A Trap for Unwary Employers – Criminal Proceedings for Failure to Account for PAYE

Criminal Charges for Failure to Pay PAYE – Taxation Today, November 2007

This year the PAYE scheme reached its 50th birthday, although the event seems to have been accompanied by distinctly muted celebrations. Despite the scheme being a relatively long-standing feature of the tax administration, ignorance or disregard of the obligations which the scheme imposes on employers regularly results in otherwise law-abiding people facing severe criminal penalties, including prison.

The Statutory Scheme

Responsibility for the deduction and payment of PAYE to the CIR rests on the employer. Under s NC 2(1) Income Tax Act 2004[1] (ITA 2004) the employer is required to make a “tax deduction” from an employee’s salary, bonus or other lump sum payment in accordance with the PAYE rules “at the time of making the payment”. The employer must pay to the CIR the amount of that tax deduction within a prescribed period: s NC 15(1) ITA 2004.

A series of deeming provisions buttress this scheme and ensure that despite the fact that an employer may not have actually set aside any money to cover PAYE, they will remain legally liable:

  • When an employer makes a salary, bonus or other lump sum payment to an employee net of tax, PAYE is deemed to have been deducted by the employer at the time of making the payment: s 4A(2)(b) Tax Administration Act 1994 (TAA 1994).
  • PAYE which is deducted or deemed to be deducted is held in trust by the employer for the CIR: s 167 TAA 1994.
  • An employer who fails to pay the PAYE to the CIR by the due date is deemed to have been misapplied it: s 4A(2)(c) TAA 1994.

In summary, if net wages are paid but PAYE is not paid to the CIR by the due date, then the PAYE is deemed to have been deducted and deemed to have been misapplied.

Criminal Liability

In terms of s 143A (1) TAA 1994, a person commits an offence if he or she “knowingly applies or permits the application of the amount of a deduction or withholding of tax made or deemed made under a tax law for any purpose other than in payment to the CIR”. As above, if net wages are paid but the PAYE is not paid to the CIR by the due date, then the physical elements of this offence are deemed to have been committed.

 As regards the mental elements of the offence, the test of knowledge is subjective: Meulen’s Hair Stylists Ltd v CIR [1963] NZLR 797 (SC). Negligence or carelessness is insufficient to satisfy the test of “knowingly”: Godfrey Allan Ltd v CIR (1980) 4 NZTC 61,548 (HC). Recklessness as to whether the PAYE has been paid has been held (in the analogous penal tax context) to be sufficient to amount to a knowing failure to pay: Case R31 (1994) 16 NZTC 6,171, but this judgment may be doubtful, at least as applied in a criminal context, in the light of analogous cases which hold that recklessness is insufficient to establish knowledge where that is an ingredient of the offence: Cooper v Ministry of Transport [1991] 2 NZLR 693 (HC). At least one case that the author is aware of has resulted in an acquittal on the basis that the directors of a company, while reckless, did not know that PAYE had not been paid by the due date.

Embodying the precept that “ignorance of the law is no defence” (s 25 Crimes Act 1961), knowledge of the existence of the facts (ie that payment of net wages has been made and that PAYE has not been paid to the CIR on the due date) will be sufficient without any need for knowledge of the unlawfulness of that situation: CIR v Gordon (1989) 11 NZTC 6,082 (HC).

Where the employer is a company, the company can obviously be liable. In addition, any responsible company officer or employee who contributed to the situation is also vulnerable to prosecution, either under the general criminal law relating to parties (s 66 Crimes Act 1961) or under the specific provisions in s 147 TAA Act 1994. In general, when considering whom to prosecute when the company is insolvent or struck off, Inland Revenue attempts to ascertain who was responsible for determining which creditors would be paid.

While there are defences to the charge set out in ss 143A(3) and (4) for causes beyond the employer’s control, it has repeatedly been held that cash-flow difficulties are not beyond the employer’s control in this context: CIR v JF McCormick Limited [1964] NZLR 56, Hammond v Walesby and Paramount Graphics Limited (1986) 8 NZTC 5,185.

In summary, while the onus is on the CIR to prove the case beyond reasonable doubt (s 149A TAA 1994), if net wages have been paid but PAYE not paid to the CIR by the due date, then it will almost always be the case that the person responsible for ensuring payment will be guilty of the offence.

Section 143A(8) TAA 1994 provides that the maximum penalty is imprisonment for five years and/or a fine of up to $50,000 for each offence, so the offence is regarded as one of the most serious revenue offences.

Sentencing schedules generally indicate that provided full reparation is made by sentencing time, a prison sentence will not be imposed. However, there are a number of exceptions to this general position and, of course, the more money involved the more likely a custodial sentence will be. If full reparation is not made prison also becomes increasingly more likely. It remains to be seen how the new amendments to the Sentencing Act 2002 which came into force on 1 October 2007 and allow for a wider variety of community-based sentences (including home detention and “community detention” – a sort of curfew) will be applied in the context of this type of offence.

No Liability on Employees

In the course of sentencing, Inland Revenue prosecutors occasionally submit (as an allegedly aggravating feature) that an employer’s failure to pay the PAYE results in the employee becoming liable for the unpaid PAYE. Whatever else may be said about failure to account for PAYE, this submission does not appear to be well-founded.

Section NC 16 ITA 2004 makes an employee liable to pay PAYE “Where for any reason a tax deduction … is not made”. As above, if an employee has received net wages, then a tax deduction is deemed to have been made at the time of payment of the net wages. It therefore follows that an employee who receives a salary, bonus or other lump sum payment from his or her employer net of tax is not liable to pay PAYE to the CIR on the payment, and the responsibility is solely the employer’s. The position is different when an employee receives a gross payment from his or her employer, ie a payment which includes PAYE. In those circumstances, while the CIR may recover the PAYE from the employer under s 168 TAA 1994, the employee will also be liable for PAYE under s NC16 ITA 2004.

The distinction between these two situations was recognised in a Taxation Review Authority decision: Case P44 (1992) 14 NZTC 4,308.

Staying Out Of Trouble

Employers get themselves into serious trouble through ignorantly regarding PAYE deductions and the attendant obligations as just another civil debt. When cash-flow is tight, the creditor whose support is seen as being the most important or who makes the loudest noise at the earliest opportunity is likely to get paid first. This creditor is usually not the tax man, so the temptation to pay other debts in priority to PAYE is obvious. However, as this article illustrates, PAYE deductions are regarded at law as trust funds, with criminal sanctions for their misappropriation. Failure to account for them may have personal consequences far more severe than non-payment of any debt.

Inland Revenue will know from the employer’s schedule that PAYE deductions are (deemed to be) made, and knows when they have not been paid. The elaborate series of deeming provisions set out above highlights the importance which Parliament puts on compliance with the PAYE system. Despite this signal, which is surely directed to the Department as much as to taxpayers, it is not unknown for 18 months to elapse before non-payment of PAYE is followed up, and by then the situation is often beyond rescue. In the author’s view the question needs to be asked: would it not be better tax administration for the Department to police breaches of PAYE obligations more proactively and, for example, issue formal warnings to employers and consider using remedies such as section 157 TAA 1994 to recover the PAYE when breaches first occur, than to let matters slide until a significant criminal liability exists on multiple charges and then seek the taxpayer’s imprisonment?

Advisors can also contribute to the worsening of the situation by trying to buy time for the client, even once an Inland Revenue demand arrives, by using tactics such as making a global repayment application to cover the client’s PAYE, income tax, and GST obligations. Usually the resulting negotiations are fruitless and the situation deteriorates further. When an advisor becomes aware that a client’s PAYE payments are in default, the client should be advised in the clearest possible terms to pay the PAYE by whatever means are possible without delay, and to ensure that the situation is not repeated, even if this involves going into liquidation immediately. An advisor who tries to put a client’s PAYE repayment into a holding pattern can contribute to putting the client into prison.

[1] All the provisions cited from the 2004 Act have identical equivalents in the previous Income Tax Act 1994

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