Tax Deductions on Expenses Incurred 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.

 

Should I transfer the family home – Beware!!

We are continually surprised by individuals who transfer ownership of their property (usually the family home) to a co-owner or family member for no consideration or for consideration of less than market value who when they subsequently become bankrupt think that such transaction may not be void (or recoverable). What sometimes concerns us more is that such advice may be given to them by consultants / advisors that are inappropriately skilled to properly advise the individual of the consequences, particularly in circumstances where their financial position is perilous.
We have recently been involved in a matter where this occurred and it provides a very useful instruction regarding the application of Sections 120 and 139ZQ of the Bankruptcy Act (“the Act”). Importantly Section 120(1) of the Act provides:

“A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the trustee in the transferor’s bankruptcy if:

(a) The transfer took place in the period beginning 5 years before the commencement of the bankruptcy and ending on the date of bankruptcy; and(b) The transferee gave no consideration for the transfer or gave consideration of less value than the market value of the property.”
In the case of a related entity (ie spouse, brother, sister, children etc), Section 120(3)(a) indicates that a transfer is not void against the trustee if:

(i) the transfer took place more than 4 years before the commencement of the bankruptcy; and (ii) the transferee proves that, at the time of the transfer, the transferor was solvent.”
So in essence if you are going to transfer within the five (5) years to a related entity then they have to pay market value for the property to the bankrupt. And regrettably love and affection afforded to the transferor doesn’t constitute consideration!!

It typically comes unstuck because the property is simply transferred by the transferor (who later becomes bankrupt) to their related entity and no consideration is paid. Importantly, that is not the end of the story. There is also a very useful Section of the Act, being 139ZQ(1)(d) which enables the bankruptcy trustee to cost effectively make recoveries for creditors. This is done by making an application to the Official Receiver to give written Notice to a person who has received the benefit of such a transaction to pay to the bankruptcy trustee an amount equal to the value of the property received. In essence, once such Notice is given, the property is charged with the liability of the person to make payments to the bankruptcy trustee as required by the Notice.

In a recent bankruptcy we were administering, a Section 139ZQ Notice was used very effectively to recover monies for creditors. We identified from our initial investigations of the bankrupt that he and his non-bankrupt spouse transferred their interests in two (2) residential properties to a related entity in the years leading up to our appointment for no consideration.

We considered that such transfers were void under Section 120(1) of the Act. Other than these transactions, we had not identified any other assets recoverable. Thus we were not in funds to become embroiled in some kind of protracted and costly litigation in the Courts.

Accordingly, we made an application to the Official Receiver to issue a Section 139 ZQ Notice to the related entity requiring payment for the bankrupt’s share of the transfers. Whilst the related entity initially did not appear to fully understand the strength of such Notice, they did seek professional advice whereupon subsequently both properties were sold and the amounts required in the Notices were paid in full – about $200,000 in all.

It is important that individuals who may be facing financial difficulty get the right professional advice before entering into these types of transactions which will not only potentially enable better solutions to be identified, but also minimise the emotional stress that is then caused when a bankruptcy trustee seeks to recovers these types of transactions.

Insolvent Builders & Home Warranty Insurance (“HWI”)

For many individuals or couples one of the biggest purchases in their lives will be the construction of a new home. Unfortunately over the years there have been many residential home builders that have gone into some form of insolvency administration and ceased to trade, leaving home owners with an incomplete home and lots of worries.
We are frequently appointed as Voluntary Administrators or Liquidators to residential home builders where they are insolvent. In one recent matter, there has been an instance where the HWI policies were not adequate to cover all costs incurred in completing the homes. We highlight in this article some important considerations customers should give if such an event occurs.

HWI is taken out by the residential home builder and is designed to cover customers. From 1 July 2010, the NSW Self Insurance Corporation, trading as the NSW Home Warranty Insurance Fund, took over as the sole provider of home warranty insurance in NSW. QBE Insurance (Australia) Limited and Calliden Insurance Limited were appointed as insurance agents of the NSW Self Insurance Corporation, through a contractual arrangement.

Importantly HWI provides a set period of cover for loss caused by defective or incomplete work in the event of the death, disappearance or insolvency of the residential home builder.

From 1 July 2002 a key element of a HWI policy is that it must indemnify beneficiaries (i.e. the customer) for non-completion of work due to early termination of the building contract. Insolvency of the residential home builder typically results in the termination of the building contract.

Critically from 1 February 2012, a HWI policy:

  • is required to be obtained where the contract price is over $20,000 or, if the contract price is not known, the reasonable market cost of the labour and materials involve is over $20,000; and
  • must provide cover of at least $340,000.

Relevantly claims for incomplete work are limited to 20% of the contract price (up to a maximum of the cover provided under the policy). It is this aspect that we believe is not always well understood by customers and indeed the residential home builder when insolvency occurs. We have set out below a recent matter we were appointed to highlight how HWI works when an insolvency event occurs resulting in the termination of the building contract.

Facts

  • Contract value for construction of home $300,000;
  • Costs paid as at insolvency event by home owner for first stages of construction $100,000;
  • Invoice issued by residential home builder for work completed but unpaid $25,000; and
  • Balance outstanding under contract at time of insolvency event / Liquidation: $200,000.

At the date of insolvency, the Insolvency Practitioner is often provided with a debtors listing relating to progress claims made by the residential builder. The recovery of each debtor is not always straight-forward and an accurate position regarding what the customer may owe (if any) can only be determined once the HWI is finalised. This can take many months to determine.

Given the above facts, the HWI and customer position unfolded as follows:

  • Following the liquidation of the residential builder, the customer lodged a claim under the HWI policy.
  • The Home Warranty Insurer arranged for an external consultant to inspect the dwelling to confirm / quantify the amount of works required to complete the contract.
  • The customer also had to prove to the Home Warranty Insurer the quantum of payments made to the residential home builder under the contract. In this case no “cash” payments had been made, but in circumstances where this occurs, this can create issues.
  • Three (3) quotes were obtained from different builders to complete the works. The Home Warranty Insurer then approved one of the builders to complete the works.
  • The certified costs to complete the dwelling were $250,000. Therefore, the customer paid the balance of the original contract price being $200,000 and made a claim for the additional $50,000 under the HWI policy.
  • In this case as the additional cost to complete the dwelling was less than 20% of the original contract price, the HWI covered the additional $50,000 that was required to complete the construction of the dwelling. Therefore there were no monies collectible under the outstanding progress claim in the Liquidation.
  • HOWEVER, if the certified costs had been for example, $285,000 (thus meaning the additional costs were greater than 20% of the contract price), then the customer would have had an uninsured loss to the extent of $25,000 that would have to be met from their own funds. In the particular insolvency administration concerned, there were 3 customers who ultimately had uninsured losses ranging from $25,000 to $60,000 per customer. Not insignificant!!

Unfortunately when an insolvency of a residential home builder occurs, it may take several months to work through this process and it will only be at the conclusion of the building contract once all of the costs are known, that the Liquidator would be in a position to determine if there is actually any debt owning by the customer.

It is important that customers get the right advice as to their position when their builder has been placed into some form of insolvency administration. We caution customers who want to go off miss-informed and complete the dwelling themselves as once this occurs they are likely to jeopardise any ability to claim on HWI.

 

Insolvency and Bankruptcy Numbers – Not What You Might Expect!

Welcome to our first Newsletter for 2014. A subject we are frequently asked about is what are the insolvency and bankruptcy statistics doing and what inferences can be gleaned from them. During the course of the calendar year we will be providing a regular commentary on movements. Set out in this article are graphs for NSW and Australia for corporate insolvencies and personal bankruptcies / personal insolvency agreements (“PIAs”) during the period 2010 to 2013 inclusive. Some key observations are:
Corporate Insolvencies

  • In both NSW and Australia appointments decreased by approximately 2% in the 2013 December quarter on the previous corresponding period (“PCP”).
  • In NSW there was a negligible change in insolvency appointments in 2013 on the PCP. However, nationally insolvencies increased approximately 1.8% in 2013 on the PCP.
  • In 2013 NSW maintained its average 39% of the national corporate insolvency market.
  • In 2013 creditors voluntary liquidations accounted for approximately 47% of all corporate insolvencies. Whilst some may express surprise about this, our own statistics broadly confirm this and given the relative ease via which this type of liquidation can be initiated by directors we believe it will continue to be widely used particularly by smaller corporates who no longer wish to continue in business.

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Personal Bankruptcies / PIAs

  • In both NSW and Australia appointments decreased by approximately 9% and 8% respectively in the 2013 December quarter on the PCP.
  • In NSW there was a decrease in bankruptcies / PIAs of approximately 12% in 2013 on the PCP. Nationally appointments decreased by 10% in 2013 on the PCP.
  • In 2013 NSW maintained its average 33% of the national personal insolvency market for bankruptcies and PIAs.
  • The three (3) postcodes with the highest number of bankrupts in 2012/2013 were:
  • 2770: Mt Druitt and surrounding suburbs;
  • 2560: Campbelltown and surrounding suburbs; and
  • 2170: Liverpool and surrounding suburbs.

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It will be interesting to monitor the numbers as the year unfolds as to where they may head and what inferences can be taken from them about correlations with the overall state of the national economy. Whilst there appear to be several economic challenges ahead (for example a notable decline in business capex spending) we generally feel that insolvency and bankruptcies levels are likely to remain flat throughout 2014.

Strengthening Our Presence in Greater Western Sydney – Narellan Office

We are excited and pleased to announce the opening of our new South West Sydney Office at Narellan. Daniel Soire, a Principal of Jones Partners and a Registered Liquidator, is a local Macarthur resident and will be supervising the Narellan office.
For many years now, Jones Partners has truly valued the importance of being accessible to professional advisors and business owners and individuals throughout Greater Western Sydney (“GWS”). The GWS region is a very significant contributor to the States GDP and has a huge diversity in the range of businesses that operate within it. Our continued presence (via our Norwest Business Park Office) has enabled us to develop strong relationships with other professionals such as accountants, lawyers and financiers, as well as and importantly assist business owners and individuals in this region who may get into financial difficulty. Having a very strong and keen interest in what happens in the region also helps us to understand the factors that can affect SME businesses as well as individuals.

The new Narellan office puts us closer to fellow professionals and SME businesses and individuals when they need expert insolvency, restructuring or bankruptcy advice in South West Sydney. We believe this proximity and not “the ivory tower” approach is what such stakeholders are seeking when looking for specialist advice in corporate and personal insolvency and restructuring.

Our continued and sincere focus throughout the GWS region reflects the importance we place on ensuring that SME businesses and individuals in this region get the “right advice” when they may be in financial difficulty. Jones Partners are a Chartered Accounting Firm that specialises in the provision of corporate and personal insolvency and restructuring services. For more information go to jonespartners.net.au

Strengthening our Presence in Greater Western Sydney

For many years now, Jones Partners has truly valued that importance of being accessible to professional advisors and business owners and individuals throughout Greater Western Sydney (“GWS”). The GWS  region is a very significant contributor to the States GDP and has a huge diversity in the range of businesses that operate within it. Our continued presence (via our Norwest Business Park Office) has enabled us to develop strong relationships with other professionals such as accountants, lawyers and financiers, as well as and importantly assist business owners and individuals in this region who may get into financial difficulty. Having a very strong and keen interest in what happens in the region also helps us to understand the factors that can affect SME businesses as well as individuals.
To further build on our presence and focus in the GWS region, we are excited and pleased to announce the opening of our South West Sydney Office at Narellan. As with our Norwest Business Park Office, the new Narellan office puts us closer to fellow professionals and SME businesses and individuals when they need expert insolvency, restructuring or bankruptcy advice in South West Sydney. We believe this proximity and not “the ivory tower” approach is what such stakeholders are seeking when looking for specialist advice in corporate and personal insolvency and restructuring.

Our continued and sincere focus throughout the GWS region reflects the importance we place on ensuring that SME businesses and individuals in this region get the “right advice” when they may be in financial difficulty. Jones Partners are a Chartered Accounting Firm that specialises in the provision of corporate and personal insolvency and restructuring services. For more information go to jonespartners.net.au

Small Business Survival Tips

On 28 August 2013, I hit the airwaves on Eagle Radio – which is Australia’s first and only radio station dedicated to empowering small businesses. As an Insolvency Practitioner that specialises in advising small to medium sized businesses when they are in financial difficulty I highlighted what are the key ingredients that keep a small business afloat. Unfortunately many small businesses don’t make it through the early years of their commencement and can end up in liquidation.
There is no doubting that small business is a vital ingredient as part of a thriving Australian business community. Running a small business carries risk, but also enormous opportunity if managed correctly. Click on the link below to listen to the interview.

Radio Interview

If would like to discuss any aspect of the interview, please don’t hesitate to drop me a line.

All the best.

 

 

 

 

 

ATO Compliance in Focus Program 2013/14 – Fraudulent Phoenixing & DPN’s a focus

The ATO’s Second Commissioner of Compliance, Mr Bruce Quigley recently released the Compliance in Focus Program for the current financial year. For those that may wish to read the entire version please go to www.ato.gov.au . As mentioned in the document, detection of non-compliance “ is achieved by analysing and matching information reported to us”. As some readers may be aware, the ATO works with other state and federal government agencies and other third parties, such as financial institutions to obtain information. That information is used to identify discrepancies including non-lodgement and under-reporting. Where the taxpayer fails to rectify errors or omissions, the Program highlights that the ATO will take action in the form of reviews and audits, final notices, penalties or legal action.
Whilst there is nothing to startling in the above, it lends support for the course of action that the ATO has taken over the past couple of years – that being the ATO appears to be more active in the compliance mode. I have seen this first hand through the use of the Director Penalty Notice (“DPN”) regime. Such DPN regime was amended in June 2012 to extend personal liability for directors regarding unpaid superannuation guarantee charge (“SGC”) amounts, but also involved the introduction of a “lockdown penalty provision” which results in automatic personal liability of directors in circumstances where either PAYG withholding or  SGC amounts are both unpaid and unreported for a period of more than 3 months after the due date.

With almost half of all tax collected by the ATO coming from employers, the ATO has stated in the Compliance in Focus Program that “we will pay particular attention to those who may not be meeting their obligations …… to ensure they are withholding and reporting the correct amount of PAYG withholding”. With SGC rates having recently been increased to 9.25%, the ATO will also be focusing on payment of the superannuation guarantee.

When looking at medium-sized businesses (classified as between $2million and $250million), the ATO will continue its focus on fraudulent phoenix behaviour. Notably, the ATO reveal “we have identified over 2,000 property developers who have placed companies into liquidation with outstanding GST obligations on multiple occasions…… In 2013-14 we will engage with developers who do this by demanding lodgement, enforcing payment and applying penalties.” Importantly the ATO indicate that they want to reduce phoenix activity by monitoring, auditing and enforcing debt collection. This includes the ATO using the new DPN regime to make directors personally liable for their company’s outstanding PAYG withholding liabilities and employee entitlements, being superannuation guarantee.

A further focus will be the analysis of the information received under the new Taxable Payments Reporting regime that started on 1 July 2012 requiring businesses that operate in the building and construction industry to report payments they make to each contractor each financial year. It will be very interesting to see this project a couple of years on when some of the data matching activities have been underway and what enforcement action the ATO is taking regarding non-reporting of income by contractors.

It is increasingly important for company directors, particularly those in the medium-sized business segment and even the micro segment to understand that the ATO has expanded its ability to extend personal liability to the director for certain company taxes. Whilst one can ponder whether it may ever be extended to GST, the message is clear, taking a position where you don’t report and don’t pay is very likely to mean that you are likely to be queried by the ATO about the poor compliance of the company. However by this time, it may well be the position that under the new “lockdown penalty” you are already exposed to a significant liability. Early intervention and professional advice is the key if you believe that your company is not meeting the liabilities for these taxes. I have advised many company directors in this zone and continue to actively monitor the stance of the ATO in this area.

Personal bankruptcies decline for the quarter ended 30 June 2013

The quarterly personal insolvency statistics for the June quarter 2013 show that personal insolvency activity declined by almost 1.4% when compared to the June quarter 2012. Interestingly NSW, QLD, WA and Tasmania all recorded falls in personal insolvency activity whereas Victoria, SA, ACT and Northern Territory all recorded increases.
Bankruptcy numbers (which accounts for approximately 68% of the personal insolvency numbers for the June quarter 2013 ) actually fell by 3.93% when compared to the June quarter 2012. NSW accounted for approximately 32% of bankruptcies across Australia for the June quarter 2013.

Personal Insolvency Agreements (also known as Part X Arrangements) also declined for the quarter by almost 24%. However it should be remembered that they only account for only about 1% of the total personal insolvency activity numbers. Part X Arrangements whilst still a viable option have significantly reduced in number over recent years as creditors tend to take a more active role in ensuring that individuals are held to account within the terms of the Bankruptcy Act. As such the prevalence of Section 73 compositions can tend to be more favorably considered by creditors because the Bankruptcy Trustee has had adequate time to investigate the individuals financial affairs. Therefore creditors can have more confidence if a Section 73 proposal is than put to them during the bankruptcy.

As a Registered Trustee, I regularly advise individuals in financial distress about the options available to them so that they can take control of a very stressful period in their lives.

 

Director Penalty Notices

In June 2012 there were changes to the Director Penalty Notice (DPN) regime. Most importantly such changes now expose directors to automatic personal liability where either PAYG or SGC obligations remain unpaid and unreported for more than 3 months after the due date. Whilst the ATO will still have to send a DPN to recover on the debt – the director can no longer avoid personal liability in such circumstance by voluntary administration or voluntary liquidation. The important message is that at an absolute minimum directors should ensure that they comply with reporting obligations on-time.
Unfortunately there is still a status quo position being adopted by some directors and advisors. If you do receive a DPN, it is critical to seek professional advice urgently so that it can be determined what type of DPN you have received.