This month we are going to look at the consequence of a business failure on a company director. Directors can be held liable for the debts of a company in some circumstances, placing personal assets, such as the family home, at risk. This is becoming all too common in the current environment, with the ATO having recommenced issuing Director Penalty Notices (DPNs) again after a long hiatus during the Covid pandemic.
Background
Our client, Alex, ran a marketing and events business under a company structure. During the pandemic, the business suffered a substantial decline in cashflow, as lockdown and social distancing rules led to the cancellation of planned events. During this period the company fell behind on creditor payments, particularly to the ATO. Alex was able to keep his staff employed and managed to battle on, but this was really only because creditors did not apply pressure for repayment.
Now, when Alex got behind with the ATO he did what a lot of company directors do. He didn’t report his obligations. He thought if the ATO knew how much the company owed they would start chasing him for payment. Better that they don’t know. That will buy a bit of time. This may be appealing, but it is a really bad idea, as we will see in a moment.
A visit from the DPN Fairy
Alex traded on, and while unable to address his outstanding ATO debt, the business kept going and things were starting to look up. Then one day in the mail Alex received a DPN for around $320,000. This is one of those instances where a director can be personally liable for the debts of a company. This liability always exists but comes to life when the ATO issues a DPN – a visit from the DPN Fairy.
In Alex’s case, he had not reported his obligations on time, being within three months of the due date for PAYG, GST, WET and LCT and by the due date for superannuation. As he had not reported the obligations by the due date Alex received a lockdown DPN, meaning he has no opportunity to remit, or get out of, the personal penalty.
So, where does this leave Alex? His options are to have the company pay the debt, pay the penalty personally or face personal insolvency.
The payment of the debt by the company raises some issues. The DPN usually only applies to a portion of the full ATO debt and payments made by the company will not necessarily reduce the debt the DPN attaches to. In Alex’s case his penalty related to unpaid and unreported PAYG and superannuation. However, the company also has a GST debt.
If the company is unable to pay, this leaves Alex the option of paying the debt personally or facing personal insolvency. At the current time, formal recovery action by the ATO is minimal and far below the historical or normal level of activity.
Bankruptcy is the end of the world!!!
What do Abraham Lincoln, Walt Disney and Elton John all have in common? You guessed it – they all went bankrupt at some point in their life. Bankruptcy is a new beginning, not an end, as it gives a person the chance to draw a line in the sand with their debts and start over.
In Alex’s case, he did not want to think about bankruptcy. Nobody does. Sometimes though, you need to hope for the best and prepare for the worst. This was the situation Alex found himself in. That lockdown DPN was not just going to go away unless either he or the company, could pay it. He was not confident this could be done. The ATO could pursue a recovery action at any time and have Alex made bankrupt whether he liked it or not.
There are a lot of myths and misconceptions about bankruptcy. Let’s talk a minute to dispel a few straight away. A bankrupt does not automatically lose their house. They can earn as much income as they want. They can travel overseas. Bankruptcy is not normally publicised. Their friends and family are highly unlikely to find out unless the bankrupt tells them.
So, if those are myths, how does it all work? A trustee in bankruptcy is only interested in assets of the bankrupt that have equity. Some assets are not available at all, such as equity in a motor vehicle up to a certain level (currently $8,150), superannuation, normal household items etc. If a bankrupt earns over a certain amount after tax they are required to pay 50 cents in every extra dollar to the trustee. As an example, the threshold for a person with two dependents is $78.472.03 p.a. after tax. A bankrupt can travel overseas as long as they have permission from their trustee.
Preparing for a bankruptcy you hope you never need
In Alex’s case, he was very concerned about losing the family home and the impact his financial issues could have on his family. He drove a company car that was under finance, with the family vehicle, or “mum’s taxi” owned by his wife and in her name. Alex had been earning under the income threshold for the last few years due to the financial performance of the business.
So, income contributions were not really an issue. He had no requirement to travel overseas regularly, so this was not a big concern either. The major issue was the equity that Alex owned in assets. Prior to bankruptcy, or in bankruptcy, the equity in the property can be sold to a third party at market value.
In this case, the family home was in joint names and was formally valued at $800,000. The mortgage on the property was $640,000. Alex’s share of the equity was $80,000. Alex entered into an agreement to sell his equity to his wife, Aiko. Payments are currently being made from an account solely in Aiko’s name to an account solely in Alex’s name. Aiko has started making all the mortgage payments from her own independent income.
When this process is complete, Aiko will hold all the equity in the property. As Alex will have no equity in the property, a trustee in bankruptcy would have no interest in this asset. Alex also owned a boat and was a keen fisherman. The same principle can be applied, and the boat sold to a third party for a fair price.
Now Alex is prepared for the future. The ATO have not taken any further action other than issue the DPN. He is now trading his business in the name of a new entity and continuing to try to meet his outstanding tax obligations, but that is another story. Importantly, the fear of the unknown has been removed, and Alex now has a back up plan if he needs it.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies.
Contact us now on p. 1300 765 080 | info@djra.com.au