If a company doesn't pay its tax, then the directors must- you can run but you can't hide

Directors — even honest directors — who incur personal liabilities for a company's tax obligations have to pay in the end. The Corporations Act discretions are no help under the tax law. A recent case is a warning to directors, Deputy Commissioner of Taxation v Dick. Julian Smith and Robert Green

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Summary — Directors need to ensure PAYG compliance

Directors must ensure their companies comply with their taxation obligations. If the companies don't pay, then the directors may face personal penalties including having to pay the tax on account of the company's PAYG obligations. In a recent case, even an honest director had to pay.

Additionally, and most interestingly, the case offers clear guidance on the interaction of these tax laws with company law. In short, directors cannot rely on the possible relief under section 1318 of the Corporations Act 2001 (Cwth) to avoid tax liabilities.

The case is Deputy Commissioner of Taxation v Dick [1]

The facts of the case

The relevant facts of the dispute were:

• Mr Dick was the director of a company that failed to remit PAYG deductions to the ATO during the period June 2002 to March 2003. The company owed $146,793 in PAYG tax.
• If a company does not pay PAYG instalments, then the amount of those instalments is imposed on the directors as a personal liability.
• The Deputy Commissioner of Taxation ( DCT) issued three separate recovery notices on Mr Dick, as a director the company, in relation to the company's failure to remit PAYG instalments.
• Mr Dick did not cause the company to remit the PAYG instalments after receipt of the notices.
• As a result of this failure, the DCT commenced proceedings in the District Court against Mr Dick to recover unpaid directors' penalties of $146,793.
• Mr Dick first argued unsuccessfully that he had a defence under the ITAA36 because he had not participated in the management of the company during the relevant period. However his alternative argument, that he should be granted the court's discretionary relief under section 1318 of the Corporations Act, was successful at trial. Mr Dick submitted that he had acted honestly, and that having regard to all the circumstances he ought fairly be excused from liability. The relevant circumstances included the fact that as of 6 January 2003, Mr Dick was excluded from management of the company by its chairman, and that Mr Dick's involvement in the company was more administrative than managerial. Also relevant was the fact that Mr Dick was "conned" by the new chairman of the company that the chairman would deal with the notices and the fact that since the new chairman became the majority shareholder, Mr Dick received no further remuneration for his services.
• Consequently, the lower court granted relief to Mr Dick under section 1318 of the Corporations Act — so Mr Dick was not obliged to pay unpaid director's penalties of $146,793.
• However, the DCT appealed to the New South Wales Court of Appeal who overruled the lower court, removed the relief and required Mr Dick to pay the tax.

What is the discretionary relief?

The Corporation Act allows a Court to grant relief from liability to various persons, (including directors) if, in a civil proceeding brought against them:

• they have acted honestly; and
• in the circumstances, they ought fairly to be excused from liability.

The relief is available for a range of acts committed by a person. In this case the relevant acts were Mr Dick's "default" or a "breach of duty" in not making sure that the company paid the PAYG instalments.

What did the Court on Appeal say?

There were two questions for the Court of Appeal to answer:

1. Does section 1318 of the Corporations Act give a Court the discretion to relieve a director of liability for proceedings issued under tax legislation? (in this case, Divisions 8 and 9 of the ITAA36); and
2. If the answer to the first question is "yes", then: Should the Court apply this discretion in favour of Mr Dick?

All members of the court answered the first question "No" — they held that section 1318 of the Corporations Act cannot apply to liabilities arising under Divisions 8 and 9 of the ITAA36. Therefore, the second question did not need to be answered.

However, the reasons the judges gave for their first answer were not consistent:

• Santow JA held that Divisions 8 and 9 of the ITAA36 are exhaustive in respect of available defences — leaving no room for section 1318 of the Corporations Act to apply. He added that but for this point, he would have considered that the relief under the Corporations Act could have applied to liabilities under Divisions 8 and 9 of the ITAA36.
• Basten JA took the view that Divisions 8 and 9 of the ITAA36 and section 1318 of the Corporations Act could not operate together, and that the former should prevail.
• Spigelman CJ went much further deciding that section 1318 was only ever intended to cover corporations law purposes, whether under statute or the general law.

Accordingly, the Court of Appeal allowed the appeal and entered judgment for the DCT.

More information

For more information, please contact Maddocks on 03 9288 0555 or 02 8223 4100 and ask for a member of the Maddocks Corporate and Commercial Team.

[1] [2007] NSWCA 190