COVID-19 “safe harbour” not for sinking ships
Director’s personal liability for company tax debts
On 10 July 2020, Inland Revenue issued a public ruling (the Ruling) considering the application of the asset stripping rules (under which directors and shareholders may be personally liable for company tax debts) in the context of the recently enacted exception to certain directors’ duties under the Companies Act 1993 (the Safe Harbour).
This Ruling will be of particular interest to company directors dealing with the economic consequences of COVID-19 and those who have already relied on the Safe Harbour.
The Ruling can be viewed here, and is summarised below.
The Safe Harbour
Under sections 135 and 136 of the Companies Act 1993 (the CA), a director of a company:
- must not agree to the business of the company, or cause or allow the business of the company, to be carried on in a manner that is likely to create substantial risk of serious loss to the company’s creditors; and
- must not agree to the company incurring an obligation unless the director believes at the time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.
The Safe Harbour provides an exception to these duties, allowing company directors to resolve to keep trading, and to incur new obligations, without breaching sections 135 or 136 of the CA if:
- in the good faith opinion of the directors, the company is facing (or is likely to face in the next six months) significant liquidity problems as a result of the COVID-19 pandemic; and
- the company was able to pay its debts as they fell due in the normal course of business on 31 December 2019; and
- the directors consider in good faith that it is more likely than not that the company will be able to pay its debts as they fall due on and after 30 September 2021 (e.g. because trading conditions are forecast to improve, or it is likely that they will reach an accommodation with the company’s creditors).
The Safe Harbour applies from 3 April 2020 until 30 September 2020 (subject to potential further extension).
Under the asset stripping provisions in section HD 15 of the Income Tax Act 2007 and section 61 of the Goods and Services Tax Act 1985 (the Asset Stripping Rules), the directors and shareholders of a company may be personally liable for income tax and GST owing by the company where an arrangement has been entered that has the effect of rendering a company unable to meet a tax liability.
The Ruling confirms that:
- The Asset Stripping Rules will not apply to a company that is unable to meet a tax obligation where:
- the directors of a company facing significant liquidity problems because of the effects of COVID-19 and the resulting economic climate decide, in good faith, to rely on the Safe Harbour and continue carrying on business; or
- as a result of the directors’ decision to rely on the Safe Harbour, the company continues carrying on business and trading, or incurs new obligations on ordinary commercial business terms (e.g. bank loans).
- The Asset Stripping Rules may still apply to any arrangement entered into in relation to a company that, on its own terms, would ordinarily be subject to the Asset Stripping Rules notwithstanding that the arrangement was entered into during the Safe Harbour period.
In publishing the Ruling, Inland Revenue has recognised the possibility that some companies may still face insolvency, and be unable to pay their tax liabilities, even after relying on the Safe Harbour – a scenario that might otherwise have attracted application of the Asset Stripping Rules. Without the Ruling, this threat of personal liability for company tax debts could have resulted in reduced uptake of the Safe Harbour rule by directors.
That said, the Ruling does not provide a free pass to all companies. It is important to note that a director’s reliance on the Safe Harbour must be in good faith. Directors must then also ensure that they continue to act in good faith and not enter into an arrangement that may ordinarily fall foul of the Asset Stripping Rules.
Please contact one of our experts if you would like to discuss Safe Harbour or the Ruling further.