The director penalty regime has been in place since 1993 and most directors have at least a “working knowledge” of how the provisions operate and when they could become personally liable for the pay as you go (PAYG) withholding tax liabilities of their company. However, from 30 June 2012, the director penalty regime has been significantly expanded to include the superannuation guarantee obligations of the company, as well as restricting the application of some of the statutory defences.
The purpose of these reforms was to protect employee entitlements and deter ‘phoenix’ activities of businesses where employee entitlements such as superannuation are often unrecoverable. However, the broad nature of the legislation ensures the reform has implications for all company directors, particularly those whose company is in financial difficulty.
Outline of the regime before the recent changes
The recent changes have maintained the existing architecture of the director penalty regime, with the changes adding to that regime (ie increasing its coverage to include superannuation guarantee) and toughening its application (ie by narrowing some of the defences). It is therefore worthwhile briefly outlining the application of the regime prior to the recent changes.
Who can be liable under the regime?
The following persons can be liable under the director penalty regime:
- directors at the time the ATO sends out the notices (even if they weren’t directors at the time the obligation arose);
- directors at the time the obligation arose (even if they are no longer directors);
- alternative directors; and
- “shadow directors”.
Tax obligations that a director may become liable for
Until the recent changes, the potential liability of directors was limited to the obligations of the company to make PAYG withholding payments (this is primarily income taxes withheld from employee’s salary but includes other withholding obligations such as withholding obligations relating to royalty, interest and dividend payments) and certain similar payments.
Notice to directors
The ATO cannot commence proceedings until 21 days after notice of the liability has been given to a director.
A director has broadly three defences:
- commence winding up the company within 21 days of receiving the notice (this has now been modified, as discussed below);
- establish, because of illness or some other good reason, the director did not take part in the management of the company at the time when the company incurred the withholding obligation; or
- the director took all reasonable steps to ensure the directors complied with their withholding obligations.
Changes to the director penalty regime
Extending the regime to unpaid superannuation guarantee amounts
In addition to PAYG withholding amounts, the director penalty regime, from 30 June 2012, applies to unpaid superannuation guarantee payments. Directors become liable for such superannuation guarantee payments on the day the company must lodge its superannuation guarantee statement. This is on the 28th day of the second month after the end of a quarter.
So, for example, for the quarter ending 30 June the lodgement day is 28 August. Therefore, directors can be liable from that date for the company’s superannuation guarantee charge relating to the June quarter.
The liability includes not only the company’s superannuation obligations (for the 2013/14 year, being 9.25% of the employee’s ordinary times earnings), but also an interest component (10% p.a.) and a penalty component ($20 per employee per quarter).
New superannuation guarantee defence
A new defence has been added that will ensure that a director is not liable to a director penalty relating to the superannuation guarantee charge, where they can establish that the penalty resulted from the company treating the Superannuation Guarantee (Administration) Act as applying to a matter or identical matters in a particular way that was reasonably arguable. In addition the director must show the company took reasonable care in connection with applying the Superannuation Guarantee (Administration) Act to the matter or matters.
For example, the company could take a view that certain persons are contractors and that, therefore, the company does not need to make superannuation guarantee payments in respect to them. If the ATO, or the Courts, subsequently find that the persons were covered by the Superannuation Guarantee legislation, and that superannuation contributions should be made on their behalf, then, although the company will remain liable for the superannuation guarantee charge, directors will not be liable, provided that the view taken by the company was reasonably arguable and the company took reasonable care in relation to its superannuation guarantee obligations.
No such defence will apply in relation to PAYG withholding obligations.
Restricting the “wind up defence”
The ability of directors to avoid director penalty obligations by winding up the company has been restricted to a period of three months after the debt is incurred. After that three month period the only way a director will not be liable for the company’s withholding or superannuation guarantee obligations is to pay the debt or satisfy one of the other two defences (ie the winding up of the company will not absolve the director of the penalties).
So to continue the example set out above, where a director becomes personally liable for the June quarter superannuation guarantee obligations, on 28 August, the “wind up defence” will lapse three months later (ie on 29 November).
New directors “grace periods”
New directors have two new “grace periods”. First, they will not be liable for either PAYG withholding obligations of a company, or the superannuation guarantee obligations of a company, for the first 30 days of their appointment. This gives a new director time to conduct due diligence on the company and resign if necessary. If the director does not resign within that 30 day period then the director will be potentially liable for both past and present PAYG withholding and superannuation guarantee liabilities of the company.
Second, the restriction on the “wind up defence”, discussed above, does not apply to new directors for the first three months after they become a director. Therefore, during that three month period, if a company is commenced to be wound up within 21 days of the new director receiving a director penalty notice, then the new director will not be liable (although other directors may still be liable). However, after the initial three month period has passed, the restrictions on the “wind up defence” will apply to that new director.
Discretion to reduce PAYG withholding credits for directors and their associates
The Commissioner of Taxation has been granted the discretion to reduce credits for tax withheld from the salary of directors and their associates. So for example, if a company has withheld $15,000 of tax from a director’s fees, the Commissioner has the discretion to reduce those credits, with the effect that the director will have to pay full tax on his or her director fees (even though that tax has previously been taken out of the director’s fees).
As noted above, the Commissioner’s discretion extends not only to reducing the credits of a director but also the director’s associates. Associate is widely defined and will include a director’s spouse/partner, children, relatives, and companies and trusts which the director controls. This is not an unrestricted discretion; rather it can only be exercised where the Commissioner is satisfied that due to the associates’ close personal relationship with the director, the associate knew, or could reasonably be expected to have known, that the company had failed to pay amounts withheld to the Commissioner.
Ability to send copies of notices to director’s tax agents
The Commissioner now has the power to send a copy of a director penalty notice to the director’s tax agent (in addition to sending the original to the director). In practice, this measure could assist affected directors in enabling them to deal with notices quickly, especially where their contact details on the ASIC database are no longer correct.
Superannuation guarantee traps
Given their potential for personal liability for unpaid superannuation guarantee payments, directors must ensure that their company has not only paid superannuation guarantee amounts on time, but that they have also paid the correct amount of superannuation contributions payable for each employee. For new directors, they should ensure they conduct appropriate due diligence on the compliance of the company with its superannuation guarantee (and PAYG withholding) obligations.
Common traps for superannuation guarantee include:
- failure to pay superannuation guarantee under the following circumstances:
o by incorrectly classifying employees as contractors;
o for non-employees who provide services wholly, or principally, for the labour of that person;
o under the special rules for directors, artists, musicians, sports persons etc.
- underpayment of superannuation guarantee in the following circumstances:
o bonus payments;
o payments in lieu of notice; or
o termination payments.
- the difficulties in clawing back the overpayment of superannuation payments.
What should Directors do?
Directors must ensure that their company has met all of its PAYG withholding, and superannuation guarantee, obligations on an ongoing basis. Where directors do not have day to day control of the company, they should ensure that management regularly confirms that the company’s PAYG withholding and superannuation guarantee obligations are met.
Where directors become aware that the company’s PAYG withholding and/or superannuation guarantee obligations have not been met, they should ensure that, within the three month period after the liabilities arose, that either the liabilities are paid or that the company is commenced to be wound up. If they fail to do this, then, unless one of the limited defences apply, the directors can be liable for those liabilities.
New directors should ensure that they conduct proper due diligence before or soon after their appointment. If that due diligence shows up unpaid PAYG withholding, or superannuation guarantee liabilities or the director cannot satisfy herself/himself that all liabilities have been met, the director should strongly consider resigning within the first 30 days of their appointment to ensure that they are not personally liable.
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