Anti-phoenixing reforms to corporate law, tax law and insolvency now open for consultation

New offences in the Corporations Act, a cab rank system for liquidators, and changes to tax laws have been put forward by the Australian Government in its consultation package of anti-phoenixing reforms released yesterday. Consultation closes on 27 October 2017.

When the Government flagged this reform package, it stated that illegal phoenix activity costs the economy up to $3.2 billion per year. Phoenix activity affects creditors, employees, competing businesses and taxpayers as it is orchestrated to leave behind an empty shell, ultimately leading to the likely liquidation of the entity with limited returns (if any) to creditors and forcing employees to look to the Commonwealth-funded Fair Entitlements Guarantee scheme to recover their entitlements.

At that time, it also said it would look at Director Identification Numbers; while this reform is not put forward in this package, the Government says it is engaging with key stakeholders on it.

Better identifying phoenix behaviour

The Government is proposing a mechanism for identifying and targeting the most egregious phoenix operators who have adopted phoenixing as a business model, using common phoenix behaviour.

First, an entity would be designated as a “Higher Risk Entity” (HRE). This by itself would have no automatic or material impact on the activities of the individual or their associated entities, as the activities which could trigger the designation are not limited to phoenixing and could include honest business failure. These triggers include:

• disqualification from managing a company; or
• being an officer of two companies which have entered liquidation in the previous seven years, and there has been a failure to provide adequate books and records to an insolvency practitioner, or an insolvency practitioner has lodged a report under section 533(1) of the Corporations Act.

The second stage is a declaration that the HRE is a “High Risk Phoenix Operator” (HRPO) by the Commissioner of Taxation.

The Government says that "the Phoenix Taskforce has developed a robust distribution mechanism to allow for information from the members of the Taskforce to be collated and shared". To get more information, however, it's also proposing a phoenix hotline be established so that suspected phoenix activity could be reported.

New phoenixing offences and remedies

A phoenixing offence has been proposed, under which the Corporations Act 2001 would be amended to create a specific prohibition on "the transfer of property from Company A to Company B if the main purpose of the transfer was to prevent, hinder or delay the process of that property becoming available for division among the first company’s creditors." There would be an initial notice from ASIC asking for that property or money's worth to be delivered up.

Remedies could include civil and criminal penalties, compensation orders and clawback.

In addition, the paper proposes making certain activities associated with phoenixing, such as the failure to maintain adequate books and records, or failure to provide them to an insolvency practitioner in a formal insolvency, also be offences (and a breach could then result in a director of a company being deemed an HRE).

Proposed changes to corporate governance

Backdating a director's appointment or resignation is a frequent element in phoenixing activity. The paper proposes amending the Corporations Act to impose a rebuttable presumption that where a change in director notice is lodged more than 28 days after the date of the director’s resignation, the director could still be held liable for misconduct that had occurred up to the point of lodgement.

Related to this is the abandonment by a sole director (or a group) of the company. To counter this, the paper proposes limiting a sole director's ability to resign from office without either first finding a replacement director or winding up the company’s affairs (similar rules would affect the near-simultaneous mass resignation of directors).

The third key proposal relates to directors' liability for tax. Currently, where a company has not met certain tax obligations, the ATO can issue a Director Penalty Notice (DPN) and make the company’s directors personally liable to pay the ATO a penalty equivalent to the unpaid tax liability. The directors then have 21 days to take action. The paper proposes removing the waiting period for directors identified as HRPOs.

Separately, the paper proposes extending the DPN regime to GST liabilities (it currently only applies to PAYW and SGC).

Proposed changes to insolvency

The central proposal here is to create a cab rank system to give a director access to an independent registered liquidator who can provide advice on the options available to the director to deal with the company's financial position.

This could either be through

• applying the cab rank rule only to a company where an officer of the company is, or was during a prescribed period prior to the appointment of an external administrator, an HRPO; or
• establishing a "government liquidator" to conduct a streamlined external administration of small-to-medium size enterprises with the option to appoint a private registered liquidator if circumstances warranted it.

In addition, the Government proposes minimising the risk that related creditors, with or without the assistance of the external administrator, can frustrate unrelated creditors by requiring the external administrator to disregard "related creditor" votes on a resolution to remove and replace an external administrator.

Proposed changes to tax laws

Under the security deposit power, the ATO can require a bond or other security from a business for existing or future tax liabilities that are at high risk of not being paid. It cannot however get this from a third party. The paper proposes strengthening the effectiveness of this power to target illegal phoenixing. It would do this by allowing the ATO to use the garnishee power to garnishee an amount from a third party to cover, in full or part, the amount of requested security.

The paper also proposes extending the promoter penalty laws to apply to promoters or facilitators of illegal phoenix activity. This could be done by:

• widening the definition of "tax exploitation scheme"; or
• adding a specific phoenixing limb to the test; or
• creating a new provision.

Finally, the paper proposes giving the ATO the power to retain refunds if:

• a person has been designated as an HRPO; and
• the HRPO has an overdue lodgement or notification capable of affecting a tax liability.