Can the ATO recover unfair preferences from directors?

Directors can be personally liable to pay the Commissioner of Taxation the amount of an unfair preference payment relating to pay as you go withholding (PAYG) where the Commissioner is ordered to pay the amount to a liquidator.

Liquidators commonly seek to recover preferences from the ATO because payments made to the ATO during the preference period can be significant and there is no risk that the ATO will be unable to pay.

The preference period is generally six months before the filing of a winding up application.

Commissioner’s indemnity against directors

Under section 588FGA of the Corporations Act 2001 (Cth) (Act), the Commissioner is given an indemnity against each person who was a director of a company at the time an unfair preference was paid to the Commissioner, provided the payment was of a type specified in section 588FGA of the Act (most commonly PAYG).

The indemnity only operates if the Supreme Court or the Federal Court makes an order that a payment is an unfair preference. If the Commissioner settles an unfair preference claim with the liquidator without a court order being made, the Commissioner will not be entitled to the indemnity.

Rights of the directors

A director has the right to become a party in court proceedings between the liquidator and the Commissioner and to defend a claim that is made by the liquidator against the Commissioner.

A director can contest the issues relating to the solvency of a company and can also seek to argue that the Commissioner is entitled to the benefit of the statutory defence that may be available to the Commissioner, even if the Commissioner does not seek to rely upon the defence.

If a director does not become a party to a liquidator’s court proceedings and judgment is given against the Commissioner, the director will not be able to argue:

• that the company was solvent at the time of any particular payment; or
• any statutory defence that may have been available to the Commissioner.

If a director does not become a party to proceedings between the liquidator and the Commissioner, the director, when being sued by the Commissioner, will be limited to the defences in section 588FGB of the Act.

Director’s section 588FGB defences

It is a defence if a director proves:

• at the payment date (being the date of the payment to the Commissioner) the director had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if the company made the payment;
• the director had reasonable grounds to believe and did believe:

(a) that a competent and reliable person (the other person) was responsible for providing to the director adequate information about whether the company was solvent; and

(b) that the other person was fulfilling that responsibility; and

(c) the director expected, on the basis of information provided to the director by the other person, that the company was solvent at that time and would remain solvent even if the company made the payment;

• because of illness or for some other reason, the director did not take part in the management of the company at the payment time; or
• the director took all reasonable steps to prevent the company from making the payment or there were no such steps the director could have taken.

Issues for directors

Directors should carefully consider whether they should become a party to liquidator’s court proceedings, particularly if they want to argue issues of solvency or to rely upon the defence available to the Commissioner.

The position and interests of individual directors of a company may not be the same, for example:

• they may not have been a director of the company at the time of the making of a particular payment;
• they may potentially have a defence under section 588FGB that may not be available to other directors; or
• their financial circumstances may differ.

If you would like more information about these issues, please contact Graham Roberts on +61 7 3231 2404.