Too close to the fire? ATO continues focus on prevention of 'illegal phoenixing'

Quick summary of this article:?

The ATO has historically identified this as an increasingly problematic trend, costing taxpayers billions of dollars each year. In order to tackle this issue, the ATO continues to utilise recent measures, including increasing penalties for illegal phoenix activity; making it easier to prosecute those involved in illegal phoenixing; and improving information sharing between agencies. Business operators that are considering 'illegal phoenixing' should pause to take note of these measures, as those operators will face significant penalties if they choose to engage in this practice.

What is Illegal Phoenixing?

Illegal Phoenixing is the deliberate closure of a company in order to avoid paying its debts, before starting a new company, with largely the same name, assets and endeavour as the previous one, and continuing to trade without having to pay the old company's liabilities and without properly compensating the former entity for the value of the business (and assets) moved to the new entity.

ATO's new measures to prevent business owners from 'illegal phoenixing'

The ATO is now more able to fight illegal phoenixing and has made clear that accountants, pre-insolvency advisors, and other ‘facilitators’ are directly in the Commissioner’s sights.

ATO Assistant Commissioner Scott Parkinson went on the record in 'Accountants Daily', promising more access visits (search warrants conducted by the ATO) to target those who participate in company "re-birthing". He suggests that if the industry does not police itself, the ATO will take matters into its own hands.

By collaborating with other financial regulators and sharing information, the ATO is able to focus on "clusters of risk". Having previously executed search warrants in Queensland, and witnessing ASIC's success in convicting a business advisor who helped a director hide assets from a liquidator, it seems that the Gold Coast remains high on the ATO's list of priorities.

As part of this discussion, it is important to acknowledge that, as in any industry, some business advisory services are disreputable.? But what about when everyday accountants give their clients advice on how to set up their businesses, protect assets and manage risk? Could these professionals be held responsible if something went wrong?

While the motives of both sides play a part in who is at fault, good intentions cannot negate the actual risk.

The Corporations Act 2001 (Act) may make those who are 'involved' in a contravention of the Act, liable as an accessory for breaches of the duties company directors commit. The relevant section of the Act - section 79 - uses criminal law as a precedent to establish four preconditions for finding 'involvement' against a third party.

Despite the language in section 79 being quite broad (for example, see subsection (c)), Courts have nonetheless set a relatively high bar in order to attach advisors to the actions of their clients...

For instance, in the case of Yorke v Lucas, the High Court expressed that in order to be held liable, the 'involved' party must have had knowledge of essential elements of the contravention - even if they didn't know those matters amounted to a contravention. Although this type of knowledge is sometimes inferred (as seen in ASIC v Somerville), it is still required for liability.? This high bar should not be seen as a green light for advisors to participate in risky behaviour.??

Recently, the relatively recent provision within the Act known as a ‘creditor-defeating disposition’ was successfully tested. This has led many to wonder if asset protection advice may soon become obsolete.

The short answer is…yes.? Liquidators are now far more attentive to these transactions and, importantly, are equipped with a more relevant mechanism to address them.? Adding to the incentive, ASIC has announced that more funding will be available to liquidators in assetless administrations - particularly those in which evidence of creditor-defeating dispositions is apparent.

So, how might these measures affect the average accountant's ability to help clients with asset protection, especially when said client may be struggling with solvency concerns?

The law seems to require that advisors must make some basic inquiry into a company's circumstances before taking part in any transactions that could be considered questionable.? We believe that this necessarily must include understanding the Company’s solvency.

Thus, an early and proper evaluation of solvency is crucial. This, in turn, requires an understanding of the objective signs likely to demonstrate insolvency.

After the solvency assessment, different options arise based on the strength of the company’s position. If the company is insolvent, typically some thought is given to whether the transaction is at arm's length, if it's part of usual business arrangements, and if an objective third party would agree that the transaction could withstand future scrutiny. Obtaining independent legal advice and producing legally binding documentation are common methods of ensuring, as far as is possible, that transactions might be able to withstand the interrogation of a liquidator or ASIC.? However, the robustness of those arrangements will always rest on the quality and depth of that advice.? Just because a lawyers says it’s so doesn’t mean it is…

If a company is facing insolvency, caution must be exercised. Liquidators have access to multiple legislative tools that allow them to ‘reach back’ into a company’s history in order to retrieve assets and reverse transactions for the creditors' benefit. As shown in the above-mentioned case of Somerville, depending on the circumstances surrounding an advisor's alleged involvement, the actual effect of a transaction may contradict any defence against how much knowledge was actually held at the time.

The policy intent, set out by both ASIC and the ATO, is to prevent directors from disposing of assets that could be used to pay creditors (primarily employee entitlements). As the most common creditor in SME corporate insolvencies, the ATO has a clear interest in the outcome, as should we all.

However, we can only establish proper regulation when all the players are transparent. The recent rise in unscrupulous pre-insolvency advisors who would assist the act of illegal phoenixing, either through illegal schemes or willful blindness, is not acceptable, and we support any reforms to the insolvency industry that will provide stricter governance and regulation.

No doubt, there will be some practitioners who make honest mistakes.? However, the goal of regulation is to protect those that follow the expected standards and to get rid of those who do not.

We anticipate that this will be a live issue for some time, and more advisors will be called to account for their conduct in the coming months and years. We hope, along with the regulators, that increased surveillance and enforcement will bring about change.

Beacon Advisory can assist you with understanding your obligations and mitigating risks. Book a call with us today to find out more about this critical business information.

Disclaimer:

This article is not intended to provide professional advice, but rather general information only. You cannot rely on the content of this article without proper advice in the context of your own circumstances. If you have specific concerns, please consult a professional who can provide advice tailored to your individual circumstances.