Given the fine line between ‘illegal phoenixing behaviour’ and legitimate restructuring activities, the jury’s out on whether planned reforms can deliver the right outcomes.
Attempts to differentiate so-called ‘illegal phoenixing’ – the stripping and transfer of assets from one company to another to avoid paying liabilities – from honest business rescue, saw the Turnbull-led coalition government announce proposed legislative reforms early-September 2017.
Government reforms attempt to crack down on both the more endemic and more sophisticated forms of illegal phoenixing behaviours alike.
For starters, the four widespread illegal phoenixing behaviours include,
- lodgment of Business Activity Statements after the company becomes insolvent to obtain a refund of GST input credits,
- non-payment or manipulation of employee entitlements including Superannuation Guarantee payments,
- non-payment of certain unsecured creditors, and
- under declaration of staff numbers to state regulators in order to minimise costs associated with payroll tax and workers’ compensation.
Proposed reforms also have more complex phoenixing practices in their sights. These include controlling directors who exploit the privilege of limited liability by denying its creditors’ access to the company’s assets to meet unpaid debts.
Then there are more sophisticated phoenix operators who set up complex corporate structures in order to place assets in certain entities, while transferring liabilities into subsidiaries, which can be subsequently placed into liquidation.
What’s in store?
The over-arching objective of the reform package is to make “phoenixing”, an offence in its own right, while targeting both those who engage in the behaviour and those who encourage or facilitate it.
Firstly, the reform seeks to tackle the low-hanging fruit by amending the Corporations Act 2001 to prohibit the transfer of property from one company to another if the sole purpose of that transfer was to “prevent, hinder or delay” that property becoming available for division among the first company’s creditors.
Such an offence would effectively empower creditors, liquidators, and the regulator alike to sue for compensation for the loss caused by the conduct.
Is the net too wide?
However, sufficient effort needs to be made to ensure legitimate advisors, carrying out honest business rescue or restructuring activities, aren’t caught in any expansion of the penalty for promoters who facilitate such outcomes. While the government has proposed a defense be made available to advisors in circumstances where advice is provided for legitimate purposes, there are guiding metrics on what constitutes legitimate purposes.
Personal liability for directors
New reforms also prevent directors from claiming GST input tax credits for their costs and expenses, collecting GST from customers and then liquidating the company – without reporting the liability to the ATO – thereby pocketing the GST collected. Those who do can end up personally liable to the equivalent amount of GST to the ATO.
Proposed reforms to implement a cab-rank system in relation to the appointment of liquidators, will make insolvency practitioners sit up and take note. In response to the current referral model, which inadvertently allows dishonest liquidators to facilitate illegal phoenix activity, proposed reforms will, in certain circumstances, see the usual referral system replaced with a system of liquidators being appointed from a panel.
Watch the consultation process closely
With illegal phoenixing activity estimated to cost the economy around $3.2 billion annually, tougher penalties should be welcomed by all. But given that the range of additional measures, to both deter and penalise phoenixing activity, has been received by the insolvency industry with mixed blessings, the consultation process should be watched closely, especially in relation to both safe harbour provisions and recent innovation agenda reforms.
At Shaw Gidley we have over 70 years combined experience in all facets of personal and corporate insolvency.
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