Decoding the Illegal Phoenix: Part 1
What is the definition of phoenix activity?
Unfortunately, there is no one agreed upon definition of phoenix activity.
- The ATO defines it as when a new company is created to continue the business of the old company that has been deliberately liquidated to avoid paying its debts.
- ASIC defines it as when company directors transfer the assets of the old company to a new company without paying market value and leaving the debts with the old company which is then placed into liquidation. When a liquidator is then appointed, there are no assets remaining to recover and creditors cannot be paid.
Illegal phoenix activity has far reaching economic impact to business in unpaid trade creditors, to employees for unpaid entitlements and to government in unpaid taxes.
A 2018 report prepared by PwC for the Phoenix Taskforce estimated the direct costs to the Australian economy resulting from illegal phoenix activities to be between $2.85 – $5.13 billion per year.
Not all phoenix activity is illegal according to the Phoenix Research Team who have categorised phoenix activity into five categories:
- Legal phoenix: also known as ‘business rescue’, where directors have no intention to defraud creditors, and saving the business (but not the company) is the best course of action for all stakeholders.
- Problematic phoenix: technically legal, where there is no evidence of directors intending to defraud creditors, but the net effect of the phoenixing is not beneficial to creditors. This may involve an ill equipped director who has had past business failures.
- Illegal type 1: where an improper intention to transfer assets and defraud creditors is formed at or immediately before the time of business failure.
- Illegal type 2: phoenix as a business model, where the company is set up to deliberately engage in personally profitable phoenix activity (i.e. the business was never operated so as to succeed).
- Complex illegal: in addition to illegal type 2, this model also coincides with more serious crimes such as creating false invoices (e.g. GST fraud), false identities, fictitious transactions, money laundering, visa breaches, and misusing migrant labour.
With these different categories, the question then becomes which phoenix activity is illegal and what is being done to combat this practice?
The Government is attempting to eradicate phoenix activity and the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 was passed by both houses of Parliament on 5 February 2020. This Bill implements four key measures to combat illegal phoenix activity:
- introducing new phoenix offences;
- ensuring that directors are held accountable for misconduct
- introducing changes to the Director Penalty Notice regime; and
- authorising the ATO to retain tax refunds where a taxpayer has failed to lodge a return.
These measures will be discussed in further detail in a later post.