Dave Ananth says tax debt cannot become permanent business finance, and to be viable any business that owes late taxes needs to have a workable plan to stay on top of current taxes due while it catches up on the older debt

By Dave Ananth*

An instalment arrangement can give a viable business breathing space. But if the business cannot meet today’s tax while paying yesterday’s debt, the arrangement may simply postpone the real problem.

Nine payment arrangements.

That number caught my attention almost as much as the prison sentence. On 25 September, Inland Revenue reported that a Christchurch businessman had been sentenced to two years and three months’ imprisonment for tax offending involving nearly $1.4 million.

The facts were serious. His company failed to pay substantial amounts of PAYE and GST. Inland Revenue said there had been deliberate decisions to use money for creditors, wages, company expenses and personal expenditure rather than meeting tax obligations.

The company eventually went into liquidation. But one detail stood out. The businessman had entered into nine payment arrangements with Inland Revenue. All nine defaulted.

We do not know from the published material the amounts, duration or terms of those arrangements. But nine failed arrangements raise a useful question:

When does a payment arrangement solve a tax problem, and when does it merely postpone it?

An arrangement buys time. It does not create cash

There is nothing wrong with a business entering into an instalment arrangement. A viable business can have a tax problem. A major customer may pay late. A contract may be delayed. Revenue may temporarily fall. An unexpected expense may arise.

In those circumstances, an arrangement can do exactly what it is intended to do: give a viable business time to clear historic debt while continuing to meet its current obligations.

But an arrangement does not change the economics of the business. It does not increase sales or improve margins. And it does not stop the next GST, PAYE or provisional tax obligation from arriving.

That is where the real difficulty begins.

The second tax bill is the one people forget

Suppose a business owes Inland Revenue $120,000 and proposes paying $5,000 a month. On paper, that may look manageable. But while the business is paying the old debt, another GST return arrives. PAYE still has to be paid. Provisional tax may fall due. Wages, rent, suppliers, insurance and finance costs continue as well.

So the real question is not: Can the business find $5,000 this month?

It is: After paying every current obligation as it falls due, can the business consistently produce another $5,000 every month to reduce the historic debt?

If the answer is no, the arrangement has not solved the problem. It has moved it.

Temporary pressure or structural problem?

This is where the distinction between a viable and an unviable business becomes important.

A viable business may have suffered a temporary cash-flow shock. A large debtor has not paid. Revenue has temporarily fallen. An unexpected expense has arrived. If the underlying business remains sound, an instalment arrangement may be entirely appropriate.

The position is different where GST has been unpaid for several periods, PAYE is becoming difficult, suppliers are being stretched, bank facilities are exhausted and the owner is repeatedly injecting personal money.

If old tax debt is being repaid while new tax debt continues to accumulate, tax may no longer be the underlying problem.

It may be the symptom.

Rescheduling historic debt cannot repair a business that does not generate enough cash to meet its ordinary expenses and current liabilities.

GST cannot become the lender

This becomes particularly obvious with GST.

A business may enter into an arrangement to repay old GST while continuing to use cash needed to meet its next GST liability to fund wages, rent or suppliers. The old debt falls. The new debt rises. That is not much of a repayment strategy. The liability is simply moving from one period to another.

PAYE raises an additional concern because deductions have been made through the payroll system and are required to be paid to Inland Revenue. An arrangement therefore has to work alongside current compliance, not instead of it.

The forecast should tell the owner something

This is why a cash-flow forecast matters.

Inland Revenue may require a business seeking financial relief to provide a 12-month cash-flow forecast. But that forecast should not simply be another document prepared for Inland Revenue. It should tell the owner something useful: What cash is genuinely left after this business pays what it must pay?

If the numbers only work because sales rise sharply, every customer pays on time, expenses fall and nothing unexpected happens for the next 12 months, the forecast is not telling the owner very much.

I see this optimism regularly.

“The next quarter will be better.”

“We have several jobs coming.”

“Christmas is our strong period.”

“A large customer should pay soon.”

Perhaps.

But a payment proposal should be based on what the business can reasonably sustain, not on the month everybody hopes is coming.

A failed arrangement tells us something

One failed arrangement may have an explanation. Circumstances change. Unexpected events happen. Repeated failures require a harder question:

Was the proposed repayment ever supported by the cash the business actually generated?

Another arrangement should not simply repeat the previous mathematics over a longer period. Something needs to have changed: revenue, costs, margins, finance, assets, the debt itself or the structure of the business. Otherwise, the new arrangement risks becoming the old arrangement with a new date.

There is a wider point here.

In the Christchurch prosecution, Inland Revenue reported that Judge Gilbert heard that the use of tax money as working capital and personal income gave the businessman an unlawful competitive and lifestyle advantage over taxpayers who paid their tax.

The facts of that case were extreme. Most businesses seeking payment arrangements are not tax evaders. But the practical point extends beyond criminal offending. Tax debt cannot become permanent business finance.

One arrangement that works

A sensible payment arrangement can preserve a viable business.

It can provide breathing space and allow historic debt to be cleared while the business remains current with its ongoing obligations. But there has to be something viable to preserve.

The objective should not be to obtain another arrangement. It should be to make a realistic arrangement work. That requires confronting the numbers before making promises and distinguishing temporary cash-flow pressure from a structural problem.

Sometimes the numbers will support an arrangement. Sometimes they will show that something more fundamental has to change. A tax payment arrangement can give a viable business time. It cannot make an unviable business viable.

And it is not a business plan.

*Dave Ananth is a partner at Meridian Partners and a former Inland Revenue solicitor. His practice focuses on student loans, tax disputes and negotiations with Inland Revenue. His background, profile and contact details are here.