Companies going into voluntary or forced liquidation may have limited liability (the extent of the money invested) but such limitations do not cover the taxes due to the Inland Revenue Department (IRD).
For instance, if a Company with $1000 as capital collapses, the liability of its Directors would be limited to $1000.
Two companies owned by people of Indian origin were recently liquidated in Auckland owing hundreds of thousands of dollars to suppliers, staff and lenders. Both companies had limited capital and hence the creditors stand the risk of losing their monies.
However, such limitations would not apply to IRD.
Directors liable
Directors of companies are liable to pay overdue taxes and taxes that are likely to become payable until the last day of trading.
Normally Directors are not liable for company liability unless they are found to have traded recklessly, fraudulently and not in the best interests of the company.
Directors of companies are now required to sign personal guarantees, making them liable for that secured amount. For example, lending institutions such as commercial banks take personal guarantee of a director for a business loan.
Tax liability works differently. IRD has more powers to recover monies owed in any form of tax including GST and PAYE and directors sometimes may be personally liable.
Statutory provisions
Section HD15 of the Income Tax Act 2007 imposes personal liability on controlling shareholders and directors when the company has been party to a transaction, which has depleted its assets resulting in its inability to meet its tax obligations.
The Section comes into effect in cases where (a) an arrangement is made in relation to the company (b) as a result of the arrangement the company cannot meet its GST and income tax liability, whether such liability existed at the time of the arrangement or arose later (c) a prudent director would have expected tax dues to occur and (d) a purpose of the arrangement was to make the company unable to meet its tax obligations.
Shareholders’ liability
The above mean that any arrangement that prevents a company from meeting its tax obligations will make directors and controlling shareholders responsible for payment of that tax debt. Directors are responsible for the full amount of tax debt, whereas shareholders would be generally responsible only for the market value of their shareholding or the value of benefit they derive from the arrangement.
Prudent approach
Directors can safeguard themselves by showing evidence of a reasonable (prudent) approach. Such an approach would include (1) regular review of the company’s tax position, ensuring that it keeps adequate accounting records (2) considering tax implications of transactions and documenting enquiries made and conclusions reached, and (3) ensuring that sufficient funds are retained in the company to meet tax liabilities.
An Example
A and B are Executive Directors of AB Limited. They sell the assets of the Company and no money is left for tax payment. IRD can apply section HD15 of the Income Tax Act 2007 to recover the unpaid taxes of the Company from from A and B.
Saurav Wadhwa is a Charted Accountant and Principal of IBBZ Accounting Limited based in East Auckland. Phone 027-5555458; Email: Saurav@ibbz.co.nz
