The Tax Commissioner and insolvent trading: Stone (Liquidator), in the matter of RIC Admin Pty Ltd (in liq) v Mandalinic (No2) [2024] FCA 164

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By Taline Chater, Partner

Key Takeaways (1)

  • This decision is one of a handful of insolvent trading cases which have gone to final hearing in recent years and is apt when you consider the ATO has more recently commenced action to recover all of the COVID accrued income and super tax debt (estimated at around $32b at the end of February this year).
  • It is a sage reminder that engaging professionally qualified and well regarded restructuring/insolvency lawyers does make a difference. It should no longer be assumed that a director may ignore tax or other key liabilities, declare themselves bankrupt as a ‘strategy’ and allow the company to be placed in liquidation, with no other consequence

Key Takeaways (2)

  • Insolvent trading risk is not dead (yet) and we now have significant funders in the market who can support such litigation, in addition to provisions under the Insolvency Practice Schedule which allow causes of action to be assigned to creditors. We have seen good outcomes for creditors where such actions have been pursued.

Background

The case concerned two claims against the sole director, Mr Mandalinic:

  • A claim for $2,014,386.38/$2,489,287.38/$474,801, pursuant to s588M(2) of the Corporations Act 2001 (Cth) (the Act), or 1317G of the Act, for breach of s588G(2) of the Act (insolvent trading claim), with an alternative claim for breach of directors’ duties in relation to that amount; and
  • A claim for $422,000 pursuant to s588FF of the Act for breach of s588FDA(1) of the Act (unreasonable director- related transaction).

The director did not appear at the hearing and instead filed a debtor’s petition for bankruptcy with the Official Trustee, the day before the original listing date for the hearing. The hearing was then stood over pending the outcome of the debtor’s petition, which was accepted with Mr Paul Weston being appointed as trustee of the director’s bankrupt estate.

After the Trustee informed the liquidator’s solicitor that he did not intend to take any further action, the liquidator sought the Court’s leave to proceed against the director (a bankrupt), pursuant to s58(3)(b) of the Bankruptcy Act 1966 (Cth), which was granted.

The Company carried on business as a construction consulting service company providing administrative services and as such it was registered for GST.

In September 2018, the ATO issued a notice to the Company for failure to lodge its BAS for the relevant quarter.

In November 2018, the ATO issued a letter to the Company for failure to lodge it income tax return for the relevant financial year.

In February 2019, the ATO issued a notice to the Company in relation to its failure to lodge its BAS for the quarter ended 30 September 2017.

In March 2019, the ATO issued a demand on the Company in the nominal amount of $522.77.

In the period 1 July 2016 and 26 March 2019, the sole director caused the Company to pay him weekly amounts of $4,400.00 in the total amount of $422,400.00.

In April 2019, the ATO notified the Company it had completed a review of the Company’s tax affairs for the period 1 September 2017- 31 December 2017 and had found that the Company did not report or remit PAYGW for this period.

In April 2019, the ATO issued:

  • A PAYGW notice to the company in the amount of $2,033,381.58 and in respect of the period 1 September 2017 to 31 December 2017, and
  • a garnishee notice in the sum of $2,033,938.22 over the companies bank account, pursuant to which it will covered the sum of $374,731.

The Company did not contest the PAYGW estimate within the relevant period under section 268/40 of Schedule 1 of the Taxation Administration Act 1953 (Cth) (TAA).

As at 6 June 2019 the Company had a deficit debt on its running balance account with the ATO of $1,941,100.91 (RB Account).

On 6 June 2019, the ATO served a creditors statutory demand on the Company for the amount of $1,941,000 100 and including for the balance of the PAYGW estimate (Statutory demand).

The Company did not make an application to set aside the Statutory demand.

On 27 August 2019, the ATO commence proceedings to wind up the Company pursuant to section 459P of the Act.

As at 13 November 2019, the Company’s indebtedness on its RB Account to the ATO was $2,014,386.18.

On 13 November 2019, the Company was wound up by an order of the Court.

On 21 November 2019, the ATO lodged a proof of debt in the winding up of the Company in the sum of $2,014,386.19.

 Insolvent trading claim (1)

  • Statutory regime (1)
  • Section 588G(1) of the Act.
  • Section 588GA(1a), item 7 of the Act , provides that a company incurs a debt at the time that it enters into an uncommercial transaction, within the meaning of s588FB of the Act.
  • Section 588G(2) of the Act.

Insolvent trading claim (2)

Statutory regime (2)

  • Section 95(1) of the Act
  • Section 588E of the Act.

Relevantly here:

  • S268-25 of Sch 1 of the TAA provides that a company is liable to pay a PAYGW estimate even if the underlying liability never existed or was discharged in full, or the unpaid amount of the underlying liability was less than the unpaid amount of the estimate.

Proving Insolvency and financial records

The liquidator relied on his own solvency reports and on the Company’s failure to keep records in support of the claims that:

  • The Company was insolvent on a cash flow basis at all times between August 2017 and November 2019; and
  • The Company contravened s286(1) and 286(2) of the Act because it failed to keep financial records that correctly recorded and explained its transactions and financial position and performance.

Failure to keep financial reports: The liquidator concluded that the Company did not have at a minimum:

  • Source documents to support the underlying amounts in MYOB financial reports.
  • MYOB transaction entries prior to 12 May 2017 and between 28 December 2018 and 13 November 2019;
  • BAS for 18 months between October 2017 – November 2019;
  • Quarterly BAS for 2019; and
  • Income tax returns and PAYGW payment summaries for FY17, FY18, FY19 and for July 2019 – 13 November 2019

The Court was satisfied that a presumption of insolvency arose pursuant to s588E(4) of the Act for the period from the Company’s date of incorporation (17 December 2014) to the date of the liquidator’s appointment (13 November 2019).

Technical solvency analysis: balance sheet and cash flow analysis conducted by the liquidator.

Cashflow test:

  • The Company’s MYOB files for FY18 demonstrated the Company had net profits of only $25,751 in FY 18. These profits were insufficient to permit the Company to meet its outstanding PAYGW Tax Liability incurred during FY 18.
  • The Company’s “current ratio” (current assets/current liabilities) for FY 18 after taking into account the PAYGW Tax Liability and the General Interest Charge tax liabilities of $2,037,110 was only 0.02.
  • Adding the impact of the GST audit undertaken by the ATO, which resulted in a net GST taxation shortfall owing to the ATO of $474,801 (GST Liability). This attracted penalties in the amount of $237,400.50. The total GST Liability being $712,201.50. This brought the Company’s net liabilities as at 30 June 2018 to $2,712,474 and the Company’s current ratio to 0.0147 as at 30 June 2018.
  • The Company’s bank statements indicated that the Company had insufficient funds since 25 August 2017 to meet its taxation liabilities.

Balance sheet test:  As at 30 June 2018, the Company had net liabilities of $2,000 272 after the Company’s PAYGW and GST tax liabilities of $2,037,110 were included as current liabilities in the Company’s balance sheet.

Commercial solvency analysis: Based on the well-established indicia of insolvency first set out in ASIC v Plymin, the liquidator concluded that the following indicia were present from his review of the books and records of the Company:

  • Overdue Commonwealth taxes
  • No evidence of any access to alternative finance
  • No evidence of any ability to raise equity capital
  • Statutory demand issued by the ATO
  • Inability to produce timely and accurate financial information to display the Company’s trading performance and financial position and make reliable forecasts.

Conclusion on solvency (1)

  • The Court found that the technical solvency analysis conducted by the liquidator established that the Company was insolvent from at least 25 August 2017 on a cash flow basis and that conclusion was further reinforced by the liquidator’s commercial solvency analysis.
  • The Court was satisfied that the director had traded whilst insolvent in breach of s588G(2) of the Act and that the liquidator was entitled to recover from the director as a debt due to the Company, the sum of $2,489,187.38 being the amount equal to the loss or damage suffered by the creditors of the Company as a result of the director’s contravention, including for the following reasons:

Conclusion on solvency (2)

  • The director, being the sole director of the Company, failed to take steps to contest the PAYGW liability or set aside the statutory demand issued by the ATO in June 2019.
  • The director made the decision to continue trading the Company during the periods in which the PAYGW liability arose (April 2019) and where the ATO had determined following its audit that the Company was not entitled to input tax credits giving rise to the GST liability (23 August 2022).
  • By failing to prevent the Company from incurring the PAYGW liability and the GST Liability, the director contravened s588G(2) of the Act.

Conclusion on solvency (3)

  • Because a reasonable person in a like position in a company in the same circumstances of the Company would be aware that there were reasonable grounds for suspecting that at the times those liabilities were incurred, the Company was insolvent by reasons set out in the Liquidator’s analysis.
  • As a result of the director’s contravention of s588G(2), the liquidator was entitled to recover as a debt due to the Company, an amount equal to the amounts of the Company’s loss or damage, being $2,014,386.38, the amount outstanding on the RB Account arising from the PAYGW Liability and $474,801 with respect to the GST Liability, pursuant to s588M(2) of the Act.

Unreasonable director related transaction (1)

Statutory framework

Section 588FDA(1) of the Act provides that a transaction of a company is relevantly an unreasonable director-related transaction of the Company if:

  1. the transaction is a payment by the company;
  2.  the payment is to a director of the company; and
  3.  it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction having regard to the benefits, if any, and the detriments of entering into the transaction.

The “natural and ordinary meaning” of a requirement that something by for ‘for the benefit of a person is that it be “for the advantage, profit or good’ of the person: Vasudevan v Becon Constructions (Australia) Pty Ltd (2014) 41 VR 445 at [23] and [24].

Unreasonable director related transaction (2)

Statutory framework

Section 588FE(6A) of the Act provides: s 6A The transaction is voidable if:

  1. it is an unreasonable director related transaction of the company; and
  2. it was entered into, or an act was done for the purposes of giving effect to it:
    i. during the 4 years ending on the relation back day; or
    ii. after that day but on or before the day when the winding up began.

Section 588FF(4) provides:

(4) If the transaction is a voidable transaction solely, it is an unreasonable, director related transaction, the court may take orders, under subsection (1), only for the purpose of recovering for the benefit of the creditors of the company, the difference between:

  1. the total value of the benefits, provided by the company under the transaction; and
  2. The value (if any) that it may be expected that a reasonable person in the company circumstances would have provided having regard to the matters referred to in section 588FDA(1).

Unreasonable director related transaction (3)

The Court considered that the director, who had admitted he had received weekly payments of $4,400 from the Company between 1 July 2016 – 29 March 2019 but asserted that they were payments for director fees and for services to the Company as director and supervisor of operations, amounted to uncommercial transactions for purposes of s588DA of the Act.

The Court came to this view based on the following factors:

  • The books and records of the Company did not disclose source documents to support the payments made which were simply referred to as “Withdrawals” in favour of the director in the bank statements

Unreasonable director related transaction (4)

The Company’s books and records did not include any contractual basis for the director fees

There was no evidence that any amounts for tax were deducted by the Company and remitted to the ATO in respect of the payments to the director or that the director declared them as income in his personal tax returns for the relevant period.

The payments were being made to the director in a period, at least from August 2017, in which based on the financial statements, the Company had insufficient funds to meet its PAYGW taxation obligations. If the Company complied with its PAYGW obligations, it would not have had the funds available to make the payments to the director.

The Court was therefore satisfied that for these reasons, a reasonable person in the circumstances of the Company would not have made these payments to the director having regard to the detriment to the Company of entering into the transactions and their benefit to the director.

Unreasonable director related transaction (5)

The Court found the payments were made with “reckless disregard” to the financial position of the Company and could be characterised as conduct by a director that amounted to “stripping benefits out of companies to their own advantage”.

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