Phoenix Fire Reignites

13/11/2012 by Michael Jones

The Phoenix Fire Reignites

Over recent years there has been growing concern about the increasing level of the so calledPhoenixactivity in relation to the use of the corporate entity.  The Australian Government has recently issued a discussion paper on the impact of this kind of activity and a number of recommendations have been foreshadowed.  It is important to note that the discussion paper distinguishes between what it refers to as fraudulent Phoenix activity which involves usually evasion of taxes and other liabilities such as employee entitlements through the deliberate systematic and sometimes cyclic liquidation of related corporate entities as opposed to the legitimate use of the corporate form where an innocent director, having incurred trading losses and facing liabilities, places the company into liquidation and then subsequently acquires some, or all of the assets from a liquidator to commence a new business.

Why it’s bad

The Government has estimated that this kind of activity is presently losing the revenue in the order of $600,000,000.  Moreover, there is a worrying concern that although the activity in the past has been limited to small businesses with a turnover of less than $2,000.000 per annum, in recent yearsPhoenixactivity is being undertaken by much larger businesses and individuals with significant wealth.

At a general level, thePhoenixactivity has a serious impact on the economy.  If directors of companies are allowed to continue in business without paying their respective taxes and employee commitments they are affording to themselves an unfair advantage over those honest company directors who meet all of their legal obligations.

Although the activity affects the general creditor community, it seems to mostly affect the Australian Taxation Office, primarily because the Taxation Office does not provide any services which can be withheld for non payment.

Existing Prevention Mechanisms

There are a number of mechanisms and legal provisions that impede directors from carrying out Phoenix activity, although it’s important to note that there are no specific provisions in any legislation that prevent it.

Section 181, 182 and 183 of the Corporations Act set out the fiduciaries duties of directors and these sections can be used effectively to target directors who transfer assets of one company into another company without proper consideration, or who do so for their own benefit and to the detriment of the company and/or its creditors.

Of course there are also the provisions relating to Insolvent Trading and Fraud by Officers found in Sections 588 G and 596 respectively of the Corporations Act.

Importantly, information that the director has obtained whilst being a director of a company cannot be used for his own benefit and to the detriment of the company and this would include details of customer lists, suppliers and other selling information necessary to run the business.

The fiduciary duties of directors was tested in McNamara v Flavel (1988) 13 ACLR 619 by the Supreme Court of South Australia and in that case, directors were found to be criminally liable in a situation where they engineered the transfer of the assets out of an insolvent company into a clean entity, specifically for the purpose of defeating the creditors.  The Judge interestingly, found it unnecessary to put any value on the goodwill of the business focusing instead on the conduct of the directors.

Recently the ASIC has introduced a regime of banning company directors after following repeated liquidations of companies and the ASIC have published statistics on their success in this regard.

The ATO have the capacity under the director penalty regime to make individual directors personally liable for PAYG holding taxes.  However in this regard the ATO are required to serve a notice allowing the directors fourteen days to take certain actions.

There are a plethora of other small areas where Phoenixing directors cannot get away with the process “scott free”, however these activities are nonetheless increasing and the authorities have found it more and more difficult to curtail them.  In this regard, the ATO proposes a number of amendments.

New Proposals

A range of proposals have been suggested.  The most significant of which is a provision that makes directors automatically personally liable for ALL outstanding taxes including GST and Superannuation guarantee that have not been remitted within three months of the due date.  The new proposal deletes the need for the tax office to formally serve the company’s directors with a Director Penalty Notice.

Insolvency Practitioners Association Australia (IPA) Submission

The IPA has generally welcomed the various suggestions put forward in the discussion paper, but have pointed out that the ATO has not effectively used the powers it has under Section 222 of the Australian Taxation Act.  Anecdotally, Liquidators have noticed that over a number of months a decline in the use of Director Penalty Notices and in this regard it is interesting to note in the discussion paper that one of the limitations of the Director Penalty Notice is that the ATO believes that the same are “highly resource intensive” and “means that director penalty notices are issued to only a small percentage of directors”.  This is an unsatisfactory position.  It will be impossible to thoroughly educate the business community of the impact of the changes and given the fact that many directors of ailing companies have much greater concerns in front of them than paying their taxes, it is important that such debts are raised in priority at least in the company directors’ minds.

Overall the biggest impact of companies being allowed to continue in business without paying the respective GST, group tax and superannuation guarantee levy as well as frequently workers compensation and payroll taxes is the unfair advantage it gives to these companies in the economy over the honest business operator.

2011 Budget Announcements

In the last Federal Budget, the Treasurer formally announced the implementation of specific provisions to be included in taxation legislation to address Phoenix Activity.

An exposure draft outlining the legislation together with an explanatory memorandum has now been issued and the government is currently seeking submissions.

The proposed provisions can be summarized as follows:-

1) The current DNP regime is to be expanded to include superannuation guarantee amounts

2) The 21 day grace period will no longer be available to directors if un reported debt exceeds 3 months and

3) No PAYG credits will be available to directors where the same as not being remitted to the Australia Taxation Office.

Jones Partners Submissions

Jones Partners has made submissions on these matters both directly to the Federal Government and theInstituteofChartered Accountants which in turn will be making submissions to the Federal Government.

In summary our position is that we generally support the amendments in relation to the superannuation guarantee and in relation to denying PAYG creditors to directors.

We have serious reservations in relation to the amendments concerning the 21 day grace period.

We believe that if the legislation is genuinely aimed at attacking “Fraudulent Phoenix Activity”, then the 21 day grace period should only be suppressed if the unreported debt exceeds 3 months and the director has had a history of involvement with failed companies.  Alternatively, we believe that the onus should be on the ATO to prove “Fraudulent Phoenix Activity”.

We have also raised issues concerning the length of time articulated by the legislation (that is 3 months) and submitted that this perhaps should be 6 months.  Overall, there is a concern that the business community will be uninformed about the changes and still see a need for formal notifications to be sent to company directors who have a potential exposure.

This last point is of great significance. The majority of business owners are somewhat oblivious to these sophisticated provisions and their consequences.  When Directors face business difficulties cash flow becomes a juggle.  Creditors are paid in priority as to the needs of the business and to the pressures placed on the business owners by the creditors themselves.  The ATO’s debt collection procedures historically have been somewhat passive and this is a major reason why such debts compound in businesses facing financial difficulty.