The Federal Court of Australia has handed down a decision that is a salutary reminder to directors that, in any corporate tax planning, it is important not to miss the forest for the trees. In a recent Federal Court of Australia decision, contentious tax planning was found to constitute a breach of directors’ duties for the directors involved, resulting in them becoming personally liable for ATO debts of the company.
On 18 November 2016, the Federal Court of Australia ruled that 4 of 6 directors had breached their fiduciary duties as directors of 4 companies, as a result of tax planning involving ‘back to back loan” schemes with Israeli and Swiss banks for the purpose of avoiding tax. In simple terms, the companies were advanced monies by the banks and claimed deductions for interest incurred on the advances. The Commissioner argued that the loans were merely a ‘sham’ and constituted payments from the banks secured by moneys deposited in offshore deposits. The Commissioner disallowed the interest deductions in the relevant tax years, resulting in a considerable liability for the companies.
The proceedings were issued by the liquidators of the 4 companies on behalf of the ATO, effectively pursuing debts owed to the ATO. As the companies were in liquidation and insolvent, the liquidators were clearly pursuing other avenues by which they could recover funds for creditors, in this case the ATO.
The findings of the Court did not turn on tax issues but rather on the duties of the directors in implementing these tax schemes. As is often the case, the broad duties of directors appears to have been forgotten by those involved.
Often, Boards and their advisers can fail to see the forest from the trees in devising a corporate action or tax planning strategy and then navigating their way through the technical provisions of the law. The forest often involves the broader directors’ duties that govern directors’ actions, above and beyond the technical requirements for particular transactions.
In this case, the Court concluded that the conduct of the directors in devising, implementing and then concealing the tax schemes amounted to a breach of their fiduciary duties to the companies. In this way, the liquidators and ATO were able to turn a company debt into a debt personally owed by the directors.
The fiduciary duties the Court relied on were:
- the duty not to permit the interests of the directors to conflict with the interests of the relevant company, without the company’s informed consent (conflict of interest duty);
- the duty not to exercise a power conferred upon the director to obtain some private advantage or for any purpose foreign to the power (proper purpose duty);
- the duty not to exercise a power conferred upon the director in a manner which is detrimental to the interests of the company (company interests duty).
The court accepted that, whilst directors have a continuing obligation to keep informed of the company’s activities, this does not mean that a director has to have knowledge of all activities of a company merely because they hold office as a director. Therefore 2 out of the 6 directors were not found liable.
However, the court did find that the evidence demonstrated that 4 out of the 6 directors participated in procuring advances from the Israeli banks and on that basis the evidentiary burden then shifted to them to demonstrate that they did not know (or understand) the terms of the financial transactions in which they were participating. They were unable to do so. The liquidators successfully argued that the arrangements were detrimental to the companies, giving rise to a liability to pay tax, penalties and interest for which the companies would not otherwise have been liable. A breach of their fiduciary duties as directors was the route the liquidators pursued to impose personal liability on those directors.
In this particular case, even though the initial claim alleged a breach of statutory directors’ duties as well as the fiduciary (general law) duties of directors, the liquidators focused largely on the general law duties in pursuing the claim so the court did not need to reach a view on the statutory duties claim. It would have been a short step to make the same finding on those, given the statutory directors’ duties largely reflect the fiduciary (general law) duties.
The breaches found in this case provide some fairly stark examples of how directors need to consider carefully the tax schemes they may undertake from a directors’ duties perspective:
- approving various advances and transfers from Israeli banks to the companies, "on-lending" these advances to the various companies and "receiving and making payments" with the advances - this exposed the companies to significant risk of tax liabilities;
- the use of "drawdowns" and "rollovers", which amounted to actions detrimental to the companies - it exposed the companies to the risk that the receipt of funds would be treated as assessable income by the ATO;
- "on lending" and "making payments" exposed the companies to the risk of being assessed for a tax liability for which they did not have the funds to satisfy;
- involvement in the lodgement of a tax return on behalf of the company, which was held to be inaccurate and therefore exposed the companies to the risk of paying penalties and interest charges if the ATO did not accept the returns as accurate - this constituted conduct detrimental to the companies;
- documenting the transactions in an "intentionally dishonest and implausible way", and lodging these documents as evidence to support the inaccurate tax returns - this was considered contrary to the interests of the companies.
De facto director
One of the directors found to have breached his director’s duties was not in fact a formally appointed director yet was still found equally liable as the other 3 (formally appointed) directors.
Under the Corporations Act, a person who is not validly appointed as a director can still be found to be a director if they act in the position of a director or the directors of the company are accustomed to acting in accordance with that person's wishes. In this case, the court found that, even though he was not formally appointed, he was a director of each of the relevant companies by virtue of his active participation in the arrangements, transaction documents and tax disputes.
Lessons for all
It is tempting to dismiss this case as an example of serious tax evasion which turned on its peculiar facts. And it does appear that the court’s findings (including in relation to the ‘director’ who was not validly appointed) indicate a clear willingness on the part of the court to find the 4 directors personally liable for what they did.
But the decision sends a message beyond that - directors’ duties are often forgotten when implementing transactions that involve technical rules. Yet they remain a fundamental starting point to every corporate decision. Acting in the best interests of the company and its shareholders remains a key test. As do the directors’ duties, including to:
- exercise powers and discharge duties with the care and diligence a reasonable person would exercise as a director;
- act in good faith in the best interests of the company and for a proper purpose;
- not improperly use your position to gain an advantage for you or someone else or to cause detriment to the company;
- not to improperly use information obtained as a director to gain an advantage for you or someone else or to cause detriment to the company.
This applies as much to tax planning as it does to any other form of strategic planning or corporate transaction. By all means, carefully traverse the technical tax rules that apply to most tax planning but also think through the broader corporate issues that may apply – keeping a keen eye on both the forest and the trees.
In this case, the liquidation provided the circumstances where it made sense to pursue the directors personally for what they had done as directors. But a liquidation is not the only circumstance where such a pursuit can occur. Australian law provides numerous ways in which directors can be pursued personally by third parties - shareholder activism, class actions, new Boards, disgruntled shareholders ably assisted by unimpressed regulators, and ASIC which has standing to pursue breaches of directors’ duties by way of representative action. Different circumstances may warrant the same approach.
What is clear is this: the ATO is very willing to pursue directors personally for breaches of their directors’ duties, if that is the way to recover outstanding tax, penalties and interest imposed on the company. Ensure you have considered not just the tax outcome but also your broader directors’ duties in planning your approach to tax.