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Liability and Defenses Under the Director Penalty Regime

01 December 2017

To have scant regard for a Director Penalty Notice (DPN), to be unaware of penalties that could be involved, or to consider possible defences with anything less than the utmost seriousness, is to invite disaster. (See an example of this in our 15/09/17 newsletter article headed “Have scant regard for a DPN at your peril”, and on our website

Division 9 of Part VI of the Income Tax Assessment Act (ITAA) imposes liability on directors for tax not remitted to the ATO, which, under the Act, may notify directors of this liability with a DPN.

Explained now will be how a DPN functions, three defences against liability (and how they may be employed), and a defence known as “an estoppel”.

Misconceptions of these matters abound, including the belief that it’s a DPN that creates the personal liability of directors when a company fails to remit withheld tax.  In fact, the liability for a penalty equal to the amount of the withheld tax is imposed immediately if the company either fails to remit withheld tax or doesn’t take alternatives provided in s222AOB of the ITAA. 

The nature of liability

Liability is imposed on a director personally by s222AOC of the ITAA.  It’s important to remember the liability is not attached to the office of a director, but personally to anyone who is, or was, a company director during a relevant period, and it’s not a responsibility that can be escaped by the director’s subsequent resignation. 

Liability is also imposed on new directors appointed after a company has failed to comply with s22AOB -- if they don’t cause the company to comply within 14 days of the issue of a DPN (s222AOD).  Directors who seek to avoid personal liability by establishing that the withholding of tax was incurred before their appointment – or that they were appointed essentially to rectify the problem – won’t succeed if the ATO has correctly issued the DPN.

A third defence relates specifically to the Superannuation Guarantee Charge (SGC).

However, it’s critical for directors (and/or their advisers) to note that before moving to instigate a tax penalty, the ATO must give notice in accordance with s222AOE, sent in the manner provided under s222AOF.  If requirements of the notice are met, then s222AOG prescribes that the penalty imposed under s222AOC is remitted.

Defences to a DPN can be raised within 60 days of notification, and penalties won’t apply if the Commissioner of Taxation is satisfied required information is satisfactory, that it has been supplied in a timely fashion, and that circumstances of the director concerned equate to one of three statutory defences.  Whether a director has fulfilled these requirements will be assessed by the ATO in individual cases.

Should It be decided a defence is inadequate, the director may request a statement of reasons under s13 of the Administrative Decisions (Judicial Review) Act 1977 (ADJR Act).  The director may also elect, pursuant to s5 of this Act, to apply to the Federal Court or Federal Magistrates Court for a review of the decision.

The three statutory defences are:

  • Section 269-35(1) provides for a director to establish inability, because of illness or for some other good reason,to have been involved in management of a company that’s subject to an ATO claim for unpaid tax.
  • Section 269-35(2) provides for a director to avoid personal liability by establishing he/she took all reasonable steps to ensure directors of the company subject to a claim for unpaid tax, complied with relevant obligations under s269-15, or, there were no such steps that could have been taken.
  • Section 269-35(3A) provides a specific defence relative to a Superannuation Guarantee Charge (SGC) where directors can seek to establish they applied relevant legislation in a particular way that’s “reasonably arguable” in regard to that guarantee.

The issue of illness

Section 269-35(1) provides a defence in proceedings against directors if it is proved that because of illness or some other good reason, it would have been unreasonable to expect the directors “at any time” to take part in company management.  This would be “at any time” while under relevant obligations of s269-15.61 – amended in 2012.

The “illness” defence has been made more difficult by an amendment that includes an objective element.

Gzell J in Deputy Commissioner of Taxation v George (2002) 55 NSWLR 511, considering (in the New South Wales Court of Appeal) the meaning of the words “at any time” in the predecessor to the current s269-35(1), said these words in section s222AOJ(2) (former s269-35(1) related to a period when a person was a director, and directors were under an obligation to comply with s222AOB(1).

“That means, in my view, that a director has to establish good reason for non-participation in the management of a company throughout the period the person is a director, and directors are under a s222AOB(1) obligation.

“The defence is not enlivened merely because on one or more discrete occasions during that entire period, a director had good reason not to participate in management.

“The requirement is that a director does not take part in management at any time.

“In my view, a director who establishes that at some time during the directorship, when under a s222AOB(1) obligation, there was good reason for non-participation in management, does not gain a defence to a penalty under s222AOC or s222AOD based on an obligation continued by s222AOB(3) at a time when there was no continuing defence.”

The ATO can require a director to pay a penalty calculated over the entire period of a company’s breach.  The non-participation defence is available only if directors can establish good reason for failing to take part in management of a company for the entire period they are under a s269-15 obligation.

The all-reasonable-steps issue

Section 269-35(2) provides a defence in proceedings against a director if it is proved the director took all reasonable steps, with the company’s other directors, to ensure compliance with their relevant obligations under section s269-15.  Alternatively there were no such steps that could have been taken to ensure either that the required tax was paid, an administrator of the company was appointed under s436A, s436B, or 436C of the Corporations Act, or the company began to wind up.

This defence requires proof of the exercise of all options under s269-15.

Furthermore courts will look at whether such defences can be established for the whole period between the due date and expiry of a DPN.  In Canty v Deputy Commissioner of Taxation [2005] NSQWCA, Handley JA, addressing the issue, said: “Proof that nothing could have been done at various times during this period, would not establish that nothing could have been done at other times.  Proof that a director took all reasonable steps at various times would not establish that this person took all reasonable steps” [at all times].

Courts don’t just take account of what directors say they knew of a situation, but rather what as directors they ought to have known and ought to have done.  Was, for example, timely advice sought from lawyers or accountants?

Rude awakening for a sleeping director

The Western Australia Supreme Court has held that a director was liable for unpaid PAYG withholding amounts, despite being a university student and having limited involvement in company activities.  In ruling that non-involvement did not reduce the director’s responsibilities, the judge observed: “He appears to have been what is sometimes called a sleeping director, and being a sleeping director is a very dangerous pastime.”

In Fitzgerald v DCT (1995) 68 ATR 770 a director of only 17 days said he wasn’t aware of the company’s tax debt until after he’d ceased being a director, and in any case he wasn’t in a position to ensure payment.  Rejecting the defence, French DJC said that while the director wasn’t aware of the company’s failure to comply with provisions of s222AQOB, there was nothing to suggest he didn’t take part in company management at the relevant time.

In Canty v Deputy Commissioner of Taxation [2005] NSWCA 84 the New South Wales Court of Appeal suggested that in order to fall within the timeline for this defence, a former director, in the capacity of a shareholder or creditor, would have to apply urgently to the Court for a winding up of the company.

The Court explained that: “A former director will be a contingent or future creditor because of the right of indemnity against the company for the penalty the Commissioner is seeking to recover.  He or she is entitled to apply urgently for a winding up order. (See Corporations Act s462(1)(b), (4)).  A company that cannot pay its group tax over many weeks is prima facie insolvent.”

When former directors of a company come under a relevant obligation provided for in s269-15 they should, in order to escape liability, take steps to ensure the company is placed into voluntary administration or wound up.

Defence specific to SGC penalty

The third defence against a claim by the ATO for unpaid tax relates specifically to the Superannuation Guarantee Charge (SGC).  Section 269-35(3A) of the ITAA provides a defence in proceedings against a director if the director had applied relevant legislation in a particular way that was “reasonably arguable”.

“Reasonably arguable” is defined in s995-1(1) of the ITAA to have the meaning given by s284-15 of Schedule 1 to the Taxation Administration Act (TAA) – the essence of which is that a matter is “reasonably arguable” if it can be concluded, in the circumstances having regard to relevant authorities, that the argument “for” is as likely to be correct as incorrect, or, is more likely to be correct than incorrect.

Exercising reasonable care means making a reasonable attempt to comply with relevant law, so that a court, in deciding whether reasonable care has been taken by a director in dealing with an SGC, will consider all of the taxpayer’s circumstances – including education, knowledge, experience and skill.

This defence is most likely to be relied upon by a taxpayer where there’s uncertainty about whether particular workers are entitled to superannuation.

Defence of estoppel

It ‘s also possible for a director to employ a defence of estoppel.  Estoppel is the principle that precludes a person from asserting something contrary to what is implied by the person’s previous actions or statements, or, by a previous pertinent judicial determination.

In Federal Commissioner of Taxation v Winters (1997) 97 ATC 4967 two directors successfully argued summary judgement shouldn’t be made against them because during negotiations with the ATO (after receiving a DPN) they were led to believe time for compliance with the notice would be extended.

Thus ,they argued they’d been induced not to appoint an administrator within the 14-day period specified in the notice, and accordingly the Commissioner should be prevented from taking advantage of that failure.

In giving the directors leave to defend themselves against the Commissioner’s claim, Moynihan J took the view that if factual issues were resolved in the defendants’ favour, then the elements of an estoppel would be established.  By contrast in the case of Deputy Commissioner of Taxation v Roche [2013] WASC 302 the court held elements of an estoppel couldn’t be established in representation because the Deputy Commissioner had expressly rejected a director’s proposal relating to a DPN.

Macks Advisory hopes lessons learned from this article are that defences against requirements of a DPN are not to be taken lightly, are usually difficult to establish successfully, and that on receiving a DPN, directors should immediately seek expert advice – and follow it to the letter.

Disclaimer: The information contained in this webpage is general information and does not constitute legal advice. Nothing in this webpage is or purports to be advice. If you do need advice, then you ought to seek and obtain appropriate personal professional advice based on your personal circumstance.

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