Unpaid taxes a direct liability for SMEs

When cashflow is tight there is a temptation for business owners to find working capital by not remitting taxes such as GST, PAYG withholding or defer payment of income taxes that are due.

While SMEs might think that not meeting or delaying their tax payments is an easy solution to a shortage of funds, they need to understand that the ATO have a number of options to recover unpaid tax from directors or directly from the company assets.

And as the economy recovers, the ATO is becoming more forthright about collecting debts.

For example, where companies fail to meet their PAYG obligations, the ATO may issue a Director Penalty Notice (DPN) instructing the directors to act within 14 days.

As a director of a company, if you receive such a notice, you need to act in one of the following ways on or before the due date:

1. Pay the liability;
2. Enter into a payment arrangement;
3. Appoint an administrator of the company;
4. Wind the company up.

It’s important directors take swift action as the ATO has no discretion to extend the 14 day period, which commences from the time the ATO posts the notice. Also some of the actions mentioned, particularly those with legal ramifications, may take longer than 14 days.

If the directors fail to act, they automatically become liable for a penalty equal to the tax liability or estimated liability and the ATO does not need to issue any notices or take any further action to create the penalty.

The liability applies to directors at any time from when the tax was deducted to when it was payable, and can even capture directors that have since resigned or been newly appointed even one day before the tax is due.

The ATO also has new powers to pursue directors that avoid their tax liabilities by using phoenix arrangements. These additional powers contained within a Bill due to be given Royal Ascent, come in addition to the ATO receiving funding in the 2009 Budget to undertake phoenix casework over four years. As part of the new powers the ATO will be able to demand uncapped security deposits for existing and future liabilities.

Phoenix arrangements arise when a company is wound up in a deliberate attempt to avoid the payment of outstanding debts such as tax liabilities and penalties, however the business continues to operate in a new company free of those debts.

The ATO has prosecuted 12 company directors and raised more than $700 million in taxes and penalties as a result of 1,500 phoenix company audits, since 1998.

With these new powers and funding to pursue these arrangements, we can expect activity in this area to increase.

While the ATO has no direct power to recover debts relating to other taxes such as fringe benefits, GST and income tax from directors, it does have a number of other options available.

These include pursuing debts under director’s duties contained in the Corporations Act that prevent a company incurring debts while insolvent. Where a director fails in this duty, they can be ordered to compensate creditors, including the ATO, for debts incurred while trading insolvent.

Even in circumstances where liquidators recover payments made to the ATO as preference payments received in priority of other creditors, directors can be made liable to indemnify the ATO for these losses or damages.

Another option available to the ATO is to pursue directors for convictions and damages under the Taxation Administration Act in circumstances where companies commit an offence that results in a loss to the Commonwealth, such as failing to provide information or lodge tax returns that enable the ATO to make a tax assessment.

Finally, the ATO may also seek to recover outstanding tax debts through issuing a garnishee order on the company, and its bank accounts. The garnishee order effectively seizes money and has it directed to pay the ATO debt. The order also covers merchant card facilities, with a financial institution being required to pay to the ATO any amounts being transacted through these facilities, rather than depositing them into the company’s account.

Garnishee orders also apply to third parties, such as debtors, that owe or hold money for the company, ordering them to pay that money to the ATO.

With many means available to the ATO to ensure companies meet their tax obligation, it’s important that directors of SMEs understand and meet their tax obligations.

Marc Peskett is a partner of MPR Group a Melbourne based firm that provides tax advice to businesses, as well as accounting, business advisory and financial services to fast growing small to medium enterprises.