• News
• News Archive
• Media Contact

GST non-payment - potential personal liability for Directors

By Grant Pearson, Partner

Companies selling assets due to financial stress potentially leave directors exposed to personal liability for unpaid GST. Lawyers need to advise clients of this risk.

To this point, when a company is under financial stress and sells assets to settle with creditors, the key advice has been to ensure nothing goes from the company at less than market value. Outstanding GST is an unsecured debt, and has not generally raised concerns different from liability to other unsecured creditors.

From its inception some 23 years ago, GST has had a glaring flaw. Due to timing mismatches in the scheme a purchaser who has not settled has been entitled to get large amounts of cash from IRD; and IRD has had to get the offsetting tax payment from a vendor of uncertain creditworthiness.

It has been obvious for a long time the rational answer is a variant of what happens in a zero rated – going concern sale. The input and the output tax are set off against each other, no cash changes hands. IRD has a current discussion paper promoting a regime of this kind. For now, we have to deal with patch up actions, aimed at preventing IRD having to pay out to dubious purchasers; and recently, more vigorous attempts to recover unpaid GST in preference to other unsecured creditors.

On the sale of an asset a secured creditor, receiver or liquidator may be obliged personally to pay GST on a sale. That is certainly so when a mortgagee is in possession, exercises a power of sale, or a receiver or liquidator is appointed. In those situations IRD moves from being an unsecured creditor to taking priority over everyone.

Obviously, secured creditors have an incentive to persuade creditors to sell assets “voluntarily”. They will take the whole of the proceeds of sale (less direct costs of sale); and likely achieve a better price, without the costs of a mortgagee sale. IRD will be left to recover the GST as an ordinary unsecured creditor.

From a director’s point of view, agreeing to a company selling assets without formal action by creditors has generally been seen as acting responsibly and reasonably. The best price for the asset is realised and applied in accordance with the appropriate priorities, the secured creditor receives the full proceeds. Indeed, refusal to co-operate could fairly be seen as unco-operative behaviour calculated to increase the costs of dealing with insolvency.

On 10 September 2009, the Court of Appeal in Peace and Glory Society Ltd (In Liquidation) v Vance [2009] NZCA 396 addressed an argument calculated to have a chilling effect on directors who might otherwise co-operate with secured creditors.

The mechanism is section 136 of the Companies Act which provides a director must not agree to the company “incurring an obligation”, unless believing on reasonable grounds the company will be able to perform the obligation. The relevant sanction is in section 301 that provides where a director has been in default or breach of duty, the court may order the director to contribute such sum by way of compensation as the Court thinks just.

The argument being that a sale where GST cannot be paid breaches section 136, and the director should be required to contribute to the extent of the unpaid GST.

Whether this will succeed remains to be seen. Certainly it is evident from the decision in the Peace and Glory Society case, the individual facts are important. It may well be that ultimately section 301 will not ordinarily be invoked simply as GST is unpaid, on an orderly sale that maximises the return to creditors, and fully complies with the priorities of creditors. Incurring liability for GST is no different from any other liability due to an unsecured creditor. IRD’s complaint is in fact that it has to live without the benefit of statutory exemptions to the general effect of making it an unsecured creditor for GST. It is not evident that a director should have any greater risk under s.301than for incurring any other unsecured debt.

Nonetheless, this view was not explored in the Peace and Glory Society case. It would be a bold adviser who did not alert a director to this risk. We can only hope to see sensible legislation that routinely offsets input and output tax, and puts an end to this ongoing problem.

Grant Pearson is a specialist taxation lawyer at Duncan Cotterill. G.Pearson@DuncanCotterill.com