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Why hanging on to PAYE can be disastrous

By Grant Pearson, Partner

First published in the NBR 13 March 2009

In today’s tough climate businesses are invariably looking at ways to cut costs and prioritise creditors. But one organisation you can’t afford not to pay is Inland Revenue.

It might seem tempting. After all, it supplies nothing; it is not as if they can cut off the power or the phone. So how bad can it be? The answer is very bad, much worse than having the power cut off. The worst case scenario is jail.

Unpaid income tax and GST can cause serious issues, but there is one tax type that stands out on its own and is quite different from any other tax liability: employees’ PAYE deductions.

Many employers do not see PAYE as different from other tax in terms of possible penalties. But because of the way the law sees PAYE, imprisonment for its non-payment is a real risk.

In a new development, IRD liquidators are insisting directors of any company they have put into liquidation are personally liable for unpaid PAYE. They say unpaid PAYE is unanswerable evidence of trading while insolvent. Whether the courts support this remains to be seen. It is further concern for directors of failing companies.

The lesson is clearer than ever. Employers must never think of PAYE as just another tax. Even if your business is operated by a company, and you are a director, or are a manager with responsibility for expenditure, you are at risk of being prosecuted if PAYE is not paid.

IRD calls it “aiding and abetting”, and you can be in just as much trouble, or more, than the company. Furthermore, the IRD is now trying to make directors personally responsible for unpaid PAYE.

The significance of a conviction should not be underestimated; imprisonment is imposed in serious cases, particularly when employers ignore their responsibilities, do not file returns, and let the money accumulate. Prison sentences have been the fate of several employers and company directors over the past six or so boom years, with sentences ranging up to 22 months.

Typically, if there is more than $60,000 unpaid, the IRD is likely to press for a prison sentence or home detention of six months or more. Longer sentences are likely when there has not been full disclosure to IRD, or the unpaid PAYE is more than $100,000.

Many more have escaped with fines and community work.  But even in the least serious case, it is a conviction that can affect overseas travel, and may have to be disclosed to employers and others.

Aside from the risk of imprisonment, the IRD have recently changed its penalties for unpaid PAYE. It can impose a monthly penalty of 10% on unpaid PAYE. So in 10 months the liability doubles, and keeps going up until it reaches a penalty of 150% of the tax owed, on top of the original tax (as well as interest of around 14% accruing each year).

There is no surer way to turn a business crisis into a collapse than to not pay PAYE, because the amount owing escalates so quickly. It often changes a problem that could be fixed to a disaster, with a prosecution likely to follow.

PAYE started overseas, following the financial strains of World War II. It was an effective way of collecting tax, and was introduced to New Zealand in 1958. The idea is an employer pays an employee’s tax to the IRD on behalf of the employee, and the employee gets the “take home pay”.

This provides an effective way of making sure employers pay the PAYE to IRD, because the law treats the PAYE as the employee’s money, not just the employer’s debt to the IRD.

If you do get into a situation where you have not paid your PAYE, the IRD will consider payment options. The first action is to file PAYE returns, even if there is no money to pay the tax. The second step is to discuss the issue with the IRD - it has the power to reduce or waive penalties, and will consider an instalment plan.

Unless there has been a one-off cause for the missed payment, business restructuring has to follow.The IRD will be looking to see a plan that will give a basis for thinking tax payments will be met in the future. Of course, the best option is to pay PAYE when it is due.

• Grant Pearson is a taxation specialist at Duncan Cotterill

Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.