Director’s personal liability – indemnity for unfair preferences to the ATO

This article:

  1. Examines directors’ liability to indemnify the ATO when certain transactions, such as payment arrangements between a company and the ATO, are set aside by the liquidator; and
  2. Provides practical tips on possible ways for directors to avoid personal liability.

For the final quarter of the 2013 financial year, the number of companies entering into external administration increased by 10.3% from the previous year.[1]

In the lead-up to its demise, it is common for companies to negotiate “payment arrangements” with the ATO for outstanding tax liabilities. These arrangements provide directors with valuable breathing space in terms of cash-flow, however they can also come back to bite directors in terms of personal liability when the company becomes insolvent.

What are “unfair preferences”?

If payments are made pursuant to an ATO payment arrangement:

  • From the company to the ATO;
  • Within a certain timeframe of the company’s insolvency;[2]
  • When the company was insolvent at the time of the payments or became insolvent as a result of the payments; and
  • Which resulted in the ATO receiving more money than what it would receive in the company’s liquidation,

then the ATO has likely received “unfair preferences.” Upon appointment, the liquidator can pursue the ATO to recover these unfair preferences.

How can directors become personally liable?

If an unfair preference claim is made, the ATO can (and often will) pursue an indemnity claim against the company director for amounts that it is required to repay to the liquidator: section 588FGA(2) of the Act. The limit to the indemnity is that the “unfair preferences” must relate to PAYG-withholding or superannuation guarantee charge liabilities: section 588FGA(1) of the Act.

What are the potential defences to personal liability?

The directors have the following defences available:

  • The director had reasonable grounds to expect and did expect that the company was solvent;
  • Due to “illness or some other good reason,” the director did not take part in the management of the company; and
  • The director took all reasonable steps to prevent the company from making the payment.

The director also has the right to “stand in the ATO’s shoes” and argue actual solvency in the liquidator’s unfair preference claim.[3] In other words, the director can challenge the underlying preference claim to defend against any personal liability.

While not impossible, these defences are hard to argue when:

  • The company was likely in dire financial straits and bordering on insolvency, if it wasn’t actually insolvent, at the time of the payments. It follows that proving solvency (or a reasonable expectation of solvency) is exceedingly difficult.
  • At law, directors are required to be actively engaged in the company’s management and its financial affairs. It follows that an “illness or some other good reason” must be a very convincing argument before it will be accepted by the Court.

Important lessons for directors

Company directors can be personally liable for hundreds of thousands of dollars in an indemnity claim, even when the company is arguably “doing the right thing” by paying its tax liabilities.

Accordingly, directors should take heed of the following lessons:

  1. When entering into an ATO payment arrangement, ask yourself this question – “Is the company actually viable in the long-term, or is the arrangement a “band-aid solution” which prolongs an inevitable liquidation?
  2. If there is any doubt about the company’s financial position you should seek immediate advice from an insolvency accountant. This external advice is often needed, as in our experience most directors hold unrealistic views of the company’s viability and attempt to “trade through” insurmountable financial difficulties.

How we can help

We often assist companies who are experiencing financial difficulty by providing pre-insolvency legal advice and facilitating referrals to suitable insolvency accountants. Where necessary we also act on behalf of company directors in defending ATO indemnity claims and minimising, as far as possible, the director’s personal liability.

Please contact our our office on (07) 3223 6100 for any enquiries relating to this or other insolvency matters, or alternatively email ManjaL@redchip.com.au.

[2] This timeframe can vary depending on how the company became insolvent. Generally speaking, it is a 6 month window from the winding-up of the company, but it can be longer in certain circumstances.

[3] See Harris and Anor v Commissioner of Taxation and Ors [2006] QSC 108.

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