illegal phoenixing

Of all the strange birds you can meet in business, the phoenix is surely one of the ugliest. It’s the company that siphons off tax collected from staff salaries and their super contributions, doesn’t pay its bills and, when the going gets tough, calls in the administrators. Staff and other creditors are left with the debts, pained and poorer for their efforts, while chapter two begins.

Up pops the director in a new company, buys the office furniture and other assets at a bargain price — and steams off again, slate cleaned, like a phoenix risen from the ashes. The mythical bird’s signature tune is the abuse of company structures to avoid paying debt. Australia’s most high-profile case is Plutus, a multimillion-dollar alleged illegal phoenixing scandal involving payroll companies that’s shaken top tiers of the Australian Taxation Office (ATO).

”It’s a crime. We want to stamp it out.” – Louise Petschler MAICD

AICD takes a strong position on illegal phoenixing as it reflects badly on the integrity of the vast majority of directors and damages people’s trust. “It’s a crime,” says Louise Petschler, AICD’s general manager, Advocacy. “We want to stamp it out.”

Now the federal government is moving to target this sort of underhand behaviour by toughening the laws and sanctions against illegal phoenixing. Not an easy crime to tackle, it requires treading the line between clamping down on illegal phoenixing while not interfering with genuine business rescues and directors trying to do the right thing.

While the new insolvent trading provisions in the Corporations Act 2001 (Cth) expanded the definition of insolvent trading to include “uncommercial transactions”, the Act doesn’t contain an explicit phoenixing offence (there are other laws that can be better enforced).

As Australian Securities and Investments Commission (ASIC) Commissioner John Price explains, the key feature of an illegal phoenix is intent… Did they intend to cheat? “There’s no legal definition of what phoenix activity is… But just from a layman’s point of view, we see phoenix activity to be basically people transferring assets for no value or less than value with the intent to defraud creditors,” Price says.

ASIC welcomes a government proposal to create a new “phoenixing law” as it will define that “intent”. “It would deal with the problem by looking at what the consequences of that activity are in a more specific way. It’s a very important step forward,” says Price.

The phoenixing law, targeting the illegal transfer of property, is a key proposal in a consultation paper released by Minister for Revenue and Financial Services Hon Kelly O’Dwyer in September 2017. It is strongly supported by the housing industry sector, where illegal phoenixing is rampant.

“Having an offence is not just about having prosecutions, it’s sending a very clear message to the community and particularly to the business community that we have identified this sort of behaviour as wrongful and you are crossing the line,” says Shane Goodwin, CEO of the Housing Industry Association (HIA).

Not all agree it would be effective. One of the foremost experts on phoenixing in the country, Professor Helen Anderson of the Melbourne Law School, says because the law is currently framed to focus on the transfer of property, it’s not hard to structure companies in ways that dodge the provisions. Even more worrying, she says, is that, paradoxically, a criminal law is likely to result in fewer prosecutions. “It is based on proving an intention to a criminal standard… beyond reasonable doubt,” says Anderson. “That’s a very high bar.”

The Australian Restructuring Insolvency and Turnaround Association (ARITA), the industry group representing liquidators, is also not a fan of a phoenixing law. “We simply believe existing laws should be enforced more rigorously,” says ARITA’s CEO John Winter. “Illegal phoenixing is because of certain activities such as wilfully hiding assets, destroying books and records or moving assets beyond the reach of a liquidator. Those are things which are readily identifiable now — and nobody should be undertaking, at any point of time, in a distressed business.”

The proposed reforms and the submissions they’ve generated are still under consideration by the government.

“…phoenixing is considered by some in the industry as merely the way business is done in order to do business.” – Senate Economics Committee

The cost of illegal phoenixing

So how big is the illegal phoenixing problem? Estimates of its scale and cost to Australia’s economy have, until recently, been little more than stabs in the dark. Illegal phoenixing activity is opaque and hidden among the more than 2.5 million companies and three million directors in Australia. In 2011, the ATO estimated 6000 companies were involved in illegal phoenixing. In July 2018, PwC’s The Economic Impacts of Potential Illegal Phoenix Activity report for the ATO, ASIC and Fair Work Ombudsman estimated from $2.85 billion to $5.13b is lost every year from salaries, superannuation, GST, withholding tax and other payments, for example, to suppliers.

In 2015, the Senate Economics Committee, inquiring into the shadow world of Australia’s construction industry, discovered pervasive phoenixing, characterising the sector as having “a significant culture of disregard for the law”.

It reported: “…phoenixing is considered by some in the industry as merely the way business is done in order to do business.” Illegal phoenixing as a business plan has burgeoned in the past decade. It’s very easy to undercut a competitor if your profit is built on the back of unpaid tax.

How the scam works

The HIA’s Goodwin describes a typical scenario in the construction sector: “It’s the chain of interconnection — the company that bought the land is connected to the one that borrowed the money. Then there’s another company, which they control and contract to build the structure. Then there might be another company they are connected with to market and sell the product. Somewhere through that murky chain there’s been monies flowing backwards and forth so that in the end there’s nothing left.”

Goodwin continues: “Once you’ve done the development, that company gets wound up. Once you’ve done the construction, that entity gets wound up. Once you’ve sold the product, the marketing company gets wound up and, all of a sudden, somewhere somebody neglected to pay the GST, and perhaps the last of the tradies or the builder hasn’t been paid. Certainly the tax hasn’t been paid.”

This practice has left thousands of people screaming about unmet obligations, with one notable example being strata residential.

“We’ve seen a lot of litigation in the courts, particularly in NSW, where there is no entity left for the body corporates to come back to and fix the building when there are problems,” he says. “There’s a saying, shut on Friday, open on Monday. How do they do that? How do they go and get new lines of credit? How do they get suppliers to support them? How does that happen? We don’t have transparency.”

HIA modelling shows illegal phoenixing’s drag on the economy, noting that if eradicating some of it lifted productivity by just one per cent, it could boost the Australian GDP by an extra $3.22b per year.

The DIN is just the beginning

The government admits there is work to do, but the proposal to introduce Director Identification Numbers (DINs), announced in September 2017, is a powerful addition to its armoury.

A unique number for every director will let regulators map relationships between directors and related entities. The DIN will allow tracking a single director over time through multiple companies, and it will interface with other regulators and government agencies. The move follows a recommendation in the Productivity Commission’s 2015 report, Business Set-up, Transfer and Closure.

An AICD survey found 66 per cent of members supported DINs. “We think there are a number of benefits to DINs,” says Petschler. DIN registration will become part of the process of appointing directors, though the transitional arrangements remain unconfirmed, and existing directors will have to sign up.

But is this enough, given how often “straw” directors are installed as part of the phoenixing process? Should there also be some mandatory training in director responsibilities? Should there be some sort of minimum standard? — or a test for what is a “fit and proper person”?

ASIC’s Price says these impositions would come at a cost to our open system, currently designed with few barriers to becoming a director. “Australia has a very free system, so you can set up a company and within a couple of days it’ll be up and running. That freeness of the systems has actually been lauded around the world,” he says.

ARITA applauds the introduction of DINs, but argues more is needed. “It’s harder to get a library card than to be registered as a company director,” says Winter. “You at least need to show identification to get a library card.”

That opens up opportunities for exploitation by directors who intend to phoenix businesses. “They can slightly misstate their own information, which then leads to challenges in matching their multiple directorships, or they can literally — and [sometimes] outrageously actually do — register their dog or an unwitting person,” says Winter.

The suite of new tools already in the pipeline to disrupt illegal phoenixing includes other sanctions and laws that directly affect directors. One stick is the Transparency of Business Tax Debts legislation currently being finalised. This will authorise the ATO to report companies with an overdue tax debt above $10,000 to credit reporting bureaus.

While this in itself is a strong sanction, Anderson argues that the draft legislation contains a “get out of jail free” card — as the directors will have 21 days’ warning. “There is a danger this will actually increase phoenixing,” Anderson says. “They have 21 days to place the company into liquidation, which will nullify the ATO’s power to disclose the tax information to the credit agency.”

Insolvency advice goes rogue

Business advisors are also attracting intense regulatory interest. When a company is in trouble, it’s easy prey for the ruthless.

A 20-agency Phoenix Taskforce, which includes the ATO, ASIC, Australian Federal Police (AFP) and the Criminal Intelligence Commission, has found struggling companies are being targeted by rogue advisors who help them phoenix.

Google “insolvency advice”, and a number of companies pop up offering help. The pre-insolvency industry is growing and is especially active in the SME sector. It’s basically unregulated — anyone can put up a shingle.

The federal government’s Black Economy Taskforce, established in 2017, heard evidence of lawyers and accountants scouring court records, looking for wind-up notices — and potential clients.

These “advisors” then assist their clients to sell assets, restructure the company, install dummy directors and use friendly liquidators to help them illegally phoenix the company. Company Director understands they ask for an upfront fee, often around $10,000 — and then the troubled company’s problems magically start to disappear.

ASIC’s current tactic to fight this is disruption. “Once we see a company is in trouble, we’re writing to the company director and saying, ‘If you get a note from someone out of the blue that says they can fix all your problems, be very careful you’re not breaching the law.’ That has been an extremely successful disruption activity,” says Price.

Legitimate liquidators are calling for a more direct attack. Anderson suggests they could be hit with laws introduced in 1980 to stamp out the notorious “bottom of the harbour” tax avoidance schemes. “The criminal laws are almost perfectly suited to all kinds of illegal phoenixing because they do not rely on asset transfers,” she says.

Using liquidators more effectively

In the forest of companies around the nation, it’s liquidators who are on the ground, with their arms around each falling tree.

They have a legal responsibility to discover what went wrong with the company, but are paid out of a business stripped of its assets. Investigations are often limited, and stymied by a lack of books and records. This has led to calls for the reforms to include dropping fees for company searches, following the precedent set by Companies House in the UK. Liquidators could extensively search companies and related entities without the prohibitive search costs — and it has the added benefit that people and suppliers could more freely learn who they are dealing with.

Currently, ASIC is able to fund a liquidator’s investigations through the Assetless Administration Fund. However, the requirements for a successful application are tricky. Company Director understands there have been a tiny number of applications so far, and all have been refused.

Even with limited investigations, of the nearly 10,000 liquidator reports sent to ASIC in 2016, nearly 8000 alleged misconduct. Of those, only 129 were referred by ASIC for investigation. Some stakeholders express frustration with the low prosecution rate, but ASIC argues that disruption is a more effective — and cost-effective — first step.

”You’re not just going to enforce your way out of this problem.” – John Price, ASIC

“Every report of misconduct, or complaint that comes into this organisation is triaged,” Price explains. “Where the evidence allows, we will take enforcement action against those directors. More broadly, we look at disruption-type activities. It’s a shot across the bows to let people know we’re looking; that’s very important.”

On one point ASIC is emphatic. “You’re not just going to enforce your way out of this problem,” Price says. “It’s about thinking holistically about all the different things we can do, and using all of those to disrupt the activity.”

This approach is disputed. ARITA’s Winter says the low prosecution rate is sending a “dangerous signal” that directors can easily get away with illegal phoenixing. “The problem isn’t a lack of law, it’s a lack of enforcement,” he says. “At the end of the day, directors need to know they can’t get away with this, otherwise they’re going to continue doing it.” Federal Treasury is currently reviewing the proposed reforms and submissions, and we should soon know how forceful the reforms will be.

Crime & punishment

New weapons in the war against illegal phoenixing activity.

In The Economic Impact of Potential Illegal Phoenix Activity — commissioned by the federal government’s Phoenix Taskforce, which comprises 30 federal, state and territory government agencies, including the ATO, ASIC, Department of Jobs and Small Business, and the Fair Work Ombudsman — PwC outlined the direct and economy-wide impacts of illegal phoenixing after analysing four years of data.

From 2012–13 to 2015–16, more than a million Australian businesses ceased operating — 36,532 were business failures resulting in insolvency with an external administrator appointed.

“In most cases, these may have been legitimate and honest commercial failures; in other cases these failures may have been deliberate.

“The deliberate and systematic liquidation of a corporate trading entity, which occurs with the intention to avoid liabilities and continue the operation and profit taking of the business through other trading entities, is known as illegal phoenix activity.

“Phoenix companies arise from the ‘ashes’ of a collapse of a commercial entity, leaving behind a trail of avoided outstanding payments to tax authorities, creditors, businesses, customers and employees.”

The ATO audited 340 businesses for involvement in illegal phoenix activity in 2017, resulting in it issuing tax bills of $270m.

Actions

The federal government has set up a Phoenix Hotline: 1800 807 875; ato.gov.au/general/the-fight-against-tax-crime/our-focus/illegal-phoenix-activity/phoenix-taskforce

Disclosures will be protected by privacy laws and the government’s legislative action in protecting whistleblowers.

The AICD View

The AICD has welcomed the announcement of new targeted measures to combat illegal phoenixing.

The AICD has previously supported the establishment of an anti-phoenixing hotline as it has the potential to yield useful information beyond that provided by liquidators to ASIC under the Corporations Act 2001 (Cth).

AICD managing director and CEO Angus Armour said the AICD strongly supports the government’s aim of deterring and disrupting illegal phoenixing activity.

“Employees, creditors and stakeholders pay the price when unscrupulous individuals misuse the corporate form to strip assets from one company to another to avoid paying entitlements and liabilities. The practice also damages confidence in the corporate model, to the detriment of the vast majority of responsible businesses and directors.

“For that reason, the AICD welcomes the establishment of a new anti-phoenixing hotline and website to assist regulators in targeting and prosecuting illegal activity.

“In order for these measures to be effective, the agencies responsible for taking action must be appropriately resourced, and willing, to act.

“We would also welcome periodic reporting of the volume and nature of reports provided via the hotline, together with statistics on the enforcement action taken in response.

“Effective laws, vigorously enforced, with impactful and proportionate sanctions, are vital in combating these destructive illegal activities,” he said.

The AICD also supports the implementation of Director Identification Numbers (DINs). These will make it easier for regulators and other stakeholders to track the corporate history of individual directors and support targeted anti-phoenixing measures, while also addressing cybersecurity and privacy concerns.

AICD notes that information confidentiality and security issues will be of paramount importance.

The dark side of Plutus

The Plutus Payroll tax fraud scheme had illegal phoenixing at the core of its business plan. It was daring and highly lucrative until a few untidy details brought the scam undone.

Illegal phoenixing is built on gaming the limited liability company system and, according to Australian Federal Police (AFP) court documents, none have done it better or for higher stakes than the founders of the Plutus Group. It may have gone undetected, except for one clue — one of its directors had been listed as a director of a phoenixed company, for a single day.

It is a colourful drama, with colourful characters. First, there’s Simon Anquetil, already a veteran of one insolvency. When his eStrategy Group went into liquidation in 2012, the court heard he had already set up a new company, eStrategy Operations, with the same office and clients.

Anquetil set up Plutus Payroll on 23 April 2014. On the face of it, the company entered contracts with employers to act as their pay office — paying contractors’ wages and handling the tax and super obligations.

Plutus was engaged by 200 clients — including, ironically, the ATO — attracted by the irresistible “no-fee service” offer. Behind the shopfront, however, were the other founders. They included Adam Cranston, a finance entrepreneur, who had worked as a pre-insolvency advisor at 180 Group. Cranston’s father, Michael Cranston, was a deputy commissioner of the ATO, in charge of investigations.

 

Also involved were Jay Onley, a former Olympic athlete and sports broadcaster. Onley worked with Cranston at 180 Group.

The fourth “controlling mind” was Peter Larcombe, a King’s School old boy and allegedly a known associate of the Comancheros bikie gang and organised crime figures. Larcombe had extensive contacts in labour hire firms, but was also alleged to have played a crucial role pulling in unwitting individuals to be “straw directors”. These people were paid nominal amounts to front the series of companies that would be phoenixed in quick succession. Larcombe and Cranston had been involved as co-founders of Aventis Capital, a property and financing company.

Documents before the NSW Supreme Court reveal how the ATO investigators say the scam worked.

Plutus was structured so it had no traceable links between the entities. Contracted companies paid Plutus gross amounts for staff salaries, PAYG tax and superannuation guarantees. Plutus then transferred money to a series of companies it called the “bots” — the “bottoms” or second-tier companies, which paid the salaries and a proportion of the taxes owed on those wages to make things look ship-shape. These payments were mostly managed by Lauren Cranston — Adam’s sister. She allegedly siphoned the bulk of the money to the controlling minds, whose rapid accumulation of wealth resulted in extensive property portfolios and sumptuous lifestyles.

A year into the scam in mid-2015, and flying under the radar of authorities, the first bots were put into liquidation and replaced with four new companies. Phoenix number one.

Six months later a red flag blipped at the tax office. A number of labour hire companies had gone broke — all owing large tax bills. ATO investigators set out to check if they were related, court documents recount. The largest of the first set of Plutus bots, Keystone Pay, owed $9.5m in unpaid taxes. It had no assets, no company records and the sole company director, a woman named Anna Waters, had no idea what the firm did.

There was no trail to Plutus. But then one small detail sparked a bigger hunt. For one day when it was first established, on 22 April 2014, Peter Larcombe’s name appears as Keystone Pay’s director. Ordinarily, this would have passed unnoticed. But Larcombe allegedly had underworld connections and his name-check lit a fuse.

By August 2016, the Cranston name started to blow the scam apart. It drew a family link into the top echelon of the tax office.

Plutus had phoenixed a second and a third time, and was still immensely profitable. But three separate investigations were now underway — two by divisions of the ATO and one by the AFP. Eventually, these investigations teamed up, hatching the Phoenix Taskforce. Plutus carried on for another seven months until the arrests of nine key insiders, including the founders and Lauren Cranston in May 2017.

Charged with abusing his position as a public official by attempting to access the investigation, Michael Cranston faces up to five years in jail. The ATO claims it is owed $144m.