the operation and management of the company’s business.

The end result was that the District Court dismissed the application by a Deputy Commissioner of Taxation for summary judgment against the company director for just over $81,000 in unpaid director penalty liabilities. However, the matter is to be considered further concerning her participation in the company and her knowledge of its taxation arrangements and obligations.

Receiving a director’s penalty notice is a serious matter. Advice should be taken immediately as to the best option to pursue. The key is the timing – don’t delay and don’t ignore the notice. Where the penalty is not paid and none of the four options is taken, the Tax Commissioner can commence bankruptcy proceedings against the director, and that can have its own implications. If a director has assets in his or her own name, those assets can be in jeopardy.