The ATO’s fervent resumption of director penalty notices (DPNs) contrasts sharply with the leniency afforded to businesses, particularly SMEs, during the most painful part of the pandemic. But the ATO has traditionally been a key driver of activity in the insolvency space and this development is likely to create an uptick in appointments.
Accountants should know how to deal with a DPN and proactively consult with clients to help them achieve the best results.
As outlined below, if it is not inevitable, appointing an insolvency practitioner is not always the best option – the situation has to be considered holistically.
What is a DPN?
A DPN is a notice that allows the ATO to recover money owed by a company directly from the directors themselves. There are three types of obligations recoverable under a DPN: PAYGW (pay-as-you-go withholding); GST; and SGC (superannuation guarantee charge). If any or all of these amounts are not remitted in time (usually three months), the ATO may issue a DPN.
There are also two types of DPNs: an ordinary (non-lockdown) DPN and a lockdown DPN.
A lockdown DPN is issued when a company has not only failed to pay the amounts due but also has not lodged the relevant statements in time (usually three months). It renders a director immediately personally liable.
Furthermore, the director is unable to implement any of the alternative options available in the case of an ordinary DPN (see below). For this reason, companies should be on time with lodgements – and their accountants and tax agents should be proactive in following up with clients.
An ordinary DPN (which is much more common) is issued where the company has lodged the relevant statements in time but has failed to pay the amounts due.
In this case the director has 21 days to implement one of the following four options:
- Pay the amount in full.
- Appoint an administrator to the company.
- Appoint a small-business restructuring practitioner.
- Wind up the company.
A fifth option, allowing a director to negotiate a payment arrangement with the ATO, has recently been removed. Although with rising inflation and interest rates, a looming credit squeeze and defaults are forecast to rise, the newly elected government might reinstate payment plans as a way to slow down or stave off mass insolvencies.
If the 21-day period expires, the debt crystallises into a primary liability payable by the director personally and significant interest would start to accrue. In addition, the ATO might take more serious legal action to recover the debts, such as:
- Issuing a garnishee notice to a third party that holds money for you/may hold money for you in the future, which would require the third party to pay money directly to the ATO to reduce the debt.
- Offsetting the debts against any available tax credits.
- Commencing legal action to recover the amount, which can lead to the winding up of the company.
A strategic way to deal with DPNs
The best way of assisting clients to get out of a difficult situation might not necessarily be the most obvious or convenient option – thought and care must be accorded in making a final decision. It would be unwise to assume that entry into a liquidation procedure is, by default, better than complying with a DPN. This might be because SME borrowing (even for trade credit and leases) is often supported by personal guarantees by directors and other third parties (such as a wife, parent, friend or related entity). While an insolvency appointment may seem like the best option to avoid personal liability to the ATO, liability under personal guarantees might be more catastrophic for the directors and/or third parties than paying the ATO.
This could easily be the case where the assets of the company were insufficient to discharge the creditors who had been given personal guarantees and the amount due to the ATO was less than the amount to be enforced under such personal guarantees.
Once a company is in liquidation, not only is this hard to reverse but personal guarantees may become enforceable, which may prove to be even more unfavourable to the director, third parties and related entities.
On the other hand, while a company is in administration, there is a stay on the enforcement of personal guarantees – although this too is only temporary.
It might therefore be prudent to explore other avenues for raising capital such as friends or family, issuing more shares if the business is viable, and other sources in order to deal with the DPN instead of taking the drastic step of a formal insolvency appointment.
Of course, if the company is insolvent and does not have a reasonable plan to trade out of insolvency or be financially supported through it, then a formal insolvency appointment may be the only way out of immediate personal liability – and the only thing to do to avoid trading while insolvent (which is itself a breach of the Corporations Act).
If a formal insolvency appointment is necessary, working with an insolvency lawyer sooner rather than later can prove invaluable. For example, the best option for a company might be to enter voluntary administration and/or use the safe harbour provisions in the Corporations Act, rather than entering into liquidation.
This is particularly true for cyclical industries (such as the minerals sector), where companies may need only a temporary reprieve from creditor action to “ride out” a period of low commodity prices rather than being shut down completely. In the context of voluntary administration, personal guarantees may be renegotiated with creditors as part of proposing a deed of company arrangement (DOCA). Creditors may consider it in their interests to forego a claim under a personal guarantee in favour of the DOCA proposal if (for example) the guarantor has limited prospects of meeting the claim or if there is some other commercial motivation – such as maintenance of an on-going supply contract once the DOCA is passed and implemented.
Instructing a lawyer early on can help ensure advice and instructions from the directors are shrouded in legal privilege, and any personal liability that might be attributable to the director should there be a new future controller of the company can be identified and navigated – indeed, this very issue might inform the type of formal appointment that is made.
Sadly, anecdotal evidence suggests that pre-insolvency advisers and (dare it be said) a micro band of insolvency practitioners have been known to promise directors immunity from any personal claims so long as the company is placed in liquidation with a particular practitioner. Those promises are generally unwise to make, and sometimes unkept. This is another reason why working with a reputable accountant and insolvency lawyer early on can help directors avoid these pitfalls and better survey all options.
What should accountants be doing?
It is therefore paramount there be continued and proactive engagement between businesses and their frontline accountant. It might be prudent for accountants to reach out to struggling clients or those who have received an ATO warning letter, both to make sure they are aware of the relevant deadlines and consequences and also to encourage those facing a DPN to seek advice rather than sticking their head in the sand. That happens far too often and can lead to much worse consequences, such as incurring significant interest once the DPN has crystallised into a primary liability to the ATO.
Time is of the essence – and so is honesty
As alluded to above, the two most important factors in dealing with DPNs are punctuality and honesty. Prompt action and truthful compliance not only offer more options (which might otherwise be precluded if deadlines lapse) but might also be useful in establishing a potential defence against a DPN.
When it comes to actually dealing with the ATO, businesses must begin engaging with their accountant or insolvency lawyer as soon as a warning letter is received – even more so if an actual DPN is received. In the past, the ATO has been understanding and lenient towards those who are cooperative and willing to work with it in fulfilling their obligations, especially during these difficult times for businesses everywhere.
Trevor Withane is a partner at Ironbridge Legal.