Unpaid tax debts – SME directors under fire

In tough times, SME owners who are directors of family companies might be tempted to delay payment of a tax debt. But as TERRY HAYES explains, that is dangerous – directors may be personally liable for company tax debts.

By Terry Hayes

In tough times, SME owners who are directors of family companies might be tempted to delay payment of a tax debt. But that’s dangerous, as directors may be personally liable for company tax debts.

SME owners who may be directors of the family company that runs the business should not need reminding of their duties as directors.

However in tough times some businesses may “sail close to the wind” concerning things like making their tax payments (such as pay-as-you-go, or PAYG, withholding payments) to the tax office on time. It can be tempting to delay a payment when cash flow is tight.

That’s dangerous.

The tax law provides that a director may become personally liable for an amount equivalent to some of the company’s unpaid taxation liabilities. That raises the stakes!

This issue is not new, but is almost continually on the taxman’s radar. In fact, the Tax Commissioner again recently flagged it as an important part of the tax office’s compliance activities.

There are three broad circumstances in which a director may become personally liable:

• Director penalties.
• Insolvent trading.
• Voidable transactions.

The director penalty provisions in the tax law automatically cause directors to become personally liable for an amount equivalent to their company’s unpaid PAYG withholding liability. This penalty comes in the form of a director’s penalty notice. Generally speaking, a director has 14 days within which to respond to a penalty notice.

Directors are obliged to ensure that by the time the due date for payment of the PAYG, the company has done one of four things:

1. Paid the amount owing in full.
2. Entered into a payment agreement with the tax office in respect of the PAYG amount.
3. Come under voluntary administration.
4. Had a liquidator appointed.

Failure to do one of those four things by the due date will result in each director automatically incurring a penalty equal to the company’s outstanding PAYG withholding liability.

A timely warning here – new incoming directors can be caught for PAYG debts incurred before they became directors.

A person who later becomes a director of a company that has an outstanding PAYG withholding liability will also incur a penalty equal to that liability unless one of those four things mentioned above occurs within 14 days of them becoming a director.

Timing is critical – don’t delay

In general, directors have 14 days within which to respond to a director’s penalty notice issued by the tax office. However, that 14 days commences from when the tax office posts the notice.

A decision by the NSW Court of Appeal in December 2007 (Deputy Commissioner of Taxation v Meredith) found that a director’s penalty notice is effectively served from the time at which it is correctly posted by the tax office and that it is not open to the director to argue that non-delivery equates to non-service.

The Tax Commissioner has accepted the decision of the Court of Appeal so that a director’s penalty notice sent to a director by ordinary pre-paid post will be “given” to the director at the time the notice is posted – and not at the time when it would have been delivered by ordinary post.

Insolvent trading

Once a company is liquidated, it is possible for the liquidator or an aggrieved creditor to pursue an action against the directors for insolvent trading. That may lead to the court ordering the directors to pay compensation in respect of debts that the company incurred when it was trading while insolvent.

Voidable transactions

Where a court finds that a payment made by the company to discharge a PAYG withholding obligation was a voidable transaction (which means it should not have been made) and the tax office has to pay back this money, the tax office will routinely seek to have the court order the directors to compensate it for that money.

Serious business

Being a company director is a serious business. Being a director of a company with unpaid tax bills is even more serious.

Failure by a company to send money deducted from the salaries or wages of its employees to the tax office is not simply a timing issue. Unpaid tax liabilities can fall on the directors – personally.

Company directors must not delay in responding to a director’s penalty notice. They should consult their accountant or adviser immediately one is received.

The tax office does not lightly issue these notices. They can effectively be thought of as a final warning. There is still time to act to avoid the penalties, but that time is short. Don’t let that time run out.

Read more about tax debt

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.