Warning - Personal Liability for Tax Already Paid!

We are currently seeing a number of factors coming together to create the “Perfect Storm” for recovery actions by Liquidators and this is a worrying sign for directors that could end up facing personal liability.

Directors and business advisors familiar with the Australian Taxation Office’s (ATO) director penalty regime and insolvent trading laws will be familiar with the circumstances under which the directors of a company can become personally liable for unpaid amounts.

However, in our experience few people are familiar with the laws that can effectively make a director personally liable for amounts that were paid.

Nearly two decades ago the Corporations Act was amended to provide the ATO with a statutory indemnity against directors for any payments clawed back by a Liquidator under Part 5.7B of the Corporations Act. 

In simple terms, directors, often unknowingly, provide a personal guarantee to the ATO each time the company makes a payment of any tax, penalties or interest, that the business won’t fail and that its Liquidator won’t claw back the payment as an unfair preference.

If an ATO payment is deemed to be an unfair preference, where the Liquidator finds that the ATO was paid ahead of other creditors, the ATO is obliged to repay that amount to the Liquidator and in turn the ATO can then sue the director for the amount repaid.

We have not seen a global economic downturn like this since these indemnity laws came into effect and also bear in mind that history tells us that insolvency rates don’t peak until around 18 months after the economy bottoms out. If we look to the ASX for the timing of that “bottoming out”, we are perhaps looking at March/April 2009. 18 months post time this means that we can now see the storm front building and at a time when the ATO have declared that they will be taking firmer action against those companies unable to meet their outstanding tax or superannuation guarantees.

Whilst we have seen storms before, this one gets its ferocity from the overwhelming use of payment arrangements during the ATO’s softly, softly approach to debt collection in the latter half of last year. The Commissioner of Taxation, Mr Michael D’Ascenzo, recently advised the Council of Small Business Organisations of Australia that the ATO had entered into more than 100,000 interest free payment arrangements worth $1.5 billion. That’s a lot of businesses that may be exposing their directors to personal liability.

With the Perfect Storm brewing, the long range forecast looks a little something like this:

• 0 to 12 months (2010 – 2011) – accelerated rate of company failures off the back of interest rate rises, the back end of stimulus programs and firmer recovery action by the ATO.
• 12 to 24 months (2011 – 2012) – Payment arrangements mean that investigations by Liquidators are more likely to identify unfair preferences to creditors, including the ATO, which are subsequently clawed back.
• 24 to 36 months (2012 – 2013) – the ATO move to bankrupt directors for unfair preferences, clawed back by Liquidators, relating to amounts that the company paid in 2009-2011.

So what should businesses with sub par financial results do? Well before businesses enter into payment arrangements or even continue with existing instalment arrangements they should firstly consider a few fundamental questions, such as:

• Have we sat down with our accountant or business advisor to review our financial performance and prepare realistic forecasts?
• Have we considered what effect the insolvency of a major customer or the loss of a contract might have on our viability?
• Are we able to pay our debts in full within agreed terms and does our forecast indicate that this will remain so?
• Have we considered the working capital needs of our business, particularly if turnover is growing?

There is no substitute for advice from an experienced practitioner, so if you think you might be looking at a potential problem, consider a free and confidential meeting with our Business Recovery and Insolvency Team.

For further information contact Partner, Brad Tonks, via email or phone (02) 8346 6000; Email Brad