Time is running out for many directors who recently received ATO letters warning of possible Director Penalty Notices (DPNs) for failure to meet tax liabilities accumulated through the pandemic. On 13 May 2022, the ATO announced that it had recommenced collection activities on taxpayers who are higher risk, refusing to engage or have unpaid superannuation guarantee debts. A total of 52,319 letters have been issued by the ATO and a further ramp up in enforcement activity is anticipated. With this in mind, directors should be considering the duties imposed on them by the Corporations Act 2001, and the risk and consequences of DPNs and insolvent trading.

The ATO announced on 13 May 2022 that for taxpayers with outstanding lodgments and tax debts who do not engage, it is now taking firmer action and expects “a number of insolvencies to occur in the coming months as the economy normalises”. ATO collection methods will include garnishees, recovery by DPNs, public disclosure of business tax debts and legal actions including issuing summons, creditors’ petitions and seeking winding-up orders. Currently, the ATO is “issuing 30-40 DPNs each day and expects that number to increase”.

What is the potential impact on Directors?

Enforcement action by the ATO is a serious matter. A DPN is a formal notice issued to directors by the ATO to hold them personally liable for specified tax liabilities of their company (including an estimate of liability if lodgments are not up to date). Put simply, if a director fails to cause the company to pay specified tax liabilities or take other action (such as appointing an external administrator) prior to the DPN’s 21-day expiry, the director will be required to pay the tax liability from personal assets. The DPN regime can include unpaid PAYG, GST and superannuation tax debts.

In dealing with the ATO, a director should have regard to their duties. In particular, to act honestly, in good faith and with reasonable competence in the best interest of the company, while avoiding conflicts of interest. Directors must also take action to prevent insolvent trading or risk exposing themselves to personal liability for their company’s unpaid debts. In Australia, insolvent trading may carry both civil and criminal penalties.

What is the duty to prevent insolvent trading?

Under the Corporations Act 2001, directors have a positive duty to prevent a company from trading while insolvent. The duty requires a director to take appropriate action and prevent their company from incurring debts where the company is insolvent, or will become insolvent as a result of incurring further debt(s). Failing to prevent insolvent trading can have the following consequences:

• If the company enters liquidation, a liquidator can commerce recovery proceedings against the director personally for insolvent trading and the director can be ordered to pay the value of debt incurred from their personal assets;
• ASIC may make a pecuniary penalty application and impose a civil penalty of up to $200,000, or if the director acted dishonestly, the director could face criminal conviction resulting in a fine of up to $444,000 or 5 years imprisonment, or both; and
• ASIC can disqualify the director from managing corporations in the future.

What should a director do if they think their company might be insolvent?

If a recent ATO letter, DPN or other indicator of financial strain has raised a concern regarding a company’s solvency, then it is imperative that directors take immediate action to reduce the risk of personal liability and optimise the outcome for the company. Options include:

• Prevent the company from incurring any further debts until it is solvent, which may be practically challenging;
• Seek professional assistance to restructure the company’s affairs, for example by debt forgiveness, deferral, refinancing or restructuring (including within the Safe Harbour framework); and/or
• Seek help from an insolvency practitioner who can conduct a solvency review and provide options available, which may include the appointment of an external administrator.

How can McGrathNicol help?

We work with directors and their advisors (accounting, financial and legal) to navigate periods of financial and operational challenge and distress, including dealing with major creditors and advising on responses to DPNs.  This includes fit-for-purpose restructuring and insolvency advice, creditor arrangements, turnaround strategies and assistance with the implementation of value-maximising restructures.

For further information on how McGrathNicol can assist you, please contact a member of our team.