The PAYE trap: How unpaid PAYE can destroy your business

Managing payroll and tax obligations is a fundamental responsibility for any business operating in New Zealand. Among these obligations, the accurate deduction and timely payment of Pay As You Earn (PAYE) tax to Inland Revenue (IR) stands out as one of the most critical. When a business faces cash flow difficulties, some directors may be tempted to use PAYE deductions as an unofficial overdraft facility to pay suppliers or keep the business afloat. However, this is an expensive and highly dangerous illusion.

The non-payment of PAYE is not merely a civil debt issue; it is a serious criminal offence that can lead to severe financial penalties, personal liability for directors, and even imprisonment. This article explores the legal framework surrounding PAYE obligations, the compounding nature of penalties, the impacts of director changes, and practical advice on how to manage PAYE effectively to prevent it from becoming unmanageable.

The Legal Framework and Trust Obligations

The fundamental principle underlying PAYE is that the money deducted from an employee's wages does not belong to the employer. Under section 167 of the Tax Administration Act 1994, every amount of tax withheld or deducted under the PAYE rules is held in trust for the Crown. This means that the funds are legally separated from the employer's general operating capital. In the event of bankruptcy or liquidation, these trust funds remain apart and do not form part of the estate available to general creditors.

The Income Tax Act 2007, specifically Subpart RD, establishes the employer's liability to withhold and pay these amounts. When an employer deducts PAYE but fails to pass it on to Inland Revenue, they are effectively misappropriating Crown funds.

Inland Revenue views this behaviour as a significant risk to the integrity of the tax system. As highlighted in the recent Revenue Alert RA 26/01, making deductions and failing to pay them to Inland Revenue is a serious criminal offence. Under section 143A(1)(d) of the Tax Administration Act 1994, an employer who knowingly applies the deductions for a purpose other than payment to Inland Revenue commits a knowledge offence. The penalties for this principal offence are severe, carrying a maximum sentence of up to five years in prison, a fine not exceeding $50,000, or both.

The Snowball Effect: Penalties and Interest

Treating Inland Revenue as an involuntary lender is an exceptionally costly strategy. Unlike standard commercial debt, tax arrears—particularly PAYE—are subject to a punitive regime of compounding penalties and interest designed to deter non-compliance.

When an employer files employment information but fails to pay the correct amount, they are immediately exposed to a cascading series of financial consequences. Inland Revenue late payment penalties are heavily front-loaded. An initial 10% non-payment penalty is applied to the overdue amount. If the debt remains unpaid, a further 10% penalty is added each month. While this monthly penalty can reduce to 5% if the employer enters into an instalment arrangement, the compounding effect is rapid and devastating.

In addition to these specific non-payment penalties, Use of Money Interest (UOMI) continues to accrue on the underpayment. As of January 2026, the UOMI underpayment rate is 8.97% per annum.

To illustrate the danger, consider a scenario where a business defaults on a $10,000 PAYE payment and leaves it untouched for 12 months without engaging with Inland Revenue. Due to the monthly incremental penalties and accumulating interest, that initial $10,000 debt can explode to more than $25,000 within a single year. This makes PAYE arrears significantly more expensive than rolling GST debt or income tax arrears, effectively making it the most expensive form of financing a business could inadvertently choose.

Director Liability and the Impact of Changes

A common misconception among company directors is that the corporate veil will protect them from personal liability for the company's tax debts. When it comes to PAYE, this protection is easily pierced.

Under section 148 of the Tax Administration Act 1994, any person who aids, abets, incites, or conspires with another person to commit a tax offence also commits a criminal offence. This secondary liability provision is the primary mechanism Inland Revenue uses to prosecute directors. If a director makes the conscious decision that the company will pay other creditors instead of passing PAYE deductions to Inland Revenue, that director is aiding and abetting the company's failure to pay.

Inheriting Debt: The Impact of Director Changes

When the directorship of a company changes, the liability landscape requires careful navigation. The company itself remains primarily liable for any historical PAYE debt. A newly appointed director does not automatically become personally liable for the historical criminal offences committed by their predecessors.

However, the new director assumes immediate responsibility for the company's ongoing compliance. If the new director discovers the historical PAYE arrears and continues to operate the business while failing to address the debt or continuing to withhold new PAYE deductions without paying them to Inland Revenue, they expose themselves to prosecution under the aiding and abetting provisions.

Furthermore, directors have strict duties under the Companies Act 1993. Section 135 prohibits reckless trading, stating that a director must not allow the business to be carried on in a manner likely to create a substantial risk of serious loss to creditors. Section 136 requires that a director must not agree to the company incurring an obligation unless they believe on reasonable grounds that the company will be able to perform it. Continuing to employ staff and deduct PAYE while knowing the company cannot pay Inland Revenue is a clear breach of these duties, potentially leading to personal liability for the company's debts upon liquidation.

Inland Revenue is also increasingly vigilant against "phoenix" behaviours—where directors liquidate a non-compliant company only to start a new, identical business to escape the tax debt. Recent legislative changes to the Companies Act 1993 (section 382(1)(ba)) now impose an automatic five-year ban on managing a company for individuals convicted of serious tax offences.

A Track Record of Prosecutions

Inland Revenue does not hesitate to use its prosecution powers when it identifies deliberate and repeated non-payment of PAYE. The courts have consistently supported this approach, viewing the misappropriation of taxpayer funds as a serious breach of trust that creates an unfair advantage over compliant businesses. Recent cases highlight the severe consequences for directors:

• Melanie Tatana (2024): The director of an asbestos removal company was sentenced to three years in prison. Over three years, her company failed to pass on $1.6 million in PAYE deductions. The court found that more than $800,000 had been diverted for her personal use. The judge described it as the worst tax offending of its kind in the Christchurch District Court in 20 years.

• David Gower (2023): An Auckland company director was sentenced to two years and three months in prison. His fire protection company was liquidated owing over $2.6 million in PAYE and $1.3 million in GST. The offending continued for 17 months after a final warning from Inland Revenue.

• Nicola Dargie (2019): Ironically, a woman who presented debt management workshops was sentenced to two years and six months in prison. She operated five companies that failed to pay more than $740,000 in PAYE over a decade. As each company fell into arrears, she transferred employees to the next company to continue the offending.

• Frederick Epiha (2025): Sentenced to 10 months of home detention for failing to pay $215,000 in PAYE. The court noted his "phoenix type behaviours," as he had set up a new company to take over the trading business of a previously non-compliant company without changing the compliance behaviour.

• Hugh Lloyd (2024): Sentenced to six months of home detention for failing to pass on nearly $560,000 in PAYE and other deductions. Crucially, he became the first director to face the automatic five-year ban from running a company under the new Companies Act provisions, after attempting to trade a new company while serving his sentence.

Practical Advice: Managing PAYE Effectively

The most effective way to avoid the severe penalties and legal risks associated with PAYE arrears is to implement robust payroll and financial management practices. PAYE should never be viewed as available working capital.

Understand Payday Filing Obligations

New Zealand employers are required to file employment information every time they pay their staff, a system known as payday filing. For most employers filing electronically, this information must be submitted within two working days of the payday.

While filing happens every payday, the actual payment of the deductions to Inland Revenue occurs on a set schedule based on the size of the employer:

• Small to Medium Employers (Gross annual PAYE and ESCT less than $500,000): Deductions must be paid monthly, by the 20th of the following month.

• Large Employers (Gross annual PAYE and ESCT more than $500,000): Deductions must be paid twice a month. Deductions from wages paid between the 1st and 15th are due by the 20th of the same month. Deductions from wages paid between the 16th and the end of the month are due by the 5th of the following month.

Utilise myIR for Visibility and Control

Inland Revenue's secure online portal, myIR, is an essential tool for managing PAYE. Employers should regularly check the 'Returns and transactions' section within their payroll account. This dashboard provides real-time visibility of the deductions required for each period, updated automatically every time employment information is filed.

By monitoring myIR, employers can ensure that their records match Inland Revenue's expectations, verify that payments have been processed correctly (which can take up to 15 working days), and immediately identify any debit balances that require attention.

Quarantine Tax Cashflow

The most practical step a business can take is to physically separate tax funds from operational cash flow. Employers should set up a dedicated, separate bank account specifically for tax obligations. Every time a payroll run is completed, the exact amount of PAYE, KiwiSaver, and other deductions should be immediately transferred into this quarantine account. Treat this account as a strict trust fund; once the money is set aside, it is entirely off-limits for paying suppliers, rent, or other operational expenses.

Align Payments with Paydays

While the law allows small employers to hold onto PAYE until the 20th of the following month, doing so requires immense financial discipline. A safer approach is to make PAYE payments to Inland Revenue on the actual payday filing dates. By paying the tax at the exact same time the employees receive their net wages, the business eliminates the risk of accidentally spending the tax money during the intervening weeks. This proactive approach prevents PAYE from ever becoming unmanageable.

Engage Early if Difficulties Arise

If a business finds itself unable to meet a PAYE obligation, the worst possible action is to ignore it. Directors must treat PAYE arrears as a financial emergency. Proactive and early engagement with Inland Revenue is crucial. By communicating before the due date, businesses may be able to negotiate an instalment arrangement, which can significantly reduce the imposition of the punitive 10% monthly compounding penalties.

Conclusion

The dangers of non-payment of PAYE cannot be overstated. It is a strict legal obligation involving funds held in trust for the Crown. Failing to pass these deductions to Inland Revenue triggers a devastating cascade of compounding penalties and interest that can rapidly cripple a business. More importantly, it exposes directors to criminal prosecution, imprisonment, and bans from future corporate governance. By understanding the legal framework, utilising tools like myIR, quarantining tax funds, and aligning tax payments with payroll cycles, directors can protect themselves and ensure their businesses remain compliant and financially sound.

Contact Greenlane CA Limited

• Email: info@glca.co.nz

• Phone: +64 9 522 5182

• Website: www.glca.co.nz

• Address: 97 Great South Road, Greenlane, Auckland 1051

Disclaimer

This newsletter is published by Greenlane CA Limited for informational purposes only. The content provided herein is of a general nature and does not constitute professional tax, accounting, legal, or financial advice. While every effort has been made to ensure the accuracy and completeness of the information contained in this newsletter, Greenlane CA Limited makes no representations or warranties, express or implied, as to the accuracy, reliability, completeness, or currency of the information.

Readers should not act or refrain from acting based solely on the information in this newsletter without first seeking professional advice tailored to their specific circumstances. Tax laws and regulations are subject to change, and the application of these laws depends on the particular facts and circumstances of each case.

Greenlane CA Limited, its directors, employees, and agents accept no responsibility or liability for any loss, damage, cost, or expense, whether direct, indirect, consequential or otherwise, incurred by any person as a result of relying on the information contained in this newsletter, or any errors or omissions therein, howsoever caused.

For advice specific to your situation, please contact Greenlane CA Limited directly.