Voluntary Bankruptcy – A big thank you from the Bankrupt! Strange – Not Really

Recently I received an email from a former Bankrupt whose bankruptcy I had been administering. The email said “thank you both for your handling of this matter. Whilst a stressful time, your communication and consideration was very much appreciated”.
This individual had accumulated a range of credit card debts of just over $350,000. The incurrence of such debts was largely due to some significant health and family issues that he had been trying to deal with over many years. However, it got to the point where he could no longer make any headway on the level of credit card debt, despite earning a six figure salary. The inability to reduce the debt was taking a toll on his health and overall future perspective.

Consequently after considering the various options, he declared voluntary bankruptcy. In years 1 and 2 of the Bankruptcy, certain realisations were made such as equity in real estate and receipt of compulsory income contributions. These realisations enabled a first interim dividend to be paid to unsecured creditors. All was going to plan.

Importantly, I recall prior to the voluntary bankruptcy commencing that I discussed the topic of “after acquired assets” with him. In particular, my example was that of an interest in a deceased estate that may arise during the 3 year period of a bankruptcy. Certainly, this was not anticipated as the relationship with his family members had become fractured and quite strained. In short, the interest acquired or that devolves upon a bankrupt at the commencement of or during their bankruptcy from a deceased estate is an asset of the bankruptcy and therefore available for the benefit of unsecured creditors.

During the latter part of the 2nd year of the bankruptcy, he received notification from the Executor of his Late Father’s Estate that he had been listed as a beneficiary to approximately ¼ of the Deceased Estate (this such share was worth approximately $400,000). This was quite a surprise given the relationship with his family. When I received such notification from the former Bankrupt and confirmed same with the Executor, I discussed a solution with the Bankrupt which saw me suspend for a period of time of the compulsory income contributions he was making. This afforded him some breathing space, whilst not jeopardising the position of unsecured creditors given the share (or distribution) expected from the Deceased Estate, ie it was going to be sufficient to pay out all unsecured creditors in full, including interest claims.

Subsequent to be notified of the interest, there was a regular exchange of information regarding the timing of the receipt of the Deceased Estate Funds, as well as timely distributions being made to unsecured creditors of the Bankruptcy. Very recently sufficient monies were received from the Deceased Estate whereby a final dividend distribution was made to unsecured creditors and the bankruptcy annulled by force of Section 153A of the Bankruptcy Act.

Whilst from my perspective as a Bankruptcy Trustee, I approached with this Bankruptcy with the same degree of care and skill as any other bankruptcy administration, it is clear that the individual was appreciative of the support, explanations and communications that he received from me and my staff which assisted in him being able to close at this chapter and commence a new one.  After all, there is light at the end of the tunnel for those in financial difficulty.

This bankruptcy administration was also a fantastic outcome for unsecured creditors who saw all monies owed to them repaid!!

Bankruptcy is often demonised by people that know little about it factually (the Jack of All Trades & Master of None!) or alternatively those that have been a recalcitrant bankrupt and did not get away with what they thought they could! Getting the right information about personal insolvency options and the outcomes can very often help alleviate (not eliminate) some of the stress that is part of making this important choice.

If you would like to know more about personal insolvency options or have a client in financial difficulty please do not hesitate to contact me.

Tax Deductions on Expenses Incurred with Director Penalty Notices (“DPN”)

The DPN Regime was introduced by the Australian Taxation Office (“ATO”) in 1993 as a method to ensure corporate compliance with taxation liabilities. Under the DPN regime, directors could become personally liable for the company’s debts under certain circumstances. The primary objectives of the DPN regime were to ensure directors caused the company to meet its taxation obligations or if this was not possible, promptly seek professional advice with the view to placing the company into voluntary administration or liquidation.
Until recently DPNs had only applied to Pay As You Go (PAYG) withholding liabilities. However, in July 2012, the DPN regime was expanded to include Superannuation Guarantee Charge (“SGC”) liabilities.  The regime was also amended to make directors automatically liable for PAYG withholding or SGC where such amounts have been both unpaid and unreported for more than three (3) months after its due date (known as the lockdown provisions). Under the new DPN regime a director cannot avoid personal liability where they have fallen foul of the lockdown provisions by placing the company into Voluntary Administration (“VA”) or Liquidation. The clear emphasis here is that directors need to ensure that at reporting the company’s obligations on time to still avail themselves to being able to avoid personal liability by subsequently placing the company into either VA or Liquidation.

In the recent Administrative Appeals Tribunal Decision of James Gerald Michael Healy v Commissioner of Taxation ([2013] AATA 281), Senior Member C R Walsh was required to consider the tax deductibility of various expenses incurred by Mr Healy in defending and addressing a DPN (and also in annulling his bankruptcy). While Mr Healy was primarily unsuccessful on a technical aspect (the expenses were not in fact incurred by Mr Healy as his brother paid them), Senior Member Walsh analysed the ability of directors to claim a tax deduction for expenses incurred “in managing his or her own tax affairs and in complying with a legal obligation in relation to another taxpayer’s tax affairs.”

Senior Member Walsh explained that Section 25-5 of the Income Tax Administration Act 1997 (“ITAA”) provides for a taxpayer to deduct expenses incurred for “complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity.” The definition of tax under the Income Tax Administration Act 1997 was considered to be sufficient to encompass amounts due under the PAYG withholding regime. Under the DPN, Mr Healy’s obligation as a director was to:

  • Cause the company to comply with its tax obligations (by paying them)
  • Make an agreement to repay the company’s tax debt;
  • Appoint a voluntary administrator to the company; or
  • Place the company into liquidation.

As such, Mr Healy’s obligation would be “complied with” if one of the above events occurred. In Falcetta v Commissioner of Taxation (2004) FCAFC 194, the Full Federal Court were of the view that under Section 25-5 of the ITAA, expenses relating to, amongst other things, preparation of income tax returns, managing and complying with a DPN and obtaining legal advice on these issues would be deductible. In that case, Mr Falcetta incurred legal expenses in obtaining advice regarding the DPN for unpaid PAYG withholding debts of the company. The ATO Interpretative Decision (ATO ID 2004/831) on this authority suggests that the legal expenses will only be deductible under section 25-5 of the ITAA 1997 of:

  • It is complying with an obligation imposed on the taxpayer by a Commonwealth law that relates to the tax affairs of an entity; and
  • The advice is provided by a recognised tax adviser.

Based on these recent cases, it appears that directors have further incentive to seek prompt professional advice regarding any DPN received.

The ATO continue to use DPNs actively as a tax collection measure for companies, particularly those in the SME sector where non-compliance with PAYG withholding and SGC is more significant. Importantly DPNs are sent to the residential address of the directors as per ASIC records. So encourage your clients to open the mail they receive to their home address, rather than leaving it unopened on the kitchen bench as we have seen occur on a number of occasions which generally limits the options available to them.

If you would like to know more about DPNs please do not hesitate to contact us.

 

Insolvent Builders & Home Warranty Insurance (“HWI”)

For many individuals or couples one of the biggest purchases in their lives will be the construction of a new home. Unfortunately over the years there have been many residential home builders that have gone into some form of insolvency administration and ceased to trade, leaving home owners with an incomplete home and lots of worries.
We are frequently appointed as Voluntary Administrators or Liquidators to residential home builders where they are insolvent. In one recent matter, there has been an instance where the HWI policies were not adequate to cover all costs incurred in completing the homes. We highlight in this article some important considerations customers should give if such an event occurs.

HWI is taken out by the residential home builder and is designed to cover customers. From 1 July 2010, the NSW Self Insurance Corporation, trading as the NSW Home Warranty Insurance Fund, took over as the sole provider of home warranty insurance in NSW. QBE Insurance (Australia) Limited and Calliden Insurance Limited were appointed as insurance agents of the NSW Self Insurance Corporation, through a contractual arrangement.

Importantly HWI provides a set period of cover for loss caused by defective or incomplete work in the event of the death, disappearance or insolvency of the residential home builder.

From 1 July 2002 a key element of a HWI policy is that it must indemnify beneficiaries (i.e. the customer) for non-completion of work due to early termination of the building contract. Insolvency of the residential home builder typically results in the termination of the building contract.

Critically from 1 February 2012, a HWI policy:

  • is required to be obtained where the contract price is over $20,000 or, if the contract price is not known, the reasonable market cost of the labour and materials involve is over $20,000; and
  • must provide cover of at least $340,000.

Relevantly claims for incomplete work are limited to 20% of the contract price (up to a maximum of the cover provided under the policy). It is this aspect that we believe is not always well understood by customers and indeed the residential home builder when insolvency occurs. We have set out below a recent matter we were appointed to highlight how HWI works when an insolvency event occurs resulting in the termination of the building contract.

Facts

  • Contract value for construction of home $300,000;
  • Costs paid as at insolvency event by home owner for first stages of construction $100,000;
  • Invoice issued by residential home builder for work completed but unpaid $25,000; and
  • Balance outstanding under contract at time of insolvency event / Liquidation: $200,000.

At the date of insolvency, the Insolvency Practitioner is often provided with a debtors listing relating to progress claims made by the residential builder. The recovery of each debtor is not always straight-forward and an accurate position regarding what the customer may owe (if any) can only be determined once the HWI is finalised. This can take many months to determine.

Given the above facts, the HWI and customer position unfolded as follows:

  • Following the liquidation of the residential builder, the customer lodged a claim under the HWI policy.
  • The Home Warranty Insurer arranged for an external consultant to inspect the dwelling to confirm / quantify the amount of works required to complete the contract.
  • The customer also had to prove to the Home Warranty Insurer the quantum of payments made to the residential home builder under the contract. In this case no “cash” payments had been made, but in circumstances where this occurs, this can create issues.
  • Three (3) quotes were obtained from different builders to complete the works. The Home Warranty Insurer then approved one of the builders to complete the works.
  • The certified costs to complete the dwelling were $250,000. Therefore, the customer paid the balance of the original contract price being $200,000 and made a claim for the additional $50,000 under the HWI policy.
  • In this case as the additional cost to complete the dwelling was less than 20% of the original contract price, the HWI covered the additional $50,000 that was required to complete the construction of the dwelling. Therefore there were no monies collectible under the outstanding progress claim in the Liquidation.
  • HOWEVER, if the certified costs had been for example, $285,000 (thus meaning the additional costs were greater than 20% of the contract price), then the customer would have had an uninsured loss to the extent of $25,000 that would have to be met from their own funds. In the particular insolvency administration concerned, there were 3 customers who ultimately had uninsured losses ranging from $25,000 to $60,000 per customer. Not insignificant!!

Unfortunately when an insolvency of a residential home builder occurs, it may take several months to work through this process and it will only be at the conclusion of the building contract once all of the costs are known, that the Liquidator would be in a position to determine if there is actually any debt owning by the customer.

It is important that customers get the right advice as to their position when their builder has been placed into some form of insolvency administration. We caution customers who want to go off miss-informed and complete the dwelling themselves as once this occurs they are likely to jeopardise any ability to claim on HWI.

 

Insolvency and Bankruptcy Numbers – Not What You Might Expect!

Welcome to our first Newsletter for 2014. A subject we are frequently asked about is what are the insolvency and bankruptcy statistics doing and what inferences can be gleaned from them. During the course of the calendar year we will be providing a regular commentary on movements. Set out in this article are graphs for NSW and Australia for corporate insolvencies and personal bankruptcies / personal insolvency agreements (“PIAs”) during the period 2010 to 2013 inclusive. Some key observations are:
Corporate Insolvencies

  • In both NSW and Australia appointments decreased by approximately 2% in the 2013 December quarter on the previous corresponding period (“PCP”).
  • In NSW there was a negligible change in insolvency appointments in 2013 on the PCP. However, nationally insolvencies increased approximately 1.8% in 2013 on the PCP.
  • In 2013 NSW maintained its average 39% of the national corporate insolvency market.
  • In 2013 creditors voluntary liquidations accounted for approximately 47% of all corporate insolvencies. Whilst some may express surprise about this, our own statistics broadly confirm this and given the relative ease via which this type of liquidation can be initiated by directors we believe it will continue to be widely used particularly by smaller corporates who no longer wish to continue in business.

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Personal Bankruptcies / PIAs

  • In both NSW and Australia appointments decreased by approximately 9% and 8% respectively in the 2013 December quarter on the PCP.
  • In NSW there was a decrease in bankruptcies / PIAs of approximately 12% in 2013 on the PCP. Nationally appointments decreased by 10% in 2013 on the PCP.
  • In 2013 NSW maintained its average 33% of the national personal insolvency market for bankruptcies and PIAs.
  • The three (3) postcodes with the highest number of bankrupts in 2012/2013 were:
  • 2770: Mt Druitt and surrounding suburbs;
  • 2560: Campbelltown and surrounding suburbs; and
  • 2170: Liverpool and surrounding suburbs.

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It will be interesting to monitor the numbers as the year unfolds as to where they may head and what inferences can be taken from them about correlations with the overall state of the national economy. Whilst there appear to be several economic challenges ahead (for example a notable decline in business capex spending) we generally feel that insolvency and bankruptcies levels are likely to remain flat throughout 2014.

Strengthening our Presence in Greater Western Sydney

For many years now, Jones Partners has truly valued that importance of being accessible to professional advisors and business owners and individuals throughout Greater Western Sydney (“GWS”). The GWS  region is a very significant contributor to the States GDP and has a huge diversity in the range of businesses that operate within it. Our continued presence (via our Norwest Business Park Office) has enabled us to develop strong relationships with other professionals such as accountants, lawyers and financiers, as well as and importantly assist business owners and individuals in this region who may get into financial difficulty. Having a very strong and keen interest in what happens in the region also helps us to understand the factors that can affect SME businesses as well as individuals.
To further build on our presence and focus in the GWS region, we are excited and pleased to announce the opening of our South West Sydney Office at Narellan. As with our Norwest Business Park Office, the new Narellan office puts us closer to fellow professionals and SME businesses and individuals when they need expert insolvency, restructuring or bankruptcy advice in South West Sydney. We believe this proximity and not “the ivory tower” approach is what such stakeholders are seeking when looking for specialist advice in corporate and personal insolvency and restructuring.

Our continued and sincere focus throughout the GWS region reflects the importance we place on ensuring that SME businesses and individuals in this region get the “right advice” when they may be in financial difficulty. Jones Partners are a Chartered Accounting Firm that specialises in the provision of corporate and personal insolvency and restructuring services. For more information go to jonespartners.net.au

Interview with Eagle Waves Radio – The Voice for Small Business

Looking forward to chatting with John Hagerty (co-host of the Eagle Business Show) today at 11.00am and discussing what key factors small business owners need to consider to “keep on top” and ensure they remain afloat particularly when business confidence remains low.
Eagle Waves Radio is Australia’s first and only radio station dedicated to empowering small businesses.

Catch up now listen to the Podcast

Director Penalty Notices

In June 2012 there were changes to the Director Penalty Notice (DPN) regime. Most importantly such changes now expose directors to automatic personal liability where either PAYG or SGC obligations remain unpaid and unreported for more than 3 months after the due date. Whilst the ATO will still have to send a DPN to recover on the debt – the director can no longer avoid personal liability in such circumstance by voluntary administration or voluntary liquidation. The important message is that at an absolute minimum directors should ensure that they comply with reporting obligations on-time.
Unfortunately there is still a status quo position being adopted by some directors and advisors. If you do receive a DPN, it is critical to seek professional advice urgently so that it can be determined what type of DPN you have received.

Liquidation is NOT a dirty word!

Whilst the term liquidation is frequently used, for many company directors or business owners it is still not always well understood and indeed feared. Whilst this is understandable, it is important to understand that this can also be a final part of the overall strategy when it is determined that a business (or company structure) is wound up. Critically directors and business owners need to seek professional advice (from appropriately qualified people – not unqualified consultants!!!) when they know the business is not heading in the right direction. In the main business failure is largely due to “micro” effects on the business, rather than “macro” factors as is sometimes reported. There is also the important consideration of trading whilst insolvent that directors unnecessarily expose themselves to when continuing to operate a business that is in financial distress. Take the pressure off yourself and get professional advice at the earliest possible stage so they can help you keep things under control.

Bankruptcy

Will you be able to keep the house? This is a question I get asked frequently by individuals that may need to contemplate voluntary bankruptcy. The short answer is YES, however it is important to understand that a bankruptcy trustee has an obligation to realise certain assets for the benefit of creditors. This includes equity you may have in the family home. It is possible for a co-owner or other family member to acquire your share of the equity in the family home from the bankruptcy trustee provided that the trustee believes it is a fair offer. It is important to examine each situation independently so that you are aware of how the bankruptcy trustee approaches determining the equity position. Being able to maintain the family home I find it quite often a high priority issue for individuals, particularly where there are children at school and other related factors.

Personal Insolvency – A Potted Summary

Personal Insolvency – A Potted Summary
Introduction

In Australia the Personal Insolvency regime is governed by the Bankruptcy Act 1966.  This is a Federal Act of Parliament and contrary to popular mythology the aim of bankruptcy is not to blame or punishes insolvent debtors but to afford them a process by which they can become financially rehabilitated.  A secondary aim is to ensure that creditors receive a fair distribution of the available assets and finally, that so far as the community is concerned; justice is seen to be done.

Like all acts of parliament, the Bankruptcy Act is divided into a number of parts

Overall Structure

Part IV is the main operational part of bankruptcy.  Alternatives to bankruptcy are found in Part X and these are known as Personal Insolvency Arrangements.  Debtors who have relatively small debts can use Part IX; however the financial limits are restrictive.  In very rare cases the Bankruptcy Act also has provisions dealing with insolvency deceased estates and these are found in Part XI.

Debtors Petition

The most widely used area of the Bankruptcy Act is in fact IV and most bankruptcies are voluntary.    These are known as Debtor Petitions.  A debtor who finds himself/herself in a hopeless financial situation is able to complete various forms and file these documents with the Insolvency Trustee Services Australia (ITSA).  Once the documents are filed and accepted, the individual is bankrupt and a bankruptcy number and a certificate of bankruptcy issued.  This is a relatively easy process, although some debtors may need assistance in completing the Statement of Affairs. It is important that this form must be completed carefully as ITSA is in the habit to rejecting forms even if minor details are omitted.

Creditors Petition

Whilst the process of becoming bankrupt on a voluntary basis (debtors petition) is inexpensive and quick, the opposite is true for creditors who are trying to force a debtor into bankruptcy. (Creditors Petition). The process is drawn out and expensive and creditors and their legal representatives are required to take great care in the way in which their application is made.  The Courts appear to be quite lenient towards the debtor, particularly in relation to requests to grant adjournments.

The process usually starts with the creditor obtaining a judgement debt against the individual.  Following the successful judgement, the creditor issues a Bankruptcy notices requiring the debtor to pay the debt within twenty one days.   Failure to comply with the bankruptcy notice is an act of bankruptcy as defined in the Act and the primary evidence required for the Creditor Petition.  Once the twenty one days has expired, the creditor is able to make an application to the Court for a Sequestration Order and in this process, the creditor can obtain Consent to Act from a Trustee whose job is to administer the bankrupt estate.

Consequences of Bankruptcy

Irrespective of how the individual becomes bankrupt, the consequences are virtually the same.  All property owned by the bankrupt, defined as divisible property vests in the Trustee for realisation and distribution to the creditors.  This property not only includes all the property presently owned by the bankrupt but any property the bankrupt acquires in the future, that is during the period of the bankruptcy, which is usually three years.  The definition of property also extends to property once owned by the bankrupt, but now divested.  The Act gives the Trustee power to undo certain transactions usually designed to defeat the creditors.  In this regard, certain transactions can be reversed within a six month period, others go back two years and yet others go back five years depending on the nature of the transaction.  In general, these “antecedent transaction” rules are designed to ensure that all the creditors get a fair distribution and no particular creditor is favoured over other creditors, and that the bankrupts are not seeking to hide property that would otherwise be available to their creditors.

Protected Property

Certain property is of course specifically protected under the Bankruptcy Act.  Necessary household property, a motor vehicle, tools of trade and superannuation are examples of protected property.  There are financial limits on these items.

Income Contributions

Another consequence of bankruptcy is that during the period of the bankruptcy, the bankrupt’s income is monitored and if the bankrupt’s income exceeds the threshold, he or she is required to make a contribution. These contributions are based on a statutory formula which broadly is 50% of the bankrupt’s income above and beyond the threshold and after income tax.  There are a number of other issues that are taken into account in calculating the Income Contributions.

In most cases the income contribution regime is not particularly onerous for individuals and of course is limited to the period of the bankruptcy.

Overseas Travel

A bankrupt needs permission from the Trustee to travel overseas. Permission should not be unreasonable withheld.  A “request to travel overseas” should be made in accordance with the guidelines.

Superannuation

Superannuation is protected property, that is to say that superannuation benefits are not normally available to the Trustee for distribution to creditors.  A problem however does occur when a bankrupt has a self-managed superannuation fund.  Superannuation rules prevent the bankrupt being the trustee of a Superfund and the Corporations Act prevents the bankrupt from being a company director, thus ruling out the bankrupt’s ability to be a director of a trustee company.  This unfortunately leaves a bankrupt really only three options.  1 if eligible, wind up the Superfund, 2 roll the fund into a retail or industry fund or, 3 appoint a new trustee known an RSE a Registered Superannuation Entity.

Discharge

Discharge from bankruptcy is normally automatic however, a trustee can object to the discharge in certain circumstances, although it is important to note that reasons must be given.  The bankrupt of course has various appeal provisions in relation to these objections.

Annulment

Conversely, a bankrupt can obtain an early annulment from bankruptcy.  Annulments can be obtained if a bankrupt either pays all creditors in full, or pursuant to Section 73 is able to be obtain the consent of creditors for a composition or a scheme of arrangement.  In practice, the Section 73 arrangements are extremely useful, primarily because there is little creditor resistance.

Tax Consequences

In general any tax debt owed by the bankrupt is treated in the same way as all of the other unsecured creditors.  That is to say the Australian Taxation Office (ATO) simply lodges a Proof of Debt with the trustee and receives a dividend as an ordinary unsecured creditor.  In addition, as with all of the unsecured creditors, the bankrupt is released from this on discharge from bankruptcy.  A small complication does occur in relation to income tax in that the amount provable relates only to the income generated by the bankrupt up until the date of the bankruptcy.  Income generated after this date is not a provable debt and the bankrupt’s obligations to pay income tax on this income continues.  This necessitates the lodgement of two income tax returns for the relevant period.  One up to the date of the bankruptcy and the next one from that date to the 30th June of that year.

Capital Gains Tax

A property sold by the Trustee; may trigger a Capital Gains Tax Event.  As this event occurs after the date of bankruptcy, it is not a provable debt.  The Courts have held that it is not a cost of the administration and therefore the debt becomes a new debt of the bankrupt.  This is an inelegant result and the only practical solution is for the debtor to file a second and subsequent petition as soon as the debt becomes provable.

P.I.A.

There are alternatives to bankruptcy and these are found in Part X of the Bankruptcy Act.  These alternatives are known as Personal Insolvency Arrangements.  These arrangements are no longer as popular or as useful as they once were having regard to significant legislative amendments that took place in the early 1990’s.  In addition because the arrangements require the creditors to vote in favour of a debtor’s proposal, they are becoming increasingly difficult to have approved primarily because of creditor resistance.  As indicated earlier, this resistance does not appear as evident when similar proposals are being put pursuant to Section 73.  In addition the cost of the Personal Insolvency Arrangement in many cases make them prohibitive for most debtors and having regard to the fact that the Personal Insolvency Arrangements still appears on the National Personal Insolvency Index (NPII), and other credit rating agencies there is little incentive for debtors to embark on this course of action.  In special circumstances however, they are still worth considering.