Note: At the time of writing, these laws may be affected by legislative changes imposed as a result of COVID-19. 

Introduction

On 5 February 2020, the Senate passed the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (‘Act’), which confers personal liability on directors for their company’s unpaid GST liabilities.[1] The Act, which received Royal Assent on 17 February 2020, has been criticised in some quarters for unjustifiably piercing the ‘corporate veil’ that exists to protect directors from company debts. 

Purpose of the Act

The extension to director liabilities is part of the Government’s broader aim of addressing ‘illegal phoenixing activity’ under the A New Tax System (Goods and Services Tax) Act 1999 and the Tax Administration Act 1953.[2] ASIC defines illegal phoenixing activities as when directors transfer a company’s assets to another company and then deliberately liquidate the former company ‘to avoid paying outstanding debts including taxes, creditors and employee entitlements’.[3] Figures show that almost $24 billion was owed to the ATO in outstanding tax debts in the 2017-2018 financial year,[4] and this Act is part of a broader scheme to recover more of these debts.

Practical Effects

 The Act begins on 1 April 2020. The way the new process works under the Act is:

1. Companies will be under the statutory obligation to review their debts and report them by lodging a Business Activity Statement form (BAS) with the ATO Business Portal within a 3-month time frame (i.e. until 31 July 2020).
2. In the event of non-compliance, the ATO may serve directors a Director Penalty Notice. The Director Penalty Notice advises directors that the ATO suspects the company for which you are or have been a director has outstanding debts and is requesting you to pay them personally.[5]
3. Directors will have 21 days from having received the Director Penalty Notice to ensure that either:

(1) the company pays the GST debts;

(2) the company is placed into liquidation; or

(3) the company is placed into voluntary administration.[6]

4. If the GST debts are not paid and the company is not placed into liquidation or voluntary administration, directors will be held personally liable for any outstanding debts.

Director Penalty Notices: Defences

If a director receives a Director Penalty Notice, it is advisable to contact a lawyer immediately. There may be defences available to avoid personal liability, which include:

• Illness or some ‘other good reason’ (such as where a business needs to cease operating under government orders due to the COVID-19 pandemic);
• Taking all reasonable steps to ensure your company complied with obligations; and
• The company treated the GST legislation as applying in a way that was “reasonably arguable” and took “reasonable care” in applying the legislation.

Our Recommendations

In light of the potential consequences for directors arising from the Act, we recommend the following strategies:

1. Addressing Known Debts: Companies should immediately address any known debts and report these as a matter of priority. The ATO will not hold a director personally liable for outstanding debts if payment arrangements have been organised.
2. Inadvertent Errors: Companies should review current reporting systems for any inadvertent errors to ensure these are correct and comply with statutory obligations.
3. Personal Asset Protection Strategies: Companies should review any personal asset protection strategies. These are strategies that involves legal tools and financial plans to protect your company. If your company does not currently have a personal asset protection strategy, we can help you set one up.
4. Due Diligence Checks: Persons intending to become a director of a company should conduct due diligence checks. From the date of appointment, new directors will be provided with a 30-day grace period to make sure that either any outstanding company debts have been paid or the company has been placed in liquidation or administration.

Concluding remarks

The new Act is clearly reflective of a broader measure to reform Australia’s corporate insolvency regime, including illegal ‘phoenixing’ activities that lock billions of tax revenue annually. Directors of SMEs – especially start-ups – should take careful note to be aware of these new measures.

If you have any inquiries regarding directors’ new obligation to pay the company’s GST liabilities, feel free to contact us below.

[1] https://www.ato.gov.au/business/your-workers/in-detail/director-penalty-regime/

[2] Sections 436A, 436B or 436C of the Corporations Act 2001 (Cth).

[3] This also includes Luxury Car Tax and Wine Equalisation Tax.

[4] (Cth).

[5] https://asic.gov.au/for-business/small-business/closing-a-small-business/illegal-phoenix-activity/

[6] https://www.abc.net.au/news/2018-10-30/australians-owe-more-debt-than-ever-to-the-ato/10443748