Why is risk-taking and entrepreneurship important to the Australian economy?


Risk is essential to the business environment. Entrepreneurship relies on creativity and imagination but with every new endeavour comes risk. The usual paradigm is that there is a direct relationship between the level of risk and return or profit attributed to that activity.

The Jones Partners’ economic research project into small to medium business (SME) Insolvencies in the Australian economy looked at the impact of risk and risk-taking on entrepreneurship. The attached video excerpt tries to answer the question -why is risk-taking and entrepreneurship important to the Australian economy? And provides an interesting narrative commentary on this issue

Most new ventures carry with them an elevated level of risk. Furthermore it is the small to medium (SME) sector that carries most of the risk burden within the Australian economic environment. It is therefore no surprise that this sector necessarily has the highest levels of insolvencies. Company Liquidations and Administrations including Voluntary Administrations and Deeds of Company Arrangement are disproportionately represented in small to medium (SME) sector. This however should not be necessarily be seen in a negative light

If we accept the value of entrepreneurship and risk-taking to the Australian economy then we must accept the consequences in terms of potential business failure.

At the present time however there appears to be a much greater cloud on the horizon. Recent observations indicate that Australian small to medium (SME) sector business leaders are becoming increasingly risk averse. Moreover it is becoming apparent that consumers themselves are becoming more cautious. In relation to consumers in particular we are observing and increased conservatism in the use of consumer credit as a consequence (having regard to the fact the Personal Bankruptcies have a direct relationship to the volume of consumer credit) Bankruptcies are for the first time in a decade levelling off and there is some indication that they may be in decline. This is not as a result of a more favourable Australian economic environment but rather the reluctance of consumers to borrow money.

In relation to the business investment there is a similar level of conservatism. Banks are reporting difficulties in finding suitable prospects and there has even been some recent evidence that in relation to the public company sector corporations are adopting a more generous dividend policy and in some cases even returning significant amounts of capital to shareholders. In short the corporate sector is saying to investors “we can’t find enough investment opportunity to use your money”

Jones partners have embarked on an economic research project that will see an annual report on the state of the Australian economy with respect to the level of insolvencies. The initial report was launched in July 2014 and made a number of key observations in relation in particular to the small business sector of the market

One relevant, if not obvious, observation is that the level of insolvencies does have an inverse relationship to Australian economic activity however there appears to be an important complicating factor. The number of SME insolvencies also has a direct relationship to the overall number of small to medium (SME) sector businesses that exist in the economy. When the economic mood is one of caution and when investors are reluctant to take risks economic activity will slow. There will be fewer new ventures. As a consequence it is possible to observe a reduction in the SME insolvency numbers whilst at the same time economic activity is subdued

These Australian economic indicators are being further research is part of the Jones Partners Economic research project which is aimed at enlightening the professions and business leaders on the impact of insolvencies have on the broader economic environment.

Jones Partners is keenly interested in investigating these issues .Jones partners specialises in providing professional advice and practical solutions. We can advise on a range of solutions that assists companies in difficulty Including Voluntary Administration, Receivership and various forms of Liquidation. In relation to personal insolvencies Jones partners has 4 registered Bankruptcy Trustees who are extremely active in assisting individuals resolve their personal financial difficulties using various parts of the Bankruptcy Act including Part 10 (Personal Insolvency Agreements) and Annulments pursuant to section 73 Of the Bankruptcy Act.

The effect of the environmental movement on Insolvencies in Australia


There are three major contributors to Australian insolvency statistics

Obviously the overall health of the Australian Economy is important and this was clearly demonstrated in the Jones Partners Report on Insolvencies in the Australian Economy launched in July 2014. In that report it was clearly demonstrated that there is an inverse relationship between the level of GDP and the number of Insolvencies. This was more pronounced with respect to Company Liquidations, Voluntary Administrations and Receiverships than with Personal Bankruptcies.

It’s important however to realise that the management of individual businesses is more important. In fact the major reason for Australian company failures as articulated in a report by the ASIC is lack of strategic management. In fact of the top 4 reasons for Australian companies going into Liquidation, Administration or Receivership – the state of the economy does not even appear.

The third major contributor to the level of insolvencies in Australia relates to structural changes within the Australian economy itself

Advancing technology is a good example of these structural changes and wherever structural changes do occur there will be winners and losers. Think of what happened to the businesses that made buggy whips when the horse and cart was replaced by the automobile.

At present one of the major structural changes happening within the Australian economy and indeed the World is the impact of the environmental movement. The attached video excerpt on the effect of the environmental movement on insolvencies in Australia provides an interesting narrative on this topic.

Specifically there is some uncertainty about the future of energy. There is robust debate about climate change and in Australia previous governments with a more leftist leaning have been more inclined to provide subsidies for Australian industries developing alternative forms of energy. At present policy seems to have shifted away from subsidising any form of inefficient industry. A good example of this is the impending closure of the car industry. Those industries such as solar and wind generation that have relied heavily on government subsidies are also clearly at risk.

Not with standing foregoing and whether or not Australia has a Carbon Tax or some form of Emissions Trading Scheme it is clear that in the medium to longer term energy prices will continue to rise. Accordingly Australian companies that are high energy users must seek efficiencies or they too will be at risk. It is therefore likely that company insolvencies in Australia including Liquidations, Administrations and Receiverships will have a much greater representation statistically from industries that are not able to adapt to this changing energy environment.

Irrespective of government policies Australia and the World are becoming far more respectful of the environment .It is also evident that things like energy efficiency is much greater driver for business changes than any form of government policy. This is an example of how free market forces can and will have a positive effect on the environment.

One example of this relates to light globe technology. New LED lighting provides light globes that last for several thousand hours as opposed to the old incandescent technology which last less than 100 hours. In addition the energy usage of the new technology is a fraction of the old .Clearly any company retailing or wholesaling old technology will find it difficult to survive and Australian businesses that don’t move relatively quickly to reduce their energy usage by adopting this kind of technology will be at a major disadvantage.

Australian companies not able to address these structural changes are at risk of closing altogether. Whilst it is difficult to implement a turnaround program using Voluntary Administration or any other procedures for that matter if the underlying business model is not addressed , if the underlying business model is sound then turnaround is a viable option notwithstanding the level of debt or the extent or previous losses.

Jones Partners is expert at investigating these issues and providing professional advice and practical solutions. We can advise on a range of solutions that assists companies in difficulty Including Voluntary Administration, Receivership and various forms of Liquidation. In relation to personal insolvencies Jones partners has 4 registered Bankruptcy Trustees who are extremely active in assisting individuals resolve their personal financial difficulties using various parts of the Bankruptcy Act including Part 10 (Personal Insolvency Agreements) and Annulments pursuant to section 73 Of the Bankruptcy Act.

Is Small Medium Enterprises — the heartland of the Australian economy?


It is clear that SMEs are the back bone of the Australian economy and at a recent function launching the Jones Partners Report into insolvency administrations in Australia Craig James, chief economist of the Commonwealth Bank said that 97% of Australian businesses employ less than 20 employees. It is therefore not surprising that over 80% of companies that fail are in this category. The businesses that dominate the corporate failure statistics roughly parallel the businesses in the SME sector and are very highly represented amongst construction, retail and professional services.

The Jones Partners Report looked in some detail at the effect on the Australian economy of the failure of companies in the Australian SME space. The report demonstrates the remarkable fact that this sector contributes substantially more to unemployment than the failure in relation to large companies which often gets much more media attention. The attached video excerpt on the significance of small medium enterprises (SMEs) provides an interesting narrative on the role they play both in respect to the Australian economy and corporate and personal insolvencies.

In the SME sector it is impossible to separate the ownership of the business from the management. Having regard to the fact that we now know that management failure is the major cause of company liquidations it is clear that these issues need to be addressed before any effective turn around program can be implemented.—Turnaround is nevertheless still achievable—

One method used in the turnaround management of companies is the Voluntary Administration process found in part 5.3 A of the Corporations Act

This process usually involves creditors accepting a compromise in relation to the outstanding debt potentially including extended payment terms

Voluntary Administrations are a formal process involving the appointment of an Administrator who prepares a report to creditors and convenes meetings the purpose of discussing the future of the company

Creditors then vote on whether or not to accept the proposal and this vote is based on numbers and value so clearly not all creditors are required to agree for the proposal to be binding

The procedure is very effective in the Australian SME sector but it does require a clear and accurate identification of the underlying problem together with a credible argument that the problem has been rectified or that the very least there is a convincing plan to achieve that end

If this cannot be done liquidation may be the only alternative

This of course does not always mean that the business is closed. It is possible in some situations of the business to be sold as a going concern to new owners. This preserves the goodwill of the business and can have the effect of saving jobs

Jones partners handle many turnaround assignments particularly using the voluntary administration process. Jones Partners is expert at investigating these issues and providing professional advice and practical solutions. We can advise on a range of solutions that assists companies in difficulty Including Voluntary Administration, Receivership and various forms of Liquidation. In relation to personal insolvencies Jones partners has 4 registered Bankruptcy Trustees who are extremely active in assisting individuals resolve their personal financial difficulties using various parts of the Bankruptcy Act including Part 10 (Personal Insolvency Agreements) and Annulments pursuant to section 73 Of the Bankruptcy Act.

How does the Asian economic boom affect Australian insolvencies?


There is no doubt that the global economy is going through enormous structural change as the weight of global economic activity increasingly shifts towards Asia. The above diagram demonstrates that in 2012 the Asia-Pacific region together with the Indian subcontinent accounts for in excess of 36% of world GDP. Australia has benefited greatly from this structural change. Three quarters of Australia’s exports are to Asia. We have a similar dependence on Asia with respect to tourism and immigration.

Australia has just emerged from the largest resources boom in its history and this is largely as a result of the economic development of mainland China. Moreover the structural change seems to be permanent which means that Australia is in an excellent position for the foreseeable future.

In June 2013, Jones Partners commenced a major research project into the state of the Australian economy, businesses at risk and insolvencies. At a function announcing the launch of this project, Mr Phil Ruthven, Chairman of Ibis World spoke in glowing terms about the opportunities afforded to Australia by the Asian economic boom. See the video excerpt taken from the presentation to see what Phil had to say on the subject.

However there are risks that cannot be ignored. There is currently a rebalancing taking place as the mining investment phase draws to an end and it is unclear as to whether the domestic economy will pick up quickly enough to counter this investment turn down. The Jones Partners research project has culminated in a report entitled “Collapse Restructure and Renewal-The State of the Australian Insolvency Market” which will be released at a function to be held at The Institute of Chartered Accountants on 29 July 2014. The author of the report, economist Mr Chris Nadarajah will join an eminent panel including Ibis World this chairman Mr Phil Ruthven and the Commonwealth bank’s chief economist Mr Craig James to discuss the report.

It is also important to note that this economic boom does not make Australian businesses immune from failure. The increased pace of the Australian economy as a result of this boom clearly leads to many more opportunities and perhaps greater entrepreneurship (which means risk-taking) and on its own this could increase rather than decrease the number of insolvencies. This is because it has been clearly demonstrated that insolvencies are more dependent on the quality of management than the state of the economy. Of course this does not mean that the state of the economy is not a major contributor to insolvency levels. Our research shows that the level of economic activity has a close correlation with the numbers of insolvencies.

The major macroeconomic contributor to insolvency levels is economic structural change which is clearly what is happening in the Australian economy as a result of the boom in Asia. We have already seen most of Australia’s manufacturing go offshore and we are now seeing external pressures on many other industries that would otherwise seem to be immune. Accountancy services for example are now being increasingly outsourced to places like India.

Overall Australia will clearly reap immense benefits from the growth in Asia however there are both downside an upside risks. The changes taking place in the Australian economy will clearly have an adverse effect on some industries and this will have a consequential increase in the number of insolvencies in those areas.

Other related articles:

Rates of Currency Exchange – Impact on Australian Businesses

Is Management the key driver of business success or failure?

About Author:

In Australia is the economy as robust as some economists would have us think?

Whilst interest rates in Australia are at historic lows and we remain in relatively good financial shape when compared to other Western Economies, what lies beneath needs to be understood.
During the calendar years 2010, 2011 and 2012 we have seen corporate insolvency levels across Australia increase on average at almost 4.5% per annum. Further, many SMEs are also reported continued periods of reduced or static profits.

Interestingly, household debt levels also remain at near historical highs, despite some media commentary to the contrary. Will this lead to an increase in personal insolvencies in  Australia? In Western Sydney, for example,  Bankruptcy and other forms of personal insolvency including Part IX arrangements are at a record.

Many family owned businesses are finding their bankers increasingly  difficult to  deal  with .Some  business  owners have reported that they  have  been asked  to  find  another bank despite having a long term and  successful relationship  with their  existing financial  institution. Is  this  really  the banks concern regarding the financial  health of these  businesses or simply an example of the banks focus on their own credit  rating?

It is clear that  some  industries are facing particular challenges in the current  environment .Accordingly at Jones Partners, we are commissioning a definitive report on the state of the Australian  Economy  from an insolvency perspective.The report will be the first of its kind and seek to set a new narrative amongst lenders and professional advisers and the business community generally in relation to insolvency trends and the economic outlook.

This report  will address;

  • Historical personal and corporate insolvency trends
  • Reasons  for major  company  liquidations, receiverships, and voluntary  administrations
  • Trends  in Bankruptcies and Personal Insolvency  Agreements
  • Industries  at risk

We  are delighted  to  be be associated with  IBISWorld, who will be looking at these issues and other issues surrounding various insolvency trends in Australia and overseas.This project will  be launched at an exciting presentation by  Phil Ruthven Chairman and founder of  Ibis World at  an exclusive event hosted  by  Jones Partners on the 3 July, 2013.The function  is  already fully  booked however a video  excerpt will be available via  download in  due course

Phil Ruthven says that the risks associated with company failures can be attributed as to ⅔  management issues relating to the company itself and only ⅓ to the industry.  Phil says that a bad company in a bad industry is sure to fail whilst a well-run company even in a tough industry has every chance of succeeding and possibly increasing market share.  The presentation will look specifically at what it takes for companies to be successful in tough times and look at those industries under particular threat having a regard to the current micro and macro-economic trends facing Australia.  there will also  be a  focus on the current uncertainties surrounding the political scene and the impact it is having on small and medium businesses.

I am looking forward to releasing the outcome of the project and I invite interested parties to contact me or make  comments below

In addition I have created a LinkedIn discussion group called “Business At Risk”   to encourage engagement in the project

 

Superannuation a useful way to protect personal assets of individuals

Asset ProtectionIt is true that superannuation funds are ordinarily protected property in the event that an individual becomes bankrupt.  There is however and exception to this general principle where a superannuation contribution has been made to defeat the creditors.  In particular Section 128 B of the Bankruptcy Act makes specific provision in relation to transfers of property to a super fund where it can be inferred from all of the circumstances that at the time of the transfer, the transferor was or was about to become insolvent.  The kinds of transactions envisaged by these provisions relate to unusually large and irregular payments that are outside of the normal scope of the individual’s contribution to superannuation.
Unfortunately there are no cases decided on what this constitutes.

One problem that does occur is that if an individual becomes bankrupt after receiving a lump sum distribution from a superannuation fund.  The protection afforded by Section 116 no longer applies as the funds received are simply divisible property within the meaning of the Bankruptcy Act.  In these circumstances a debtor would be wise to delay receiving superannuation money until after the date of the bankruptcy.

Another problem occurs in relation to self-managed superannuation funds.  Pursuant to the superannuation legislation, an individual who is a beneficiary under a self-managed super fund must be a trustee of the fund, either individually or as a director of a trustee company.  Unfortunately the legislation prevents a person who is a bankrupt from being a trustee under of a self-managed superannuation fund and the Corporations Act, prevents an individual from being a director of a company if that individual is bankrupt.  This means that whilst the intention of the Bankruptcy Act is to protect superannuation from creditors, in the case of a self-managed super fund there are practical difficulties.  One solution for an individual in these circumstances is to roll their superannuation into a retail fund.  Whilst this is not an ideal solution, particularly in that the individual, during the course of the bankruptcy loses control over the investment strategy in relation to the super fund, it does not of itself erode the protected nature of the superannuation, afforded by the Bankruptcy Act in relation to superannuation.

Finally, if the bankrupt receives their superannuation benefits by way of an annuity or pension, that will be taken into account by the trustee in calculating the bankrupt’s income for the purpose of the Compulsory Income Contribution Scheme.  Therefore an individual facing bankruptcy is much better to receive a lump sum from his or her superannuation fund rather than an annuity.

 

 

Asset Protection for Directors and Business Owners


Antecedent transactions

Business owners are often anxious about what might happen to their private assets should their business runs into difficulties and ultimately fail.

Many individuals contemplate transferring private property into some form of entity separate from the individual (such as a company or a trust), or transferring the property to a close relative or friend in the hope that if something untoward happened to them creditors would not be able to access the property.

Unfortunately the Australian Bankruptcy Act anticipates this kind of conduct and in certain circumstances affords provisions for a subsequent Bankruptcy Trustee to reverse the effect of a transfer.

In particular, two sections are relevant.  Section 120 of the Bankruptcy Act deals with transfers of property for undervalue or for no value at all.  Section 121 deals specifically with transfers of property with the intention of defeating creditors.

Undervalued Transactions

These provisions make void transfers of property within 5 years of the date of bankruptcy.  Certain kinds of property are of course exempted.  When the property is transferred to a related party, even if that party can demonstrate that at the time the transfer was affected, the transferor was solvent, i.e., can meet all his or her debts, the transfer may still be void if it is within 4 years of the date of bankruptcy.

The situation is a little easier if the property is transferred to an unrelated party.  In those circumstances, the relation back period is only 2 years.

What this means is that if an individual decides to transfer his house, for example to his daughter, and at the time of the transfer he has no debts or liabilities, the transfer may still be void as against a future bankruptcy trustee if the transfer is within 4 years.  This is because the transferee is a related party.

Transfers designed to defeat the creditors

These provisions introduce the concept of intention to defeat the creditors and the Act specifically states that if the transfer is done at a time when the transferor is insolvent, then that is an indication that the transfer can be taken to have its main purpose in defeating creditors.  Clearly the fact that there is no time limit placed on reversing transactions of this nature, these provisions are very powerful indeed.

 

 

ATO – Insolvency and the Tax Man Jekyll & Hyde

The title of this paper is named after the character created by Robert Louis Stevenson commonly known today as “The strange case of Dr Jekyll and Mr Hyde”.  The Jekyll and Hyde description usually refers to a person with a split personality, one good and one bad.  So it is that in many cases the Australian Taxation Office (The ATO) seems to have a Jekyll and Hyde approach when it comes to tax payers who are unable to pay their debts due to insolvency.
WHY IS THE ATO THE CENTRE OF ATTENTION

When businesses get into financial difficulty, cash flow becomes extremely tight.  The simple principle is that the noisy cog gets the oil, thus employees are paid before critical suppliers, critical suppliers are usually paid before the landlord, and the landlord is usually paid before the ATO or any other statutory obligations.

In effect, and as a result of the somewhat slow response that the ATO has to its recovery policies, it effectively becomes a tacit funder of businesses that are failing.  In certain industries, it is almost an industry paradigm that the ATO is used instead of a bank overdraft.  Of course the net effect of this is that the ATO has been criticised for funding businesses or business operators that should not be in business.

The apparent inertia of the ATO in its debt recovery program seems to have the effect of lulling business operators who have outstanding tax debts into a false sense of security.  At least initially.  It appears that, prior to the ATO commencing legal proceedings it has historically been quite open to coming to sensible payment arrangements with business operators in relation to reduction of debt.  In fact during the height of the global financial crisis the ATO had demonstrated some considerable tolerance and was entering into remarkably easy repayment plans. Dr Jekyll, if you like.

This position has clearly changed and moreover it appears that the ATO has increased its activity in relation to legal proceedings. Furthermore, it appears that once the ATO has commenced legal proceedings, its ability to negotiate payment plans and concessions seems to disappear.  Mr Hyde has emerged.

The action that the ATO takes in relation to debt recovery depends on whether business is operated as a company or as a partnership or sole trader.  I will deal with the situation affecting individuals first.

ATO ACTION AGAINST INDIVIDUALS

It must first be remembered that the ATO, except for superannuation guarantee charge is an ordinary unsecured creditor when it comes to debt recovery proceedings and as such it has legal rights pertaining to an ordinary unsecured creditor only.  This means that in most cases, the only viable action the ATO can take against individuals is to proceed with a judgement against the individual and then in order to enforce the judgement proceed to what is referred to as a Creditor’s Petition and Sequestration Order.  This means the ATO will be seeking to make the individual bankrupt.  Of course as with any other unsecured creditor, the ATO also has the option of serving a Writ of Execution on the debtor’s property or obtaining a garnishee order against wages or salary.

It is important to note that at any time prior to the granting of the Sequestration Order individuals can step in and take control over their own affairs.

HOW DO INDIVIDUALS TAKE CONTROL?

An individual can either file his or her own Bankruptcy/Debtor’s Petition or appoint a Controlling Trustee with a view to entering into a Personal Insolvency Agreement (P.I.A.).  There is an advantage for the debtor in doing this as he or she can choose the time of commencement of the Bankruptcy or P.I.A. and has the opportunity of appointing his or her own Bankruptcy or Controlling Trustee.  No matter how aggressive the ATO has been in pursuing an individual, once a Debtor’s Petition has been filed all action is stopped and the file is effectively closed.  Mr Hyde now becomes Dr Jekyll.

If the debtor wishes to enter into the P.I.A. a creditors meeting is convened by registered bankruptcy trustee pursuant to Section 188 of the Bankruptcy Act 1966 and a special resolution of creditors is required.  This means that 75% of the value and a majority in a number of creditors who attend the meeting are required to approve the proposal.  Of course if the ATO is a major or dominant creditor it is difficult to obtain a yes vote so Mr Hyde has once again returned.

As an alternative to a P.I.A. experience indicates that Section 73 of the Bankruptcy Act is far more effective.  In short Section 73 applies to an individual who is already bankrupt.  The Act provides that a person in this circumstance can simply request his or her trustee to convene a creditors meeting for the purpose of putting a proposal to the creditors for an arrangement or a composition. The voting requirement is the same as for a P.I.A. that is a special resolution.  However, experience indicates that creditors including the ATO are far more receptive to supporting a proposal under Section 73 than a similar proposal under the provisions found in Part X.  Dr Jekyll is back.

There are a number of reasons for this.  The first is that creditors are far less suspicious of a debtor who is already bankrupt proposing an annulment of the bankruptcy than an individual who is not yet bankrupt but trying to avoid the same.  The second is, once an individual has become bankrupt most creditors seem to write off the debt or alternatively the file is passed to a different department.  Furthermore experience demonstrates that meetings convened under the Section 73 attendances can be poor to non existent and this has the added advantage of removing the anxiety and stress from the individuals who are making the proposal.  This is an important consideration for professionals advising debtors as the emotional state of clients is very important.

ATO ACTION AGAINST COMPANIES

Where the ATO is pursuing a company, the process is slightly different.  Again it must be remembered that the ATO is merely an unsecured creditor (except for S.G.C) and it cannot appoint a Receiver or an Administrator.  The ATO must proceed as with any other unsecured creditor in obtaining a judgement, issuing a statutory demand and then commencing winding up proceedings.

It is important to note and this is somewhat different to the position in bankruptcy that once the ATO has commenced formal winding up proceedings, it is not possible for the directors of the company to commence the Voluntary Liquidation of the company.   The only option available to directors in these circumstances is to appoint an Administrator.

Furthermore, this is not without its complications.  It must be remembered that once the ATO has commenced winding up proceedings a hearing date has been set. An Administrator will need to have the winding up hearing adjourned to enable him to complete the normal investigations, Report to Creditors and convene the requisite meeting to consider the company’s future.  In most cases the Court will grant an initial adjournment providing the Administrator gives certain undertakings in relation to not holding the decision meeting of creditors without first referring to the Court.

Once the Court does provide the initial adjournment, the Administrator’s task is to prepare a report to the creditors and to submit the director’s proposal for consideration.  Clearly the proposal will need to provide a better outcome to creditors than the winding up. The matter usually then goes back before the Court for considering a further adjournment to enable the creditor’s meeting to be held and this adjournment is not automatic.  Frequently the ATO opposes the adjournment and often the reason given is not commercial but that the company should be wound up “in the public interest”.  Issues such as the taxpayer’s compliance history and the extent to which public funds have been used to support the failing company’s business are often put forward as reasons for discontinuing the operation of the business.  It looks like Mr Hyde is back. In most cases the Court takes an objective view of this and looks for evidence that there are other creditors whose interests need to be served, thus justifying the need to proceed.

If the Court grants the second adjournment the creditors meeting can proceed and the outcome and future of the company will then depend on the resolution of creditors.  It is important to note that this vote will simply be on a bare majority number and value (a poll) and if the numbers and the values disagree, the chairman has a casting vote.  It should be obvious that once it gets to a creditors meeting stage it is far easier for a company to enter into a Deed of Company Arrangement than the counter part in the bankruptcy jurisdiction in relation to a Personal Insolvency Agreement which of course requires a special resolution for acceptance.

Again as a matter of experience even if the ATO votes against the proposal, providing the other creditors are sufficient to out vote the ATO, it is unusual for the Court to grant a winding up Order unless there are some extenuating circumstances. This could be if the resolution was passed due to related entity claims.

EARLY ACTION IS GOOD

If the company goes into Administration before the ATO commences legal action the situation is totally different.  Clearly there is no Court involvement and the matter will be dealt with at a creditors meeting by a simple vote (a poll).  In most cases the ATO will be out voted and must acquiesce unless there are unusual circumstances.  As a consequence, the attitude of the ATO again returns to that of the good Dr Jekyll.

OTHER REMEDIES AVAILABLE TO THE ATO IN RELATION TO COMPANIES

The ATO has the capacity to issue a Director Penalty Notice in relation to outstanding PAYE Group Tax deductions.  This notice is sent to the Director’s home address and it gives the directors 21 days to comply.  Compliance means the company either, pays the debt, make arrangements to pay the debt, goes into liquidation, or appoint an Administrator.  Default means that the director or directors will be personally liable for the outstanding debt and the ATO can then commence personal bankruptcy proceedings against the directors.  It is important to note that this notice is not sent to the company’s registered office, nor is it sent to the company’s tax agent and as a result it is often overlooked and by default expires.

The notice itself is somewhat bland and certainly less intimidating than much of the other correspondence being received by directors whose companies are facing financial difficulty.  This is another reason why the notices are often overlooked.

Another tactic the ATO can use against companies is to serve a Garnishee Notice on the company’s debtors or bank accounts pursuant to Section 260-5 of the Taxation Administration Act.  If this tactic is used it can be somewhat fatal to the company’s operation as it has the effect of cutting off the company’s cash flow.  This can happen to a company at any time and without notice and the company director should therefore be aware of the potential of this axe falling at any time.

Clearly the conclusion again that should be reached in relation to all of the above matters is that if a company is facing financial difficulties it is far better to act earlier than later.

ANTI FRAUDULENT PHOENIX LEGISLATION

The Government announced in the 2011 budget that it would expand the current director penalty notice regime to include superannuation guarantee amounts and to deny directors the benefit of PAYG credits when such payments are not remitted to the government or to the ATO.  Most importantly the new legislation denies the 21 days grace period where there is unreported debt exceeding 3 months.

This legislation is purportedly aimed at preventing fraudulent Phoenix activity whereby directors purposely use a succession of companies in a cyclic manner specifically to avoid statutory debts.

The legislation has been criticised on a number of levels.  Firstly, it has been submitted that the ATO has already significant debt recovery tools which it currently under utilises.  Secondly, the fact that the ATO is so tardy in relation to its debt collection proceedings will not be solved by the new legislations.  This is an administrative issue not a legislative one.  Thirdly, it is quite clear that the directors would not take positive steps unless they are forced to and in the absence of serving directly penalty notices it is unlikely that the directors or failing companies will take any action whatsoever.

The fifth issue is that the broader economic concerns will not be addressed by this legislation and may get worse. If the ATO relies on the new legislation and “cherry picks” directors it wants to pursue rather than address the administrative issues the net effect will be inefficient business will continue to be propped up.  This has significant impact on the competitive environment in particular it allows inefficient businesses to unfairly compete with legitimate and honest businesses that are paying all their taxes as and when they fall due.

Finally and most importantly, there is no mention in the Legislation of “Fraudulent Phoenix Activity” and many commentators believe that the Legislation whilst intended to attack such activity misses the mark entirely and simply allows the ATO to cherry pick those directors it intends to pursue.

We have submitted that the legislation by and large is well intended and conceptionaly sound, but we have suggested amending the legislation such that grace period be deleted where there is an unreported debt of 3 months and the directors have been an officer of a previous failed company within the last 5 years OR the ATO can prove that there is a “Fraudulent Phoenix Activity”. (to be defined)

We further believe that notwithstanding the fact that no notification is required, there is sound public interest issues involved with the ATO serving some sort of warning notification as the business community generally is unaware of the ramifications and most directors will not take action unless some critical issue occurs.

Importantly the legislation should not replace more rigid administrative procedures in relation to debt recovery.

We believe that without the amendments suggested, that many innocent directors will be caught by the legislation, the community will not be well informed and not served by this legislation and that struggling businesses will continue to be propped up by the ATO as there is no clear evidence that the ATO will use its new tools any more aggressively than the tools it currently has.

CONCLUSION

In a subtle way the Jekyll and Hyde theme continues because it is the lack of action by the ATO in regard to debt recovery that causes most of the harm to the business environment.  This is so firstly because it creates a false sense of security to poor performing businesses and secondly by effectively propping up such inefficient businesses it adds unfair competitive pressures to compliant tax payers.

 

Ponzi Scheme

Overview
In the 1920’s an Italian emigrant in the United States by the name of Charles Ponzi perpetrated a number of frauds against fellow Italians emigrants in the Boston area in the United States of America.

The frauds committed by Ponzi were many and various but his most successful schemes related to the genre that now bears his name.

The essential element in the Ponzi scheme involves the offer and often payment of extremely high returns from doubtful sources in circumstances particularly where the investors who come into the scheme at the beginning are paid their investment returns using funds raised from investors who subsequently come into the scheme.

Mr. Ponzi did not in fact invent the swindle.  In all probability similar schemes had been around since the beginning of commercial activity.

Of recent years in Australia, we have seen the unique adaptation of the scheme to various property investment companies.

The collapse of West Point, Fin corp and Australian Capital Reserves all has very similar elements to the original Ponzi scheme methodology.  In each of these companies we see the return to investors promoted widely particularly in the media and the investment returns are advertised at significantly higher rates than generally available in the market.

When these companies have collapsed, the investors are often left wondering what happened to all of their money.

Separate and apart from these spectacular crashes, my firm has been involved with a number of smaller property investment groups operating under similar rules.

Set out below are some of the characteristics that we have observed that seem to encompass many of these investments scams.

High Rates of Return

As previously indicated, all of the schemes offer extraordinary high rates of return.  Clearly this appeals to the investor’s greed, as all investors wish to receive the best rate of return possible in the market place.  However, the recent property collapses also use the media to convince the investor public that not only is the rate of return extremely high, but the investment is extremely safe.  For the investor, the investment is simple.  All they have to do is hand over their money.  No where in any of the documentation or any of the publicity or in any of the marketing surrounding the investment scheme is there any mention of the word “risk”.  The whole concept that the high the return, the higher must be the risk is very well disguised.

High Returns are Actually Paid

This is the next key element of Ponzi style investment schemes.  It is important to send a message to the investor public that not only is the yield high, but the return is secure.  In order to do this, significant returns either by way of dividend or interest are paid to the initial investors.  The initial investors of course then tell all of their friends and family about how attractive the investment opportunity is.  This has the effect of sending a message of high confidence to their friends and associates and networks, enabling and encouraging particularly more investors to come into the scheme.  Of course, the schemes rely of fresh investors coming in all of the time to continue with the high yield returns back to the investors.

Network Marketing

The scheme operators frequently target special interest groups into which to market the investment schemes.  The matters that I have handled seemed to have a high number of particular professions or groups as victims amongst the shareholder, investors.  It is not uncommon to see a disproportionate number of teachers or policemen or nurses within a particular group of investors.  Similarly, it is also not uncommon to see a disproportionate number of members of particular church groups or other specialist interest groups.  This is consistent with the points above, that is to say because the initial investors in the scheme seem to be receiving a good return and they tend to spread the word amongst their networks and groups.  Little do they know that they are really setting up their friends and families and associates to a major disaster.

Sophisticated Seminars

One of the methodologies used to promote these schemes is with the use of sleek and sophisticated “evangelical” seminars.

The presenter is extremely experienced at playing to an audience.  The message is extremely polished and manages to play on the emotions of the audience.  Church groups are particularly vulnerable to this type of presenter, because the presenter often stylises himself after some of the motivational characters that are often associated with evangelical churches.  The presenters are expert at plugging in to the needs of the investors.

The underlying need, that is pure greed, is on its own an irristable force; however this motivation on the part of the investors is cleverly disguised by the presenters so that the investors seem to going into the scheme for other “higher reasons”.  The scheme presenter will plug in to other emotions for example,

Envy                             –           Everybody else is making this money, why don’t you,

Urgency                      –           Whilst ever you sit back and do nothing, other people are doing well,

Need                             –           What happens if a member of your family needs an urgent and

expensive overseas operation?

Charity                        –           How are you going to help your children buy their first home?

Security                      –           Have you got enough to retire on in your old age?

Financial Freedom –           Don’t you just hate your current job?

The presenter manages to convince the audience that all of the above problems can be solved simply by putting your money into the investment scheme.  It is so simple and foolproof.  Again the concept of risk is never discussed.

The Underlying Investments are Obscure

This is a critical part of the scheme and it involves the mixing up and merging the various corporate structures.  Principally, the underlying investment, that is the properties that the investors believe that they are funding are often in a completely different geographical location to where the investors reside.  This of course prevents the investors from having a very close look at the progress of their investment.  This is particularly useful when the investment involves a property development involving multi story developments.  Further obscurity is provided by holding these properties in complex and unintelligible corporate and trust structures such that the investor has no real idea of the legal ownership of the underlying assets

Unclear Documentation

This follows from the previous point.  It is extremely common for the investors to have no real idea of the nature of their investment.  Sometimes the investment is referred to as shares, other times it is referred to as units, sometimes the investors believe they have security or equity in the underlying properties but on investigation and review, the investors are shown to be clearly nothing more than unsecured creditors in some entity.  This creates further confusion because often times, it is very unclear on a complete analytical review exactly which entity the investor has a relationship with.  The investor may have relied on various advertising literature, or representations made by the company representative, or representations made by his friends and associates, or information he may have received at a promotional seminar.  Usually the investor simply signs some form which is often changed and amended from time to time depending on the circumstances.

It is also very rare for the promoters of these schemes to provide any information or meet with solicitors or accountants or other advisers to the investors.  Clearly if the investors are not prepared to put their money into the scheme at the point of sale, there is a very strong chance that that they may have second thoughts. This of course does not suit the promoters.  It is often the lack of documentation and the overall lack of clarity concerning the specific nature of the investment and the entity to which the investor is a party that causes the most grief to the investor when it comes to a later recovery.  When the company ultimately collapses, and the investor is invited to a creditor’s meeting, it can even be difficult to ascertain which entity within complex groups the investor in fact has a claim.

Substantial Fees taken by the Promoters

Another curious observation in relation to these schemes is that the promoters of these schemes seem to be able to persuade the investors to pay them substantial fees for the privilege to put their money into the schemes.  Often the investors are so enthusiastic about the opportunity that they fail to critically analyse the value of the promoter’s services.  Ironically when a subsequent liquidator is appointed, the liquidator’s own fees for doing that work is put under substantially more scrutiny than the originally promoter’s fees.

Conclusion

The recent property collapses are somewhat more complex than the early Ponzi Schemes, and in general particularly in relation to the very large matters, there is at least an apparent attempt to be commercially realistic about the underlying investment strategy.  In most case there are usually a number of property developments under way, however, the ultimate profitability or viability of these schemes usually does not stand under any degree of professional scrutiny.  In most cases, the investments strategies of these property companies are flawed and their ongoing survivability again depends on large numbers of new investors coming into the scheme to bankroll the operation.  In the meantime the company directors and other promoters of these businesses manage to extract large amounts fees in the form of management fees, director’s fees and other such emoluments.  Sadly many professional advisers to these schemes do very well, also at the expense of the investors.  Such advisers rarely if ever are put under the microscope.

 

Phoenix Fire Reignites

The Phoenix Fire Reignites

Over recent years there has been growing concern about the increasing level of the so calledPhoenixactivity in relation to the use of the corporate entity.  The Australian Government has recently issued a discussion paper on the impact of this kind of activity and a number of recommendations have been foreshadowed.  It is important to note that the discussion paper distinguishes between what it refers to as fraudulent Phoenix activity which involves usually evasion of taxes and other liabilities such as employee entitlements through the deliberate systematic and sometimes cyclic liquidation of related corporate entities as opposed to the legitimate use of the corporate form where an innocent director, having incurred trading losses and facing liabilities, places the company into liquidation and then subsequently acquires some, or all of the assets from a liquidator to commence a new business.

Why it’s bad

The Government has estimated that this kind of activity is presently losing the revenue in the order of $600,000,000.  Moreover, there is a worrying concern that although the activity in the past has been limited to small businesses with a turnover of less than $2,000.000 per annum, in recent yearsPhoenixactivity is being undertaken by much larger businesses and individuals with significant wealth.

At a general level, thePhoenixactivity has a serious impact on the economy.  If directors of companies are allowed to continue in business without paying their respective taxes and employee commitments they are affording to themselves an unfair advantage over those honest company directors who meet all of their legal obligations.

Although the activity affects the general creditor community, it seems to mostly affect the Australian Taxation Office, primarily because the Taxation Office does not provide any services which can be withheld for non payment.

Existing Prevention Mechanisms

There are a number of mechanisms and legal provisions that impede directors from carrying out Phoenix activity, although it’s important to note that there are no specific provisions in any legislation that prevent it.

Section 181, 182 and 183 of the Corporations Act set out the fiduciaries duties of directors and these sections can be used effectively to target directors who transfer assets of one company into another company without proper consideration, or who do so for their own benefit and to the detriment of the company and/or its creditors.

Of course there are also the provisions relating to Insolvent Trading and Fraud by Officers found in Sections 588 G and 596 respectively of the Corporations Act.

Importantly, information that the director has obtained whilst being a director of a company cannot be used for his own benefit and to the detriment of the company and this would include details of customer lists, suppliers and other selling information necessary to run the business.

The fiduciary duties of directors was tested in McNamara v Flavel (1988) 13 ACLR 619 by the Supreme Court of South Australia and in that case, directors were found to be criminally liable in a situation where they engineered the transfer of the assets out of an insolvent company into a clean entity, specifically for the purpose of defeating the creditors.  The Judge interestingly, found it unnecessary to put any value on the goodwill of the business focusing instead on the conduct of the directors.

Recently the ASIC has introduced a regime of banning company directors after following repeated liquidations of companies and the ASIC have published statistics on their success in this regard.

The ATO have the capacity under the director penalty regime to make individual directors personally liable for PAYG holding taxes.  However in this regard the ATO are required to serve a notice allowing the directors fourteen days to take certain actions.

There are a plethora of other small areas where Phoenixing directors cannot get away with the process “scott free”, however these activities are nonetheless increasing and the authorities have found it more and more difficult to curtail them.  In this regard, the ATO proposes a number of amendments.

New Proposals

A range of proposals have been suggested.  The most significant of which is a provision that makes directors automatically personally liable for ALL outstanding taxes including GST and Superannuation guarantee that have not been remitted within three months of the due date.  The new proposal deletes the need for the tax office to formally serve the company’s directors with a Director Penalty Notice.

Insolvency Practitioners Association Australia (IPA) Submission

The IPA has generally welcomed the various suggestions put forward in the discussion paper, but have pointed out that the ATO has not effectively used the powers it has under Section 222 of the Australian Taxation Act.  Anecdotally, Liquidators have noticed that over a number of months a decline in the use of Director Penalty Notices and in this regard it is interesting to note in the discussion paper that one of the limitations of the Director Penalty Notice is that the ATO believes that the same are “highly resource intensive” and “means that director penalty notices are issued to only a small percentage of directors”.  This is an unsatisfactory position.  It will be impossible to thoroughly educate the business community of the impact of the changes and given the fact that many directors of ailing companies have much greater concerns in front of them than paying their taxes, it is important that such debts are raised in priority at least in the company directors’ minds.

Overall the biggest impact of companies being allowed to continue in business without paying the respective GST, group tax and superannuation guarantee levy as well as frequently workers compensation and payroll taxes is the unfair advantage it gives to these companies in the economy over the honest business operator.

2011 Budget Announcements

In the last Federal Budget, the Treasurer formally announced the implementation of specific provisions to be included in taxation legislation to address Phoenix Activity.

An exposure draft outlining the legislation together with an explanatory memorandum has now been issued and the government is currently seeking submissions.

The proposed provisions can be summarized as follows:-

1) The current DNP regime is to be expanded to include superannuation guarantee amounts

2) The 21 day grace period will no longer be available to directors if un reported debt exceeds 3 months and

3) No PAYG credits will be available to directors where the same as not being remitted to the Australia Taxation Office.

Jones Partners Submissions

Jones Partners has made submissions on these matters both directly to the Federal Government and theInstituteofChartered Accountants which in turn will be making submissions to the Federal Government.

In summary our position is that we generally support the amendments in relation to the superannuation guarantee and in relation to denying PAYG creditors to directors.

We have serious reservations in relation to the amendments concerning the 21 day grace period.

We believe that if the legislation is genuinely aimed at attacking “Fraudulent Phoenix Activity”, then the 21 day grace period should only be suppressed if the unreported debt exceeds 3 months and the director has had a history of involvement with failed companies.  Alternatively, we believe that the onus should be on the ATO to prove “Fraudulent Phoenix Activity”.

We have also raised issues concerning the length of time articulated by the legislation (that is 3 months) and submitted that this perhaps should be 6 months.  Overall, there is a concern that the business community will be uninformed about the changes and still see a need for formal notifications to be sent to company directors who have a potential exposure.

This last point is of great significance. The majority of business owners are somewhat oblivious to these sophisticated provisions and their consequences.  When Directors face business difficulties cash flow becomes a juggle.  Creditors are paid in priority as to the needs of the business and to the pressures placed on the business owners by the creditors themselves.  The ATO’s debt collection procedures historically have been somewhat passive and this is a major reason why such debts compound in businesses facing financial difficulty.