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TAXMAN HANGS TOUGH ON SMES

Newsletter

by Paul Gidley20.08.15

Market data out this quarter suggests the Commissioner of Taxation is maintaining the rage in collection activities against the SME sector; May’s 556 winding up applications has blown away the previous all time record of 361 applications filed in August 2013.

Below we discuss the possible rationale for this increase, the Commissioner’s recent treatment of SMEs facing winding up applications, how this activity may affect the broader business community and what to do if your clients find themselves as the recipient of a winding up application.

The increased volume of winding up applications suggests there is a relatively large amount of pent-up financial distress in the SME sector and is reflective of the Commissioner’s revised collection policies, which include commencing recovery proceedings at an earlier point in time and on smaller levels of debt.

Interestingly, we have noticed over the past few months that this increase in winding up applications has also culminated in an increase in the number of dismissals. In the fourth quarter of the 2015 financial year, a large number of winding up applications for which we were approached to consent to act as liquidator were dismissed by the Court, suggesting the Commissioner has been paid or has successfully negotiated a suitable payment arrangement to reduce the exposure. It will be interesting to see whether this increased trend of dismissals will continue.

So what could this mean for the broader business community?

In July this year the ABC reported that the ATO was owed more than $35 billion dollars. As advisers, it is worth considering what impact the Commissioner’s gung-ho receivable collection policy will have for the broader business community. It’s no secret that the Commissioner’s historically lax collection behaviour has benefited the private sector to some extent, in that suppliers were paid at the expense of the ATO. If the ATO continues its aggressive collection policy, we anticipate that those businesses that were not paying the taxman will attempt to shift the problem to their suppliers with poor receivables and credit policies.

The takeaway from this is to make sure your clients remain vigilant with debtor and credit policies, or they may end up shouldering what was once the taxman’s problem.

Received a winding up application? To VA or not to VA that is the question!

The increased tax collection activity prompts us to consider what a client should do if they are faced with a winding up application (either from the ATO or from any other creditor), particularly if they can’t pay the claim and the creditor will not negotiate informally.

As you may have experienced, when a winding up application becomes public, your client will be bombarded by unsolicited offers from director advocate firms and unknown insolvency practitioners offering a variety of solutions for your client’s financial woes, many of them too good to be true.

When this happens there are two options:

  1. Appoint a Voluntary Administrator (VA); or
  2. Let the winding up application proceed and allow the Court to place the company into Official Liquidation.

Obviously, from your perspective as the company’s trusted advisor, the major consideration will be “what is best for my client”. Therefore, you must also consider your client’s duties and obligations as set out in Part 2D.1 of Corporation’s Act 2001 (CA) which implies that directors and officers should put the best interest of various stakeholders before theirs, which would include creditors. In accordance with Section 435A of the CA, the objective of the VA process is to provide for the business, property and affairs of the insolvent company to be administered in a way that:

  • Maximise the chances of the company, or as much as possible of the business, continuing in existence; or
  • Results in a better return for the company creditors and members than would result from an immediate winding up.Upon first reading, s435A (a) is somewhat esoteric.

To share the knowledge behind s435A (a) we need to look at the expectations of the legislators when drafting this section. In summary it was the expectation of the legislators that the insolvent company could be returned to a solvent state. The objective of returning a company to a solvent state is to maintain market value and enable the company to pay its creditors in part or full.The VA process is not a means to an end in regards to the CA’s objectives. The VA must transition the company to one of three options determined by the Administrator to be the best for the creditors. These are:

  1.  Enter a Deed of Company Arrangement; or
  2. Bring the administration to an end; or
  3. Wind the company up.

Considering s435A (b) and option 3 in tandem, albeit one must attempt to define “better return”, s435A (b) to some extent pre-empts the possibility that the VA may result in the company being wound up.

Further, consideration must be given here as to what circumstances the appointment of an Administrator would result in a better return to creditors if the company enters liquidation following the VA, particularly when you take the additional costs of the VA process into account. It is difficult to find a good example to justify the appointment of an administrator as a means to enter liquidation.

In addition to the above, Section 436A of the CA requires that the Board of the company must have determined the company is, or may become insolvent.

Practical and commercial implications of appointing a VA

Having considered the statutory requirements and options available one must now consider the practical and commercial implications of appointing a Voluntary Administrator. Some of the broader considerations are: –

  1. How bad is it – there needs to a degree of positivity in the business when considering the business as a whole for example – reputation, longevity of business, market position, staffing, technology, relationships with mission critical stakeholders, cash position, quality of asset , competitive advantages, reasons for insolvency – if there’s nothing to work with its difficult to implement a turnaround.
  2. Affordability – the voluntary administration requires intensive involvement of the administrator and his or her staff. An inexpensive administration may run into tens of thousands of dollars. Often for micro/small companies with low exit costs they can achieve a better result for all stakeholders by utilising the liquidation process.
  3. Economic conditions – difficult economic times, particularly if they are industry specific make it very difficult for marginal businesses to survive at the best of times, let alone if they are subject to a Deed of company Arrangement.
  4. Structural change – if a business sector is undergoing structural change it can result in higher levels of corporate failure than the norm. Once again it’s the marginal businesses that suffer the most and prove extremely difficult to keep in existence.
  5. Company history – despite the financial aspects of proposing a DOCA, the vote will often come down to how much goodwill the company has with the creditors voting on the Deed.
  6. Owner’s capabilities – mum and dad micro/small business insolvencies often can be linked in some way to a lack of, or poor decision making by the owner managers. Genuine consideration needs to be put towards whether or not the owner manager has the commercial acumen to lead a business through a turnaround.


In conclusion

The takeaway from this article is that advisers must properly consider whether the VA process is the right insolvency tool for your client when faced with a winding up application. This is where experienced, independent and professional advice can assist.

If your client receives a winding up notice, we invite you to contact one of our principles to discuss the company’s circumstances to determine the best process for that company under the circumstances.