On 5 July 2011, the Government released the Tax Laws Amendment (2011 Measures No. 7) Bill 2011: Companies' non compliance with PAYG withholding and superannuation guarantee obligations (and associated explanatory memorandum), for public consultation. Although the focus of this legislation is to deter fraudulent "phoenix" activity, in fact the proposed law would apply more broadly. It would extend the personal obligations of company directors to ensure that the company complies with its PAYG withholding and superannuation guarantee obligations.
hat is fraudulent "phoenix" activity?
Fraudulent "phoenix" activity involves directors evading responsibilities by:
- having the company intentionally accumulate debts to improve cash flow or wealth;
- then liquidating the company to avoid paying its liabilities — which include employee entitlements and taxes; and
- then having the company's underlying business (as opposed to the company itself) 'rise again' and continue operating through another corporate entity that is controlled by the same person, or group of people, and is free of the debts.
This description is of "phoenix" activity at a basic level. Some forms of "phoenix" activity can be significantly more sophisticated.
There is a clear distinction between:
- on the one hand, company failure due to poor company management and underlying business failure; and
- on the other hand, deliberate avoidance of financial obligations.
The ATO has described fraudulent "phoenix" activity as:
'the deliberate, systematic and sometimes cyclical liquidation of related corporate trading entities and has the potential to severely erode the revenue base and undermine business and community confidence'.
Fraudulent "phoenix" activity has been particularly widespread in the building and construction industry — with an estimated cost to the Australian economy of between $1 billion and $2.4 billion a year.
ASIC administers the Assetless Administration Fund which has a particular focus on eliminating fraudulent "phoenix" activity. The Fund facilitates a proper investigation of a failed company by a liquidator, which helps ASIC determine whether enforcement action is warranted.
What are the proposed legislative changes?
Three key measures proposed to be introduced into tax legislation are:
1. Extending the director penalty regime to make directors personally liable for their company's failure to pay employees' superannuation guarantee amounts;
2. Allowing the Australian Taxation Office to immediately pursue directors under the director penalty regime if the company's unpaid PAYG withholding and superannuation guarantee liability remains unpaid and unreported three months after becoming due. (Under the current law there is a 21 day grace period, the significance of removing this grace period is explained below.); and
3. Providing the Commissioner with the discretion to prevent directors and, in some instances their associates, from obtaining PAYG withholding credits where the company has failed to pay amounts withheld to the Commissioner.
Why is removing the 21 day grace period significant?
Under the current directors' penalty regime, the ATO can pursue directors for failing to meet their PAYG withholding obligations. However directors are given a 21 day notice period of the penalty before the Commissioner is able to commence proceedings against them to recover the liabilities. This period allows directors to place the company into voluntary administration or liquidation during that 21 day period to avoid personal liability. As a result of this, the PAYG withholding liabilities are never recovered from the Company.
The new laws propose to extend the director penalty regime to address non-payment of superannuation guarantee charges. Significantly, the Commissioner would be able to immediately commence recovery of all director penalties when the company's unpaid liability remains unpaid and unreported 3 months after the due day.
What if it is unclear which employees are entitled to the superannuation collected under the director penalty regime?
If the Commissioner cannot identify the employee entitled to receive the superannuation entitlements, then the employee's superannuation will be held in the ATO's Superannuation Holdings Account for a 10 year period. The employee can claim the superannuation from that account. If after the 10 year period the superannuation is still unclaimed, then it is transferred to consolidated review — however the employee can still claim it.
Comparison of key features of the current law and the proposed law
Paragraph 1.16 of the Explanatory Memorandum sets out the following comparison table:
Directors are personally liable for their company's unpaid PAYG withholding amounts.
In addition to liability for PAYG withholding amounts, directors are personally liable for the company's unpaid superannuation guarantee amounts.
An estimate can only be raised in relation to PAYG withholding liabilities.
In addition to estimating unpaid PAYG withholding liabilities, the Commissioner can estimate the superannuation guarantee charge.
Where a director is liable for a director penalty, the Commissioner must issue a director penalty notice and may only commence recovery 21 days after the notice was issued.
A director can extinguish their personal liability by causing one of 3 things to happen within that 21 day notice period:
1. Payment of debts;
2. Appointment of an administrator under Sections 463A, 463B or 463C of the Corporations Act 2001; or
3. Beginning the winding-up of the company.
The current law continues to apply where a company's debt to which the director penalty applies is less than 3 months old or where the debt has been correctly reported for 3 months from the due date passes.
Once the company's unreported debt is three months old, the Commissioner can commence proceedings to recover the penalty immediately and, a director's personal liabilities is only extinguished by payment of the debt or penalty.
Regardless of whether a company has paid PAYG withholding amounts to the Commissioner, its directors are entitled to PAYG withholding credits withheld by the company from a withholding payment made to the director, for example, their directors fees.
Where a company has failed to paid PAYG withholding amounts to the Commissioner, the Commissioner has a discretion to reduce a director's entitlement to PAYG withholding credits relating to withholding payments made from the company.
A company's director's associates are entitled to PAYG withholding credits withheld by the company from a withholding payment made to the associate, such as salary, regardless of whether the company has paid PAYG withholding amounts to the Commissioner.
Where a company has failed to pay PAYG withholding amounts to the Commissioner, the Commissioner has a discretion to reduce the credits of a director's associate that relate to withholding payment made from the company.
Please note, that for a superannuation guarantee charge, the 3 month period starts on the 'lodgement date'.
What defences are available to directors?
Directors will be able to raise various objections and legal defences if they have been made personally liable for their company's non-compliance. The defences available include proving that:
- because of illness or for some other good reason, the director was not involved in the management of the company and it was reasonable for them not to be involved; or
- they took all reasonable steps to ensure that the directors complied with their obligations or no such steps were available.
However, directors will not be able to claim that they are not liable merely because the company had insufficient funds.
Liability of new directors joining an existing company
New directors joining an existing company need to be mindful of the proposed changes as:
- under the automatic recovery proceedings, they are liable 14 days after they start as a director; and
- the Commissioner will have the power to commence proceedings to recover liability from a new director if they are liable 3 months after the due day and the company's liability remains unpaid and unreported.
Closing date for submissions
Submissions on the draft legislation close on 1 August 2011.
More information from Maddocks
For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Superannuation Team.
More Cleardocs information on related topics
You can read earlier ClearLaw articles on a wide range of SMSF topics here.