Directors’ duty to act with care, skill and diligence in the context of the general anti-avoidance rules

The recent Federal Court decision in BCI Finances Pty Ltd (In Liq) v Binetter (No 4) [2016] FCA 1351 (Binetter) is a timely reminder of company directors’ common law duties to act with care, skill and diligence in the discharge of their responsibilities (in addition to the statutory duties imposed under the Corporations Act 2001) – not least in the context of tax risk management.

The Binetter decision

The liquidators of four companies succeeded in a Federal Court action claiming that among other things, several directors of those companies breached their duty to act with care, skill and diligence as a result of certain arrangements involving offshore banking deposits, and as a result of their conduct in the context of an Australian Taxation Office (ATO) audit into the arrangements.

The impugned arrangement comprised of ‘back to back’ arrangements involving the use of funds held by directors and associated entities (in Switzerland and Israel) as security for advances from the Israeli banks to the four companies. The advances were equivalent to the offshore deposits.

The liabilities in the revised assessment arose as a result of the disallowance of deductions for the interest expenses claimed to be paid to the Israeli banks and the inclusion of other related amounts in the companies’ assessable income.

The Court held that the four directors breached their duties by agreeing to participate in a scheme between the companies and the Israeli banks. The Court found that:

• the directors intentionally concealed the existence of the offshore deposits and any income earned from the deposits
• the scheme was implemented for the sole benefit of the directors and did not benefit the company
• the sole purpose behind the scheme was to avoid tax, and
• the directors took active steps to obscure the facts and evidence in respect of the arrangement.

In finding against the directors, Justice Gleeson noted at [300] that:

“Lodgement of a tax return on behalf of the company … involves an exercise of power in that it affects the company’s legal rights. In this case, lodgement of the relevant tax returns exposed the applicants to the risk that, in the event the Commissioner did not accept the tax returns as accurate, the applicants would be liable to pay penalties and interest charges”.

Her Honour went on to hold, at [948], that

“The conduct of Andrew and Michael Binetter in failing, in the course of the ATO audit, to disclose documents to explain the transactions or alternatively to take steps to minimise the applicants’ liability for penalties and interest charges, was also in breach of their respective fiduciary duties to the applicants, and their general law duties”

Tax avoidance amounts to a breach of director’s duty

What is required of directors?

The statutory duty to act with care, skill and diligence is required by section 180(1) of the Corporations Act 2001 (Cth) (Corporations Act) and aims to ensure that a director performs his or her duties to the standard expected of a ‘reasonable person’ in the circumstances of that director, working in that particular corporation.

The same duty is imposed on directors at common law, per Australian Securities and Investments Commission v Rich [2009] NSWSC 1229.

The majority of directors are well aware of their statutory and common law duties. For the most part, these duties are clearly defined and easy to understand.

A number of factors are taken into account when determining whether a director has acted reasonably, including their experience and skills, and the function they are performing.

The duty to act with care, skill and diligence is more nebulous than other duties because it requires an analysis of what is ‘reasonable’, which can be interpreted in different ways depending on the circumstances. The duty to act with care, skill and diligence is therefore not always clear cut, especially in the context of tax risk management.

In this article, we will explore the level of knowledge and involvement a director should have over the tax affairs of a corporation in order to satisfy the duty of care, skill and diligence in the context of the general anti-avoidance rules.

Part IVA – The general anti-avoidance rules

Briefly, Part IVA is directed at taxpayers that have obtained a ‘tax benefit’ in relation to a scheme, where the scheme was entered into for the dominant purpose of obtaining the tax benefit. The ATO can apply Part IVA broadly and successfully, unless the taxpayer can demonstrate that it entered the scheme for the dominant purpose that is not the tax benefit.

In analysing whether a taxpayer has entered into a transaction for the dominant purpose of achieving the relevant tax benefit, it is important to consider the commercial, non-tax drivers of the relevant transaction, and to weigh these against the identified tax benefit. This balance is particularly important for directors as their personal liability may be engaged.

In the context of the director’s duty to act with care, skill and diligence, it seems clear that a director could fall short of the duty where the director’s corporation enters into a scheme against which the ATO might apply Part IVA. This was confirmed in the Binetter decision.

The need for evidentiary documentation

It is incumbent on Boards to ensure that, when approving transactions, due consideration has been given to any risk that Part IVA could apply.  In this regard, an objective assessment should be made of the commercial rationale against any tax benefit that may arise to ensure that the risk of any Part IVA impact has been properly managed.

In doing so, the existence of contemporaneous documentation that evidences the commercial, non-tax drivers of the relevant transaction has proven invaluable in assisting taxpayers to discharge their onus of proof, and demonstrating that the transaction through which a tax benefit was realised was in fact entered into for the dominant purpose of achieving certain commercial outcomes.

It is not possible to definitively categorise all the transactions to which Part IVA may apply and of which directors should, therefore, be particularly cognisant. However, corporate restructures are often one area where there is often a potential risk with regard to Part IVA, because restructures often result in a more favourable tax outcome, even though that is not the dominant purpose of the restructure.

Directors’ Part IVA Toolkit

Directors should ensure that any documentation which evidences the commercial rationale of a transaction is meticulously prepared, and retained. Such documentation includes, but is not limited to:

• correspondence between directors and other stakeholders about the transaction
• correspondence between the company and external advisors (including lawyers, bankers and accountants) about the transaction
• directors’ diary notes
• detailed board minutes and papers which evidence a discussion of the commercial drivers of the transaction
• transaction bible containing all the relevant information and documentation from a transaction, and
• privileged advice opining on the potential application of Part IVA to the proposed transaction.

Any document which shows why the company has chosen to proceed with a transaction, or even why the company has chosen to carry out the transaction in a particular way, might become relevant later if the ATO wishes to confirm that Part IVA does not apply.

It is critical that documents which were generated in the earliest stages of the transaction are retained. This is the time when the company was still deciding whether to enter into the transaction or how to carry out the transaction.

The contemporaneous documentation should also have regard to the expected tax outcomes of the proposed transaction. It is well known that tax may be a significant consideration in structuring a transaction. The absence of evidence explaining the tax motives of participants in transactions may be more harmful than having an analysis that considers various alternatives, highlights their respective tax outcomes and explains the commercial justification for selecting a particular course of action.

This article was written with the assistance of William Sabatier, Seasonal Clerk.