• Phoenix practices are on the radar

    Business failure, and the fallout for creditors and equity holders, is a fact of life. For most of us it poses a largely unavoidable but low-level risk that we accept in return for the benefits of an entrepreneurial economy.

    In most cases, where failure is just the consequence of getting it wrong, stakeholders dust themselves off and move on.

    But some business operators try to use liquidation as a means of avoiding their financial obligations, without risking their assets and with the full intention of resuming business operations through a new entity.

    Like the mythical bird, the phoenix, these businesses rise from the ashes and are 're-born' as new entities which essentially continue running the same business.

    The net effect of these activities is that competitors, debtors and employees are left in the lurch.

    ATO Deputy Commissioner, Mark Konza, said this behaviour is a deliberate attempt to avoid financial obligations.

    'Liabilities are 'parked' in the liquidated business and the underlying business activity is resumed free of liabilities', he said.

    The cost to the Australian economy of phoenix and related practices has been estimated at between $1 billion and $2.4 billion a year.

    This cost includes competitors being unfairly priced out of business, trade creditors being left unpaid and employees missing out on vital superannuation payments.

    The Australian community also bears a significant part of this cost through reduced tax revenue.

    'This type of tax evasion is the deliberate, systematic and sometimes cyclical liquidation of related corporate trading entities and has the potential to severely erode the revenue base and undermine business and community confidence', Mr Konza said.

    And the risk is growing.

    Phoenix-related tax evasion takes place mainly through the failure to pay (to the ATO) tax that has been correctly withheld from payments to employees and others or, in the case of GST, payments by customers.

    Phoenix operators also may claim tax credits for tax that is due but not paid. The entity in question may have outstanding superannuation guarantee obligations to the ATO on behalf of its employees.

    In reality, income tax withheld from employees wages and GST collected from customers do not belong to the business but are owed to the community through the ATO.

    Phoenix operators may also be trying to avoid paying wages due to employees and supplier accounts.

    This activity is concentrated in business groups with turnovers up to $15 million and in sectors where labour costs are high relative to assets used, such as building and construction, security services and labour hire.

    They are generally privately-held companies.

    The arrangements will often involve a group in which each main business function is operated through a separate entity, one of which will supply workers to the entire group. This labour supply entity will withhold taxes from workers, the proceeds of which will be siphoned off and the entity declared insolvent and wound up without paying the withheld amounts to the ATO - and without affecting the assets held elsewhere in the group.

    A new labour supply entity is then created, the workers are transferred to it and the process is repeated.

    These companies are easy to liquidate or wind up, as they normally hold few, if any, assets.

    'We take an early intervention approach to phoenix activity', Mr Konza said.

    'We don't just react when entities have already been wound up with outstanding tax liabilities, we seek to identify and deter potential phoenix activity before it occurs. An audit is rarely the response of first choice.'

    For small to medium enterprises generally, the economic group is a focus of compliance monitoring and verification across the board.

    When an entity goes into liquidation with outstanding tax debts, and there are related entities that are going concerns, we closely examine their tax affairs, including their directors.

    The bottom line is, a business that is liquidating for the purposes of addressing tax debt but intending to continue business operations through another entity, can expect attention from the ATO.

    'Where we see this behaviour emerging, we write to people highlighting the range of potential sanctions that can be applied and point out the very serious consequences.

    We effectively take these cases out of the self-assessment regime and actively investigate. Serial offenders are closely monitored to ensure tax payments are made on time.'

    Cases are managed by a dedicated phoenix risk management team with around 36 staff, which carries out phoenix-specific reviews and audits. Increased resources for this work were provided in the 2009 Federal Budget.

    Some $694 million in taxes and penalties have been raised through 1,420 phoenix audits since 1998, when the ATO began a specific focus on phoenix arrangements.

    During the 2008-09 financial year the ATO had finalised 73 audits and raised $83.3 million in tax and penalties in relation to phoenix arrangements.

    The most serious cases are referred to the Australian Federal Police and Commonwealth Director of Public Prosecutions for prosecution.

    Like other forms of tax crime, fraudulent phoenix behaviour often involves criminal activity outside the tax jurisdiction. The ATO has been working closely with the Australian Securities and Investments Commission on strategies to combat phoenix behaviour.

    'We share information and work together to take action against company directors suspected of breaching the corporations and tax law', Mr Konza said.

    Given its potential to undermine business confidence by giving criminally motivated operators an unfair advantage, the ATO receives strong cooperation from industry stakeholders and the insolvency profession in its efforts to tackle fraudulent phoenix activity.

      Last modified: 28 Jan 2010QC 28245