Director Penalty Notices - A blunt instrument

The post COVID honeymoon is over.  The Australian Taxation Office (ATO) is back with a mission – to collect more than $34 billion in debts owed by small businesses and self-employed Australians, which was put on hold during and after the pandemic.

The ATO’s tool of choice – the most effective in its arsenal – is the issue of Director Penalty Notices (DPNs).  DPNs are very blunt instruments.  They sheet home personal liability to directors for a company’s outstanding liability for pay as you go withholding tax (PAYGW), goods and services tax (GST) and super guarantee charge (SGC).  

Given the increased use of DPNs it is important and timely to understand what they are, what liability they create, what must be done to avoid personal liability, and what defences might be available.  

By the numbers

In the 12 months to the end of May 2024, corporate insolvencies totalled 10,774, up 36% on pre-pandemic levels and exceeding the post-GFC peak of 10,757 in the 2012 financial year.

During COVID, and in the year or so thereafter, the ATO refrained from issuing DPNs. That approach has now been abandoned, with the ATO issuing over 20,000 DPNs to directors in the financial year ending 30 June 2023, and over 26,000 (with a debt value of over $4.4 billion) in the following financial year.

Further, the ATO has increased its use of “lockdown” DPNs, which allow the ATO to collect historical debt from directors often many years after the liquidation of the company.

There is presently about a 70%/30% split between lockdown and non-lockdown DPNs. That division was previously at 20%/80%, demonstrating the ATO’s focus on utilising the lockdown DPN as the means to recover older debt.

What are DPNs

The DPN regime relies on the fact that a director of a company maintains a statutory obligation to ensure that the relevant company’s PAYG, GST and SGC payment obligations are reported and paid on time.  Where a payment obligation is not met, the director becomes liable to pay the ATO a penalty equal to the overdue and unpaid payment obligation.

A Director Penalty Notice is the Notice by which the ATO seeks to enforce that personal liability.    

There are two types of DPNs:

1. non-Lockdown DPNs, and
2. lockdown DPNs.

A standard, or non-lockdown, DPN can be issued to a director where the company has completed its Business activity statement (BAS), Instalment activity statement (IAS) and SGC lodgements as required by the legislation but has not paid the relevant PAYGW, GST or SGC debts by the due date.

A lockdown DPN is issued where a company fails to complete its BAS, IAS or SGC lodgements within the required timeframes and fails to pay the relevant (estimated) outstanding tax liability.

A DPN is effectively the first step in the Commissioner’s action against a director to recover unpaid PAYGW, GST or SGC; the Commissioner cannot commence proceedings against one or more of the directors of the company without first serving a DPN on them.

Dealing with a DPN

The issuing of a standard DPN requires the director to do one of the following within 21 days:

1. cause the company to pay the underlying tax debt
2. personally pay the debt in full
3. appoint a voluntary administrator (VA) to the company
4. appoint a small business restructuring practitioner (SBRP), or
5. appoint a liquidator to the company.

Where the director takes one of those steps within the 21 days, the director will avoid personal liability.  However, if a director fails to take one of those steps within 21 days, the DPN will subsequently “lockdown”, meaning the director will become personally liable and the ATO can commence recovery proceedings.

A director issued with a lockdown DPN has only one option—pay the penalty in full using personal or company funds. A director is not released from personal liability under a lockdown DPN by placing the company into administration or liquidation.

While the penalty that attaches to the serving of a DPN on a director is a separate from the company’s underlying payment obligation, the regime recognises each as a ‘parallel liability’. That is, the payment of the liabilities owed by the company, or of the penalty owed by the director under the DPN will reduce or discharge the debt owed by the other. Importantly, where a company’s overdue payment obligation remains outstanding, and the company goes into liquidation, the director is likely to remain liable for the penalty under the DPN.  

Director resignation or appointment

A director cannot avoid liability under a DPN by resigning as a director of the company.

Similarly, where a new director is appointed to a company the new director will become liable from 30 days after their appointment for a subsequently issued DPN in respect to Payment Obligations that a company accrued and did not pay prior to the director’s appointment.

Accordingly, it is important that people considering becoming a director of a company or who have recently been appointed to promptly ascertain whether the company has any outstanding PAYGW, GST or SGC reporting or payment liabilities. If they do, the prospective director should take action to bring the taxation and superannuation affairs of the company up to date or alternatively decline the appointment.

Defences

A director who had received a DPN may not be liable for the debt the Commissioner seeks to recover if the director can establish one of three defences.

1. Illness – Due to illness (or other acceptable reason) it would have been unreasonable to expect the director to take part (and in fact the director did not take part) in the management of the company during the time that the payment obligation accrued for which a DPN was subsequently issued.
2. All reasonable steps – the director took all reasonable steps to have the company pay its relevant taxation obligations, appoint an administrator or small business restructuring professional to the company or cause the company to be wound up.
3. Reasonably arguable position - available for SGC liabilities and net assessed GST amounts when a DPN results from the company treating the Superannuation Guarantee (Administration) Act 1992 or A New Tax System (Goods and Services Tax) Act 1999 as applying in a particular way that was reasonably arguable. The general test is whether, having regard to the relevant legal authorities, what is argued for is about as likely to be correct as incorrect.

With respect to these defences the courts have indicated that:

1. one or more of the defences must cover the entire period under which the director had a prime facie obligation to ensure the company (and subsequently by extension the director via the issuing of a DPN) met its payment obligations, and
2. a defence will not be available where the director relied on others (including fellow director or professional advisers) to ensure the company or the director individually complied with the company’s payment obligations or those of the director personally.

Takeaway

Where a director ensures that his or her company complies with its taxation lodgement and payment obligations, they will never receive a DPN. 

Where lodgements or payments fall behind and a DPN is issued, it is vital that the director understands the personal implications, and relief potentially available, in response to such a notice, especially in light of the ATO demonstrated appetite for this means of recovery.

Most importantly, upon receiving a DPN, a director should:

1. Act quickly: take action immediately, be aware of short timeframes to respond.
2. Understand: consult with legal and financial advisors to comprehensively understand the available options.
3. Evaluate: consider the available options including paying the debt, entering into external administration (voluntary administration, liquidation, or appointing a SBRP).