Government Crackdown on Businesses Rising from the Ashes
The Government has recently released further detail in relation to action to crackdown on illegal phoenixing activity.
Phoenixing activity occurs where a business owner allows a business to fail owing money (particularly to the Australian Tax Office – ‘ATO’) and then immediately restarts the same business in a new entity. It may also involve using ‘straw man’ directors of the failing companies to shield the real business owners from liabilities.
The government has proposed a package of reforms including:
- the introduction of a Director Identification Number (DIN);
- implementing a specific phoenix hotline for reporting of suspected phoenix activity;
- creating a phoenixing offence;
- not allowing sole directors to resign and not allowing directors to backdate their resignations;
- extending penalties to promoters and advisers who assist in the implementation of phoenix activities;
- removing the current 21 day waiting period before the ATO can enforce a director penalty notice which makes directors liable for unpaid Pay-as-you-go (PAYG) withholding tax and superannuation guarantee obligations;
- making directors liable for unpaid GST liabilities of companies under the director penalty notice provisions; and
- strengthening the rules requiring entities perceived to be at high risk of phoenixing to provide security deposits to the ATO.
In our view, the introduction of the DIN, if done well, should be supported. Identity crime is a rising issue and anything that the regulators can do to seamlessly prevent such crime is to be encouraged. Of course, this will require that the security of the DIN system is first rate otherwise it runs the risk of identity fraud itself. The provision preventing directors from resigning where that will leave no directors for an entity, may lead to a ‘last director standing’ rush in situations where a company is showing signs of failure. That is, compared to the current law, directors may be more likely to want to resign earlier because, if they happen to be the last director, they will not be able to resign. This also has implications where the directors of a company fall out with the shareholders and the board is spilled.
One of the more controversial proposals will be the extension of the director penalty notice regime to GST liabilities. This regime has historically been used to ensure payment of ‘other people’s money’ – such as PAYG withholding and superannuation guarantee. This is a defendable reason to pierce the corporate veil and make directors personally liable.
Extending that personal liability to other tax liabilities of the entity even where there is no evidence of phoenix activity is a large step because:
- It militates against ordinary businesses and directors having a ‘licence to fail’ – which the government itself acknowledges is important in encouraging entrepreneurship and innovation.
- It makes the government more likely to collect money out of an insolvency than ordinary creditors and, in some cases, employees.
The removal of the current 21 day waiting period for enforcement of director penalty notices is proposed to only apply to directors who are considered at high risk of being a phoenix operator. As such, this draconian provision is unlikely to affect the vast majority of law abiding directors and companies.
The ATO already has the power to require security deposits where it considers that an entity is at high risk of not meeting its tax liabilities. However, the enforcement of these security deposits was difficult for the ATO and not always successful. The proposed changes will make t considerably easier for the ATO to ensure that taxpayers perceived to be at risk of not meeting their obligations are made to put real money on the line.
It will be important to ensure that the proposed rules, when enacted, strike the right balance between penalising criminal behaviour and not stifling entrepreneurship. Excessively broad provisions that unfairly target directors of entities that fail in the ordinary course of operations, without any hint of phoenixing, is not a recipe for encouraging entrepreneurial behaviour.
Further, some of the proposals risk reinstating a right for the ATO to rank ahead of other creditors where phoenixing occurs. Where the other creditors are related to the real business owner, this is unobjectionable. However, where the other creditors are innocent third parties, any such preference in creditor ranking runs the risk of making the business community less likely to trade with one another. That cannot be considered a desirable outcome.
The proposals are open for consultation until 27 October 2017. If you are interested in contributing ideas to a submission, or would like to discuss the proposed amendments further, please do not hesitate to get in touch.
Mark Molesworth is a Tax Partner with BDO in Brisbane. His legal and accounting training provides the basis for a comprehensive understanding of taxation laws. He is a key author of BDO’s analysis of the Federal Budget and a regular commentator on a range of tax issues. BDO offers a wide range of business and corporate advisory services to large corporate organisations, Government & Public Sector entities, private businesses, entrepreneurs, and individual clients across a wide range of industry sectors.
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