As recently reported by Vincents….
Phoenix activity has been on the rise in companies facing financial difficulty and is often prescribed by pre-insolvency advisors as a scheme to evade creditors. It can best be described as the evasion of tax and other liabilities, such as employee entitlements, through the deliberate, systematic and sometimes cyclic liquidation of related corporate trading entities.
In the first of this two-part series, we will explore the illegalities associated with phoenix activity in some more detail.
This process of stripping an ailing company of its assets in an attempt to defeat creditors is a significant problem which impacts stakeholders to the tune of $1.78 billion to $3.19 billion per year.
Misuse of the company structure is not always illegal and, in some cases, may save a business from its downfall. However in many cases it involves a fraudulent scheme involving breaches of Directors’ duties and potentially criminal offences. The end result is that employees lose their entitlements, businesses won’t have their goods and services they’ve paid for, suppliers left with outstanding debts and government revenue impacted by phoenix companies not paying tax debts.
The typical illegal phoenix activity as seen by many insolvency practitioners involves a company entering into an asset/business sale agreement with a related company without paying fair or market value leaving the debts with the existing company and allowing the new company to trade debt free and without interruption. After the assets are transferred the director usually places the existing company in liquidation leaving no assets to pay creditors.
The sale of business may occur more than once between a number of companies, and Directors are protected by the limited liability of the company. The likely eventuality is that the phoenix will fall over again as, notwithstanding the business is owned by a new entity, the management and trading is typically unchanged and operated by the same Directors in the same industry.
In an effort to further combat illegal phoenix activities the Treasurer, in the new Budget 2018/19 handed down on 8 May 2018, outlined tough anti-phoenixing plans to stop small businesses from getting “ripped off” by other businesses that deliberately enter into liquidation to avoid paying their bills.
A two (2) pronged approach has been enlisted to crackdown on illegal phoenix activity which involves making the following changes to the corporations and taxation laws:
- implement new phoenix offences to target operators who conduct or facilitate the practice;
- prevent Directors from improperly backdating resignations to escape liability or prosecution;
- limit a Director’s ability to resign if this would leave a company directorless;
- restrict the ability of related creditors to vote on appointing, removing or replacing an external administrator;
- extending the Director penalty regime to GST, luxury car tax and wine equalisation tax which would make Directors personally liable for company taxes. The Director penalty regime currently only makes Directors personally responsible for PAYG and superannuation guarantee charge which only impacts companies with employees, by extending this regime many more companies and Directors will be effected; and
- expanding the ATO’s power to retain and offset refunds where there are outstanding tax lodgements.
The new initiatives will undoubtedly put more pressure on Directors to take a keener interest on their company’s GST compliance to ensure the taxes are correctly accounted for and paid.
The effects of phoenixing activity in the economy are wide-reaching an ultimately impacts all Australian taxpayers when operators deliberately misuse the corporate form. It will be interesting to observe whether the new changes will achieve the Government’s overall intention to discourage illegal phoenix activity to protect SMEs, encourage risk taking by honest entrepreneurs and promote a business rescue culture and to place a greater compliance burden on directors by putting the ATO in a stronger position.