Contractors or Employees and Director’s Personal Liability

It appears that regulatory bodies have increased audit activity in respect of company’s who use contractors as the main part of their workforce, typically seen in industries such as construction and cleaning to name just a few.
Should the audit find the contractors of the company are actually employees pursuant to the relevant law the company can then find itself liable for unpaid super, PAYG, workers compensation premiums and payroll tax (let alone potential employee entitlements such as annual leave and long service leave etc).  Often the company has no possible way to meet its crushing new liabilities and the director must consider both the company’s options and their own personal liability.

Please click on the link for a guide on the ATO’s position on whether your workers would be considered contractors or employees.

ATO Debts – Outstanding PAYG / Superannuation Guarantee Charge

The company must report its PAYG obligations within three months of their due dates or the director becomes personally liable for said obligations.

If all obligations are reported and the ATO issues a Director Penalty Notice to try and collect the outstanding amounts the director can have the personal liability penalty remitted if they at any times within 21 days of being ‘given’ the notice:-

  • Place the company into Liquidation or Voluntary Administration

Payroll Tax Obligations

Payroll Tax and other NSW state taxes can become a personal liability of a Director under a similar regime to the DPN regime detailed above. Section 47B of the Taxation Administration Act 1996 (NSW) outlines a regime the rules whereby a “compliance notice” will be issued to a director. Similar to the regime above , the compliance notice can be rectified by placing the company into liquidation or administration.

Workers Compensation

Sections 145, 145A and 175A of the Workers Compensation Act 1987 (NSW) provide the circumstances whereby a director may be personally liable for payments to an insurer in respect of a workers compensation claim and outstanding premiums.

In circumstances where a contractor’s audit has been undertaken and contractor’s have been deemed employees by the ATO the best option available to a company and it’s director may be to place that company into voluntary administration or liquidation.

For a confidential free chat regarding you or your client’s situation please do not hesitate to contact Mr Josh Taylor of my office on (02) 9251 5222.

Tax Deductions on Expenses Incurred in dealing with Director Penalty Notices (“DPN”)

The DPN Regime was introduced by the Australian Taxation Office (“ATO”) in 1993 as a method to ensure corporate compliance with taxation liabilities. Under the DPN regime, directors could become personally liable for the company’s debts under certain circumstances. The primary objectives of the DPN regime were to ensure directors caused the company to meet its taxation obligations or if this was not possible, promptly seek professional advice with the view to placing the company into voluntary administration or liquidation.
Until recently DPNs had only applied to Pay As You Go (PAYG) withholding liabilities. However, in July 2012, the DPN regime was expanded to include Superannuation Guarantee Charge (“SGC”) liabilities. The regime was also amended to make directors automatically liable for PAYG withholding or SGC where such amounts have been both unpaid and unreported for more than three (3) months after its due date (known as the lockdown provisions). Under the new DPN regime a director cannot avoid personal liability where they have fallen foul of the lockdown provisions by placing the company into Voluntary Administration (“VA”) or Liquidation.The clear emphasis here is that directors need to ensure that at reporting the company’s obligations on time to still avail themselves to being able to avoid personal liability by subsequently placing the company into either VA or Liquidation.

In the recent Administrative Appeals Tribunal Decision of James Gerald Michael Healy v Commissioner of Taxation ([2013] AATA 281), Senior Member C R Walsh was required to consider the tax deductibility of various expenses incurred by Mr Healy in defending and addressing a DPN (and also in annulling his bankruptcy). While Mr Healy was primarily unsuccessful on a technical aspect (the expenses were not in fact incurred by Mr Healy as his brother paid them), Senior Member Walsh analysed the ability of directors to claim a tax deduction for expenses incurred “in managing his or her own tax affairs and in complying with a legal obligation in relation to another taxpayer’s tax affairs.”

Senior Member Walsh explained that Section 25-5 of the Income Tax Administration Act 1997 (“ITAA”) provides for a taxpayer to deduct expenses incurred for “complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity.” The definition of tax under the Income Tax Administration Act 1997 was considered to be sufficient to encompass amounts due under the PAYG withholding regime.Under the DPN, Mr Healy’s obligation as a director was to:

  • Cause the company to comply with its tax obligations (by paying them);
  • Make an agreement to repay the company’s tax debt;
  • Appoint a voluntary administrator to the company; or
  • Place the company into liquidation.

As such, Mr Healy’s obligation would be “complied with” if one of the above events occurred. In Falcetta v Commissioner of Taxation (2004) FCAFC 194, the Full Federal Court were of the view that under Section 25-5 of the ITAA, expenses relating to, amongst other things, preparation of income tax returns, managing and complying with a DPN and obtaining legal advice on these issues would be deductible. In that case, Mr Falcetta incurred legal expenses in obtaining advice regarding the DPN for unpaid PAYG withholding debts of the company. The ATO Interpretative Decision (ATO ID 2004/831) on this authority suggests that the legal expenses will only be deductible under section 25-5 of the ITAA 1997 of:

  • It is complying with an obligation imposed on the taxpayer by a Commonwealth law that relates to the tax affairs of an entity; and
  • The advice is provided by a recognised tax adviser.

Based on these recent cases, it appears that directors have further incentive to seek prompt professional advice regarding any DPN received.

The ATO continue to use DPNs actively as a tax collection measure for companies, particularly those in the SME sector where non-compliance with PAYG withholding and SGC is more significant. Importantly DPNs are sent to the residential address of the directors as per ASIC records. So encourage your clients to open the mail they receive to their home address, rather than leaving it unopened on the kitchen bench as we have seen occur on a number of occasions which generally limits the options available to them.

If you would like to know more about DPNs please do not hesitate to contact us.

ATO Director Penalties – 5 months on

Previously, the Australian Taxation Office (“ATO”) were able to issue Director Penalty Notices (“DPN”) to make directors personally liable for unpaid Pay As You Go (“PAYG”) Withholding tax obligations that were not paid by the due date. The ATO were able to issue a DPN to the director for an amount equal to the unpaid amount. The director had the following options:

  1. Pay the outstanding amount; or
  2. Place the company into voluntary administration; or
  3. Place the company into liquidation.

By taking any of the above options within 21 days of receiving the DPN, the director could remit or avoid personal liability. If no action is taken during the relevant timeframe, the ATO could commence recovery action against the director. These DPNs were found to be ineffective in preventing directors placing companies with large PAYG Withholding tax liabilities (and other statutory debts) into external administration and creating a ‘phoenix’ company to continue operations.

On 29 June 2012, new laws were introduced to reduce the scope for companies to engage in fraudulent phoenix activity or escape payments of employee entitlements. This involved the strengthening of the ATO’s director penalty regime.

Amongst other things, the new director penalty regime:

  1. Extends director penalties to include unpaid Superannuation Guarantee Charge (“SGC”);
  2. Does not allow the director to discharge their personal liable by placing the company into external administration if the company has not paid or reported its PAYG Withholding or SGC for at least 3 months after its due date; and
  3. Denies the director the ability to claim PAYG Withholding tax credits in their personal tax return in the event that the company failed to pay the PAYG Withholding tax by imposing a PAYG Withholding non-compliance tax.

The new director penalty regime in relation to unpaid and unreported PAYG is effective retrospectively which allowed the ATO to issue DPNs for these debts despite the liability having accrued prior to the enactment of the legislation. From July 2012 to November 2012, the ATO have issued just over 1,000 DPNs in this regard. The ATO have indicated that at this stage, the focus has been on the worst offenders of suspected fraudulent phoenix activity. Notwithstanding, the ATO have continued to issue DPNs under the old director penalty regime (approximately 3,000 between July 2012 and November 2012). The ATO estimate in the short-term that it will issue up to 20,000 DPNs for unpaid PAYG Withholding or SGC liabilities per year. If this is the case, it would appear likely that the number of directors seeking insolvency advice would dramatically increase.

In the interim, 29 November 2012 marked the date in which 3 months had elapsed since the SGC liability for the June 2012 quarter would have become due and payable. For those directors who did not make their SGC lodgements and remittance by that date will now be automatically liable for the company’s SGC liability.

To avoid personal liability under the new regime, it is recommended that directors ensure that taxation lodgements and payments are made in a timely manner. In the even t that the payment of company tax, employee entitlements such as SGC, and other liabilities will cause the company hardship, it is recommended that the director seek professional advice immediately.

The Fair Entitlements Guarantee

The Fair Entitlements Guarantee (“FEG”) Act 2012 received Royal Assent on 28 November 2012 and becomes effective for liquidations and bankruptcies commencing on or after 5 December 2012. The FEG Act replaces the administrative General Employee Entitlements and Redundancy Scheme (“GEERS”) which came into operation in 2001 was set up by the then Minister for Employment, Tony Abbott as a result of large corporate collapses in the 1990’s including Ansett and National Textiles.

GEERS was designed to pay unpaid wages, annual leave, long service leave and redundancy entitlements of employees that cannot be met by their insolvent employer. The FEG system will largely remain the same as GEERS in respect of employee eligibility rules. However, the criteria has changed to allow former employees access to their entitlements through FEG even if the company had formerly been subject to a Deed of Company Arrangement that had failed. The Government is also set to simplify the eligibility criteria further by refining rules for employees that may or may not have been offered new employment with a new operator or purchaser of the former business. The system will continue to be administered by the Department of Education, Employment and Workplace Relations.

Since inception, GEERS have assisted over 110,000 former employees in recovering over $1.02 billion in workplace entitlements as a result of the failure of their employer. Not surprisingly over 40% of these entitlements have been paid over the past 3 years. Concerns have previously been raised that employers are abusing the system by continuing to trade until cash flows are exhausted and relying on GEERS to ‘pick up’ unpaid entitlements.

Is Management the key driver of business success or failure?

Although external factors do play a part in the success or failure of a business, research shows that internal factors such as the quality of management is far more important.
The report prepared by the Australian Securities and Investments Commission (ASIC) on the reason for company failures has consistently concluded that the major reason for company failures is “poor strategic management “. The second most common reason cited for business failure is a failure to maintain proper books and records. This of course can be seen as one in the same as bad strategic management.

In June 2013, Jones Partners commenced a major research project into the state of the Australian Economy, Businesses at Risk and Insolvencies. At a function announcing the launch of this project, Mr Phil Ruthven Chairman of IbisWorld, drew some interesting conclusions. Refer to the video on an excerpt taken from the presentation.

Many economists consider that the Australian economy is in reasonably good shape. Clearly interest rates are low inflation appears to be under control and growth appears to be positive. Notwithstanding these happy statistics company liquidations continue to rise and Personal Bankruptcies remain at record high levels. Factors other than general economic conditions are clearly very relevant.

The ASIC report also demonstrates that the vast majority of company liquidations relates to small independent family owned businesses. In particular, 81% of companies that failed had less than 20 employees and 85% had less than $100,000 in assets. The small business sector is clearly under the most pressure at the present time and the major risk factor is the quality of management. The components of good management are not well defined particularly with reference to the small business sector. However, it is my belief that it is the personality drivers of individual business owners that defines management.

Economist Chris Nadarajah has been commissioned by Jones Partners to oversee this project and his report will be presented at a function to be held at the Institute of Chartered Accountants Australia on 29 July 2014. If you are interested in attending this meeting, please feel free to contact me.

Related Article:

Rates of Currency Exchange – Impact on Australian Businesses – Jones Partners

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ATO Debt Collection Process under review

On 26 May 2014, a review into the ATO’s approach to debt collection was announced by the Inspector General of Taxation, Mr Ali Nozoori. It was noted that over the last 10 years that the ATO has reported an increase in total collectible debt. In 2012/13 the total amount of this was about $17.7 billion and importantly over 60% was owed by small business. This supports what I frequently see, whereby the ATO is quite often the largest creditor in small company insolvencies.
Attached is an audio link of an interview between Ross Greenwood from 2GB and the Inspector General Ali Nozoori.