When a business is struggling, the question most often asked by directors who are considering Company liquidation, is whether they will be held personally liable to pay its debts.

Ordinarily, the purpose of having a company is to separate business risks and company debts from a directors’ personal assets.

A company is a separate legal entity and as such, a director has no personal liability for business debts the company is unable to pay unless the director does one of the following:

• sign Personal Guarantees to secure payment of a company debt;
• incur a debt knowing the company is insolvent; or
• fail to comply with a Director Penalty Notice issued by the Australian Taxation Office.

In order to avoid personal liability for a business debt, directors are encouraged to actively avoid signing personal guarantees.

While in many cases, such as dealing with banks and sophisticated finance companies, it will not be possible to avoiding a personal guarantee, the same does not apply when it comes to supply accounts and rent of premises. In these cases, a director should refuse to provide a guarantee.

If supplies are unable to be obtained on credit from any source, a director should limit the amount they personally guarantee –  up to a specific amount they are comfortable with. 

If over time the supplier allows the debt to increase beyond the specific amount, that is their risk and not likely to fall within the limited guarantee.

The issue with personal liability for a business debt is that it can lead to the loss of personal assets and the bankruptcy of a director. As such, if you are going to have a company, do not easily give up the protection that structure provides.

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Directors can also be held personally liable for unpaid company ATO tax debts

The ATO can hold a director personally liable for certain unpaid company tax debts including:

• unpaid PAYG withholding
• unpaid superannuation guarantee payments

Presently, the ATO does not hold directors personally liable for unpaid GST.

What is a director penalty notice ?

A Director Penalty Notice must be issued by the ATO if it is to be in a position to recover unpaid tax from a company director personally. The Notice works in two distinct ways – see below.

The notice may be issued to the director in two different places. Firstly, to the home address of the director as it appears on the ASIC register or to the company’s tax agent address. If these addresses are not maintained by the director and the notice is not received and not complied with because of the directors failure, the penalty will stand.

The penalty in the notice is equal to the amount of the outstanding debt owed by the company for unpaid PAYG and unpaid super.

A person may comply with a Director Penalty Notice if they achieved one of the options allowed within 21 days of the date on the notice:

• pay the debt in full
• appoint a voluntary administrator
• appoint a liquidator

If compliance with the Notice is not achieved within 21 days, the director becomes personally liable for the tax debt of the company.

What is a Director Penalty Notice and when is it issued?

A Director Penalty Notice will usually be issued if a company is significantly behind in remitting its returns and/or payments, or following a long history of failed payment arrangements, broken promises etc.

What is a Director Penalty Notice and how does it work – It works in 2 very different ways

First, where all BAS & Super returns are up to date, with all having been lodged within 3 months of the due date, even though there may be amounts outstanding for PAYG and superannuation, a director will be granted a period of grace in which to comply with the Director Penalty notice and thereby avoid personal liability for a company tax debt.

The grace period allowed is 21 days but this only applies where all lodgements had been made within 3 months of the due date and where one of the 3 options above has been achieved.

Again, if compliance is achieved within 21 days, the director will avoid personal liability for the stated company tax debts.

Second, If BAS & Super returns have been lodged more than 3 months after the due date, a director will be immediately personally liable for the company tax debts. No avoidance of personal liability is possible.

This means if the company cannot pay its tax debt, the director must pay. 

If a director has not lodged returns, the ATO can either audit the company to calculate a debt or simply issue an estimate of what it believes the debt is and then issue a Director Penalty Notice based on those estimates.

If you are more than 3 months late in lodging your returns, there is no escaping personal liability for the amounts shown in a Director Penalty notice.

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