Director Penalty Notices - Court Rules on the Validity of Estimates of PAYGW Amounts on Wages/Salary

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In a recent decision, Derrington J summarily dismissed proceedings seeking judicial review of the ATO’s decisions and conduct in relation to estimates of PAYGW amounts and director penalty notices (DPNs) of those estimated amounts under Divisions 268 and 269 of Schedule 1 to the Taxation Administration Act 1953: CLK Kitchens & Joinery P/L v Commissioner of Taxation [2019] FCA 1086.

This decision is illustrative because it not only provides clarification on the somewhat convoluted legislative regimes on PAYGW amounts, estimates and DPNs, but also considers who bears the obligation to withhold amounts under s12-35, what constitutes an “estimate” under s268-10, and the avenues to reduce or revoke an estimate such as by way of statutory declaration under s268-40. It also explores the distinction between an underlying liability to withhold/remit and a liability created by giving an estimate notice, in the context of making an “election” to pursue inconsistent rights relating to recovery in a company’s administration. 

Facts 

Mr Karananos was the sole director of each of CLK Kitchens & Joinery P/L, which operated a kitchen joinery business, and CLK Services P/L, which was a labour entity that provided labour hire services (i.e. workers) to CLK Kitchens. At CLK Services’ direction, CLK Kitchens paid amounts to each of the workers. These amounts were equal to the amount of wages (net of PAYGW) that were due to be paid by CLK Services. Neither CLK Kitchens nor CLK Services remitted to the ATO PAYGW amounts in respect of the wages paid to the workers.

On 11 July 2017, the ATO issued to CLK Kitchens, under ss268-15 and 268-20, an estimate of the PAYGW amounts, totalling $19,475,997, which the ATO asserted was withheld by CLK Kitchens as the payer of the wages to employees of CLK Services but which had not been remitted to the ATO (Estimate Notice).

The next day, the ATO issued, under s269-25, two DPNs to Mr Karananos in respect of the PAYGW amounts identified in the Estimate Notice. Mr Karananos sought to have the Estimate Notice reduced or revoked on the basis of a statutory declaration he provided to the ATO within 7 days of giving the Estimate Notice. The ATO refused this request.

However, separate to the statutory declaration, the ATO ultimately reduced the estimate of the PAYGW amounts to $587,354 under s268-35, based on other material (e.g. bank statements) that Mr Karananos provided to the ATO.

An administrator was appointed to CLK Services. The ATO proved in the administration for PAYGW amounts and superannuation guarantee charges (SGCs). Under a deed of company arrangement (DOCA), the ATO did not receive any dividends in respect of the outstanding PAYGW amounts, though it did in respect of the outstanding SGCs.

The ATO sought summary judgment.

Summary of the Legislative Regime

In summarily dismissing the proceedings, Derrington J reviewed the legislative regime regarding PAYGW obligations and the estimate regime, and provided some useful observations:

• Obligation to withhold and pay – an entity must withhold an amount from salary or wages it pays to an individual as an employee (whether of that or another entity) (s12-35). An entity that so withholds is discharged from all liability to pay or account for that amount to any entity, except the ATO (s16-20).
• Obligation to remit – an entity that withholds an amount under Div 12 must pay the amount to the ATO (s16-70). To withhold means “to keep back” and in the context of Divs 12 and 16, connotes “deprivation, the holding back of something due to the employee” (Price v Commissioner of Taxation [2019] FCA 543; Cassaniti v Federal Commissioner of Taxation (2010) 186 FCR 480).
• Estimate – the obligation to remit is enforced by a regime that includes the estimate regime under Div 268. That regime does not enforce the obligation to withhold. The ATO may estimate an unpaid and overdue amount of liability under s16-70 (that is, an amount, such as PAYGW, that an entity has failed to remit to the ATO). Such an estimate need only be “reasonable” and need not be accurate or perfect (s268-10(2) and (3)).
• Effect of reducing an estimate – the effect of reducing a PAYGW estimate does not affect the validity of a DPN issued for a higher original amount (Commissioner of Taxation v Craddock (2006) 204 FLR 274; Roche v Deputy Commissioner of Taxation (2014) 290 FLR 268).
• Statutory declaration – an entity that receives an estimate under s268-15 can submit a statutory declaration (or affidavit) verifying the facts to the effect that the entity was not obliged to withhold amounts under s12-35 or that no amounts were withheld (s268-40(1)).

Who bears the obligation to withhold PAYGW amounts under s12-35? Can an entity, other than the employer, bear that obligation? 

CLK Kitchens argued that because CLK Services (and not CLK Kitchens) was the employer of the workers, CLK Kitchens was not liable to withhold PAYGW amounts on “salary” and “wages” it paid to the employees of CLK Services under s12-35. It followed, as CLK Kitchens contended, that it was not capable of having an underlying liability to remit under s16-70 with the result that the ATO was not entitled to make an estimate in respect of CLK Kitchens under s268-10. 

Derrington J rejected this argument, finding that s12-35 was not concerned with the fact that the workers (who were paid wages by CLK Kitchens) were no its employees, but the employees of CLK Services. His Honour found that this was because the words “whether of that or another entity” in s12-35 had the result that the obligation to withhold simply falls upon the entity which pays the salary or wages, regardless of whether or not that entity is the employer (Re Plutus Payroll Pty Ltd [2017] NSWSC 1360). Therefore, the relevant question under s12-35 is not whether the entity was an “employer” but whether the amount paid was “wages” or “salary” (DCT v Applied Design Development P/L (in liq) (2002) 117 FCR 336).

Derrington J held that, on the facts, the character of the amounts paid were wages and salary. This was because the payments by CLK Kitchens, which was authorised by CLK Services, to the employees of CLK Services effected a discharge of the salary or wages obligation which had arisen by reason of the employees providing consideration by undertaking work. When the employees were credited with a sum of money by CLK Services, there was a corresponding debit in CLK Kitchens’ account for that amount. CLK Services did not merely authorise the use of its money to discharge the debt but actually discharged the debt itself by use of its own credit.

In his Honour’s view, this situation could be contrasted to a financial institution transferring wages to a person, which is not properly the subject of s12-35. This is because a financial institution merely operates credit facilities whereby debtors are able to discharge their financial obligations to creditors through the medium of money or credit transfers. The transfer itself does not, of itself, discharge anything. Rather, the ability to discharge an obligation arises from the authority of the payer to do so. As such, if the analogy were to be applied in this matter, Derrington J considered that it is only CLK Kitchens (being the customer of any bank with the relevant authority) which, through the medium of the bank, could discharge the wages debt and thus, can be said to have “paid the wages”. 

Was the amount calculated an “estimate” for the purposes of s268-10?

CLK Kitchens submitted that the Estimate Notice was invalid because it was not based on any valid “estimate” by the ATO for the purposes of s268-10.

Derrington J rejected this argument, observing that the power to make an estimate under s268-10 was not conditioned on the formation of a “reasonable belief” or an identified state of facts. The only requirement was that the estimate was, in the ATO’s view, reasonable. His Honour opined that, first, an estimate necessarily involves an assessment of the facts known and the giving of weight to the various factors which might affect the conclusion, secondly, the weight so given is a matter of judgment with the result that reasonable persons may reach different estimates, and thirdly, estimates are inherently approximations based upon judgment, which necessarily makes assessing the unreasonableness of an estimation difficult.

On the facts, CLK Kitchens did not report the wages it paid to workers and so the ATO had little information on which to make its estimate. There was no evidence that any step in the process of estimating the amount was unreasonable, illogical or contained some element that might have suggested that the ATO acted in excess of power.

What is the effect of the ATO proving its debt in CLK Services’ administration on the ATO’s ability of making an estimate and issuing a DPN?

An interesting submission that arose was whether the ATO was precluded from making an estimate under s268-10 and issuing a DPN for that estimate under s269-25 in circumstances where it successfully proved in the administration of CLK Services for debts that included CLK Services’ PAYGW amount obligations.

CLK Kitchens argued that the ATO had to elect between mutually alternative and inconsistent rights (being proving its debt in CLK Services’ administration, on the one hand, and pursuing estimate and DPN liabilities with respect to CLK Kitchens on the other hand) (Bibby Financial Services Australia P/v v Sharma [2014] NSWCA 37; Commonwealth v Verwayen (1990) 170 CLR 394). Specifically, CLK Kitchens contended that the ATO elected to prove its debt in CLK Services’ administration, was paid on its proof and therefore, could not now assert that another entity, being CLK Kitchens, was liable for the same amount under s12-35 on the same basis on the same employee entitlements. As such, it argued that the ATO was precluded from recovery under the estimate and DPN regimes.

Derrington J rejected the election argument. In so doing, he held that the basis of the liability that the ATO proved against CLK Services was different to that against CLK Kitchens. Specifically, whereas the liability (PAYGW amounts) that the ATO proved against CLK Services was based on what CLK Services reported as being responsible for, the liability of CLK Kitchens arose by reason of the giving of the Estimate. 

His Honour distinguished the “underlying liability” from the liability giving rise to an estimate under Div 268, namely that an “underlying liability”, which arises by reason of the obligation to withhold under s12-35 and then remit to the ATO under s16-70, is separate and distinct from the liability, which arises by reason of the ATO giving an Estimate Notice of an estimate under ss268-10 and 268-15. He supported this by reference to s268-20(2), which made plain that, “for all purposes”, the liability to pay an estimate is “separate and distinct from the underlying liability”.

The consequence of this is that the ATO is entitled to commence one proceeding against one entity to recover the underlying liability and separate proceedings to recover the estimated liability. Derrington J held that, as taking proceedings to enforce one right is not an election, neither would proving in a liquidation.

Accordingly, he found that no election could arise where the liability arising as a result of service by the ATO of an Estimate Notice is a different liability to that of the underlying liability arising as a result of s16-70.

Did the statutory declaration reduce or revoke the estimated liability under s268-40?

CLK Kitchens argued that the Estimate Notice ought to have been reduced or revoked under s268-40(2) or (4) on the basis of Mr Karananos’ statutory declaration. Section 268-40(2) provides that an amount of an estimate is reduced if a statutory declaration (given in the form under s268-40(1)) is to the effect that a specified lesser amount is the unpaid amount of the underlying liability. Equally, s268-40(4) provides that an estimate is revoked if a statutory declaration is to the effect that the underlying liability never existed.

Derrington J held that the statutory declaration was not effective to cause a reduction or revocation of the estimate under s268-40. His Honour observed the following: 

• The immediate effect of giving a statutory declaration of affidavit that complies with s268-40 is not, of itself, to reduce the estimate (Transtar Linehaul Pty Ltd v Deputy Commissioner of Taxation (2011) 196 FCR 271).
• A statutory declaration must verify facts sufficient to prove: (a) that a specified lesser sum is the unpaid amount of the underlying liability, in that the amount of withheld PAYGW amounts which have not been remitted is less than that estimated by the ATO; or (b) that the underlying liability never existed, which might be established by disclosing that nothing which ought to have been withheld had been withheld albeit in contravention of s12-35.
• It is insufficient simply to swear to the issue that no PAYGW amount was withheld or that the total amount withheld is nil as that will not “verify” the fact in question (Re Plutus [2017] NSWSC 1360).
• Specifically, a deponent must attest to facts which, if accepted on a contested dispute, would be sufficient to establish that the estimate recipient did not retain any portion of the employee’s wages which might be the PAYGW amount. Where the characterisation of the facts is in doubt, the deponent would usually have to dispel the facts which support the conclusion that the liability exists. If the facts are equivocal and are equally consistent with the existence or non-existence of liability, the statutory declaration will not satisfy s268-40(2) or (4) (DCT v Armstrong Scalisi Holdings Pty Ltd [2019] NSWSC 129; Transtar Linehaul)

On the facts, Derrington J held that Mr Karananos’ statutory declaration did not have the effect of reducing or revoking the estimate under s268-40(2) or (4) and thus, CLK Kitchens’ liability to pay the estimate remained unabated. The statutory declaration was vague and did not detail the transactions by which the employees of CLK Services were paid using the funds of CLK Kitchens. None of the assertions verified the facts to the effect that no underlying liability existed or that a specified lesser amount is unpaid.

Does the ATO have a duty under s268-35 or an overarching duty to reduce or revoke the Estimate Notice? 

CLK Kitchens also argued that whilst the statutory declaration did not have the effect of reducing or revoking the estimate under s268-40, the ATO was obliged to consider reducing or revoking it based on some other power. It is unclear whether CLK Kitchens contended that this other power was sourced in s268-35.

In any event, Derrington J found that there was nothing in Div 268 which suggested that there existed any “super-added duty” on the ATO to consider reducing or revoking an estimate. Rather, such power of the ATO is conferred by s268-35, as are the conditions and obligations of its exercise under s268-35(5). Specifically, if material comes to light, by whatever means, which impacts upon the estimate, the ATO may, in the exercise of its discretion, consider exercising the power to reduce the estimate and, if the ATO chooses to exercise the discretion, it may reduce or revoke the estimate.

Certainly, this occurred on the facts where upon the receipt of bank statements and further documents (separate from the statutory declaration), the ATO reduced the estimate.