On Friday, the District Court of New South Wales handed down a decision with potential relevance to any director penalty notice (DPN) claims involving a DPN issued before 1 July 2010.

In the course of handing down the decision, the court also criticised the ATO for engaging in sharp practice when it was supposed to be a “model litigant”.

The case

In Deputy Commissioner of Taxation v. Zammitt [2012] NSWDC 135, the factual (and legal) scenario was relevantly as follows:

Under the original DPN regime: –

1. Sections 222AOC and 222AOD of the Income Tax Assessment Act 1936 (Cth.) imposed a penalty on directors whose companies failed to remit PAYG. This had the effect of making directors personally liable for unremitted PAYG.
2. Section 222AOE said that, before the ATO could chase a DPN debt, it needed to serve a DPN on the director. An early court decision had said that, to be valid, a DPN must not be misleading about what the recipient needed to do to comply with it (Deputy Commissioner of Taxation (NSW) v. Gruber (1998) 43 NSWLR 271).
3. Section 222AOF said that DPNs could be served by post. The traditional view had been that a DPN was served (and the countdown to expiry started) when the DPN was delivered to the director’s letterbox. However, on 10 December 2007, the New South Wales Court of Appeal said the countdown actually started when the DPN was put in the post (Deputy Commissioner of Taxation v. Meredith [2007] NSWCA 354).
4. Section 222AOG said that if the director did certain things before the DPN expired (including appointing an administrator or liquidator), he or she would have the penalty remitted (i.e. waived).

That was the legal position on 27 November 2009, when the ATO served a DPN on the director involved in this case. The DPN was drafted, consistently with the decision in Meredith, to indicate that the time for compliance commenced on the date of posting, rather than delivery.

Thereafter, on 1 July 2010, the DPN provisions were all shifted from their original home in the Income Tax Assessment Tax 1936 (Cth.) to their new home in Schedule 1 to the Taxation Administration Act 1953 (Cth.). Additional “transitional provisions” were enacted to enable this transition, being the Tax Laws Amendment (Transfer of Provisions) Act 2010 (Cth.). The transitional provisions said, among other things, that the new DPN provisions would apply to any amount formerly payable under the old DPN provisions.

Some time thereafter, the ATO commenced proceedings against the director to recover the penalty set out in the DPN served on him back in November 2009.

1. While the proceedings were still on foot, the New South Wales Court of Appeal suddenly overruled its earlier decision in Meredith and said that the DPN expiry countdown actually only starts when the DPN is delivered to the director’s address (Soong v. Deputy Commissioner of Taxation [2011] NSWCA 26).
2. This had the effect of giving the director a knockout argument in this case, because the DPN that was served on him said that the countdown started on the date of posting, making the DPN misleading about what he needed to do to comply with it, and consequently invalid.
3. After the Soong decision was handed down, the ATO scrambled to have legislation enacted to undo it. In the meantime, it sought an adjournment of its proceedings against the director (as well as other DPN proceedings it had commenced against other directors).
4. In an effort to procure the director’s agreement to the adjournment, the ATO indicated to him that there would be no prejudice to him from the adjournment, even though at the time it was “aware of the prospect of utilizing retrospective legislation to turn [the director’s] certain success in the proceedings [as a result of the Soong decision] into likely failure”.
5. On 29 November 2011, the ATO’s rescue legislation was enacted. The legislation was retrospective and said that courts must deal with all DPN claims (including claims already before the courts) on the basis that service is deemed to occur as soon as the DPN is put in the post.

That was the legal and factual position when the District Court heard and determined this particular matter.

The defence

The director defended the claim on several grounds, many of which related to the timing of service and whether or not the DPN was “misleading” for various other reasons. The court’s thoughtful analysis of these arguments makes for very interesting reading, if you like that sort of thing. However, hardly anyone does like that sort of thing, and this bulletin is already lengthy, so we will skip straight to the argument that won the case for the director. In a nutshell, the director’s successful argument attacked the wording of the transitional provisions and went like this: –

1. The transitional provisions say that director penalties that were payable under the old DPN provisions are now governed by the new DPN provisions (sub-items 65(3) and (4) of Division 5 of Schedule 1 to the Tax Laws Amendment (Transfer of Provisions) Act 2010 (Cth.).
2. The new DPN provisions have certain specific requirements for DPNs, including a requirement that the DPN has been issued under the new provisions (section 269-25(1) of Schedule 1 to the Taxation Administration Act 1953 (Cth.), as well as other requirements (see paragraph 119 of the decision).
3. The DPN in this case was issued under the old provisions. In the circumstances the ATO should have issued a new DPN when the new provisions came into effect, and relied on the new DPN. However, it did not, and it is too late to do so now (the company having been placed into administration in the meantime), and so the penalty simply cannot be enforced.

The court accepted this argument, dismissed the ATO’s case, and ordered that the ATO pay the director’s costs.

It also criticised the ATO for trying to trick the director into agreeing to successive adjournments on the basis that the adjournments would not prejudice him, when all along the ATO knew that the purpose of the adjournments was to give the ATO time to rush through legislation to torpedo the director’s defence.

The outcome for the ATO

One must have some sympathy for the ATO. Fundamentally, all it is trying to do is hold to account directors who spend withheld PAYG money on other things, so that their companies are not given an unfair trading advantage over businesses that do the right thing and pay their taxes.

Furthermore, it is not the ATO’s fault that the New South Wales Court of Appeal keeps changing its mind – or that the legislative drafters left that aspect of the original legislation (concerning the timing of service) ambiguous in the first place.

That said, given the quite extraordinary power that the ATO has to “lift the corporate veil” through the application and enforcement of director penalties, it is appropriate that any director penalty legislation be construed strictly, and it was that approach that led to the decision in this instance.

What does all of this mean?

As always, but particularly as a result of the decision in Zammitt, those advising directors who received DPNs should: –

1. make sure they are thoroughly familiar with the various legislative and common law changes to the DPN regime over the last few years, the specific dates upon which each change came into effect, and the ramifications of each change; and
2. having regard to those changes and the timing of them, pay particular attention to:
   1. the date the DPN was served; and
   2. what the DPN says about what needs to be done to comply with it.

Of course, it cannot be guaranteed that the ATO will not appeal the decision in Zammitt – given its potential importance, an appeal seems almost inevitable. We will continue to monitor developments in this area and, in the meantime, if you or your clients have any queries about director penalties then please do not hesitate to contact one of our experienced advisors.