The Danger of Making Preferential Payments to the ATO

September 26, 2012

With the recent high-profile cases of James Hardie and Centro, many company directors are becoming more mindful of the duties that they are under. However, many are still unaware of the extent to which they can be held personally liable for events leading up to company failure.

One of the statutory provisions that creates a significant risk of personal exposure for directors is section 588FGA of the Corporations Act 2001 (Cth). In essence, if a company makes unfair preferential payments to the Australian Taxation Office (‘ATO’) that the ATO is later required to disgorge to a liquidator, the ATO has the right to pursue the directors of the company for the amount of ‘loss or damage’ incurred by way of a personal indemnity. This right arises when:

1. The company was insolvent at the time the disputed payment to the ATO was made or became insolvent as a result of making the payment;

2. The payment resulted in the ATO receiving more than it would have if the transaction were set aside and the ATO proved for the debt in the winding up of the company; and

3. The transaction was entered into during the six months preceding the relation-back day, or if after that day, on or before the day on which the winding up began.

Liability can extend to each director who was a director ‘when the payment was made’, even if he or she was not a director at the time the debt was incurred, or resigned prior to liquidation.

This section places directors in the difficult position of needing to carefully consider their company’s ability to meet all creditor obligations equally, or run the risk of being held personally liable for preferential payments made to the ATO.

The situation can also be further complicated if a Director Penalty Notice has been issued by the ATO to the directors of the company.

Before making any payments to the ATO in a situation where the company is struggling to pay its debts as and when they fall due, or after a Director Penalty Notice has been issued, directors should carefully and urgently consider placing the company into liquidation or administration so as to avoid personal liability for preferential payments to the ATO.

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