We are in a precarious situation, pincered between the claws of rising input costs and falling consumption as inflation begins to bite. The ATO has been inactive over the last two years, delaying its debt collections to allow businesses to recover from lockdowns. That’s all about to change. Now that we’ve emerged from the most challenging pandemic, the ATO has started pursuing unpaid liabilities with accelerating speed as it surpasses $34B in tax debt.
It is a little-known fact that the ATO is Australia’s largest creditor. It is responsible for the largest number of company wind-ups and can put a black marker on businesses that fail to comply with its standards through CreditorWatch. Over the pandemic, this reduced greatly for two key reasons; enormous government stimulus and a policy of ‘ignorance is bliss’ from the ATO. Arguably the most important stimulus package was the $130bn JobKeeper policy.
JobKeeper offered businesses a $1,500 payment per fortnight, per employee, to cover the cost of wages. It can be considered a wage subsidy, reducing the cost of inputs for businesses, and allowing them to maintain or increase supply whilst lowering their total cost.
This prevented or forestalled insolvencies for viable firms and those with endemic cash flow problems, mounting debts, and chronic under-capitalisation. Compounded with a suspension of insolvent trading laws, many businesses that would have gone under normally were kept buoyant. The stability of business exits throughout this period was deeply misleading.
Insolvency rates are returning to their pre-Covid levels, according to data from ASIC. Over 1560 firms entered external administration or controller appointments in the June quarter of 2022. Additionally, from ASIC data, the number of insolvency appointments for July is 674.
What is the relationship between tax and inflation?
The ATO’s new momentum makes sense in a high-inflation economy. Taxation is as much an anti-inflation policy tool as it is a means of generating government revenue. When the government collects tax revenue, it is working with money already in the system that becomes reallocated for a new purpose – spending on public goods and services.
Collecting tax debt allows an increase in stimulus and public investment and helps with managing inflation as the govt recalls money from the market. Furthermore, large govt spending requires a large volume of tax revenue so that they don’t keep adding to inflation.
If there is a large pool of tax revenue, govts can invest in the local economy without hurting it. This is also helped by recalling credited sums from other countries, central banks, or financial institutions. Thus tax is a structural policy tool that determines the scale of the govt.
By pursuing tax debt more aggressively, the ATO is supporting the government’s agenda of reining in inflation. It provides a substantial resource bank for the government to spend unencumbered without needing to print more money. Remember, money printing is the surest way to have inflation knocking on your door. This link makes obvious sense – the ATO is the principal funding arm of the government and is intertwined at a federal level.
How best can business owners handle tax debt?
The ATO is a phoenix, and it has risen from the ashes of Covid-19. Thousands of businesses are about to get burned from this rebirth. So, what can directors and smbs do to stop the sting? Apart from applying some aloe vera, you could consider restructuring your business.
Director Penalty Notices
If you are one of the 70,000 businesses the ATO has written to under its Director Penalty Notices and business tax disclosure programs, you might want to pay attention. Once a notice has been issued, directors have 21 days to ‘remit’ the debt by paying the full debt amount, appointing a voluntary administrator, or entering the company into liquidation.
If the director penalty notice is not adhered to, business directors will be held personally liable for the business’ outstanding obligations. This would create a lot of financial pain; you can forget your Sunday avocado toast (but keep the bottomless mimosas)! This situation can very easily spiral out of control. If a company is insolvent and has made a voidable unfair preference payment to the ATO, the payment may be recoverable by liquidators.
The ATO may indemnify the firm’s directors, forcing them to compensate the ATO for the amount recovered by the liquidator. In the case of Brierty, a company which went into voluntary administration with $60 million in debt, its directors are facing the risk of being indemnified to the count of $5.57 million. Certainly nothing to scoff at. This underscores the value of the order in which you pay your debts – secured creditors followed by unsecured.
Arrange a payment plan with the ATO
If you receive a Director’s Penalty Notice, the first step is to arrange a payment plan with the ATO. When setting this up it is important to consider how much you can afford to pay to meet each scheduled instalment – including interest – as well as your future obligations.
The payments are spread over a fixed period, and the instalments can be paid weekly, fortnightly, or monthly until your balance is cleared. You may modify the instalment amount, defer them, or cancel them up to 2 days before the payment date in some cases.
Remember that payments which are not made on time will accrue interest, so there is a good incentive to get on top of this. It is best to get in contact with the Australian Taxation Office to determine the specifics of your plan. There are many alternative options and specialised components to these plans which apply for different business types. For example, businesses with annual turnover of less than $2m are eligible for interest free repayments.
The ATO may refer debts to external collection agencies. While it hasn’t done this since April 2020, it has not ruled out this option in the future. This is a bit less intimidating than it sounds (there won’t be a loan shark with a cricket bat at your door), but they may propose aggressive payment plans or recover mortgaged goods if they have the right to do so.
Refinance your tax debt
If your business has good cash flow, you may qualify for tax debt loans to aid in your debt recovery too. These loans are short-term solutions tailored to assist businesses settle outstanding debt. Private lenders will generally want loans to be secured by assets, with a loan to value ratio of about 70%. It is worth noting the fees involved with private lending.
Often, they are higher than a typical bank loan, but they give you greater flexibility and have much less stringent standards for approvals. The extra cost may be worthwhile to stop the ATO from breathing down your neck, and to clean up your debt to qualify for a cheaper loan.
Private lending may also be an important means of readjustment for businesses. Many businesses will likely have forecasted on current profit margins and costs, potentially taking out a loan facility with variable rates which could become expensive as conditions change.
Many businesses are likely to overshoot their costings as rates rise aggressively and inflation continues to lash the economy. Businesses charging higher prices will automatically become less attractive as mortgage repayments skyrocket, and with incorrect cash flow projections, they may have to readjust themselves. These conditions are the perfect breeding ground for financial problems, raising the risk of defaulting on tax debt and raising the alarm of the ATO.
Restructure your business
If the options above don’t work for your business, it would be wise to talk to a tax, insolvency, or restructuring expert while your business is still solvent. This can help save you from pain down the track, as they can advise you on changes you should make to your business structure or any more general ‘next steps’ going forward. They will guide you on restructuring your debt if you can remain solvent and avoid trading insolvent.
Face the music
Insolvency is when a company can’t pay debts when they are due. It is illegal to trade while insolvent, so it is something we want to be aware of and address as soon as possible.
The most common corporate insolvency procedures for an insolvent company are liquidation, voluntary administration, and receivership; the three sisters you don’t want to visit. But if these are your only options there are still ways to come out alive. Liquidation of an insolvent company enables a qualified party or person called a liquidator to take control of the firm so that business operations can be wound up in a way which benefits all creditors.
It is a painful process. The liquidator’s main role is to convert viable firm assets into cash, report to creditors about the true extent of the company’s problems, inquire into the conduct of the company’s managers and directors to see if any duties or laws were breached, distribute the proceeds from the sale of the company, and deregister the organisation.
There is a wide scope of responsibilities here, so you are hopefully getting the picture that it would gut your businesses. Receivership is a situation where an appointed person (a receiver) takes control of an insolvent company’s assets and sells some or all of them to recover debts owed. They may be appointed by the courts or by secured creditors.
This sounds like a lot of jargon, but a secured creditor is anyone that holds a security interest in the company, which can include land, property and equipment, or debt, cash, and stock.
Once the receiver has sold the organisations’s appropriate assets, they will pay out the money collected from the sale in the order required by law and report to ASIC any offences or irregular practises they come across. It is important to note that receivership does not affect the legal existence of a company, so directors will remain in their position. Sometimes they will see their powers limited, particularly around the control of secured assets.
In voluntary administration, an independent registered liquidator takes full control of the company. This gives the director some time to find a way to save the company and return it to solvency, such as through finding new financing means or restructuring. We’ve seen quite a few companies fall into voluntary administration over the pandemic, notably Virgin Australia, which was forced to recapitalise and change some operating processes to continue trading.
It is possible to exit this status, as Virgin was able to do – but it is not guaranteed. If a business cannot save itself, the voluntary administrator will find a way to maximise creditor benefit beyond what they would have ended up with if the firm had shut down immediately.
The three situations we’ve outlined above are what could happen if you allow your debts to mount without intervening sooner. Pride of place among these debts are the ATO’s tax debts, which it is willing to aggressively pursue if you don’t act early. To make matters worse, directors are personally liable for business tax debts, so if you’ve been issued a penalty notice, you should be aware that the money you owe could be coming out of your wallet.
The good news is that the ATO doesn’t get joy from sending small businesses to their grave. It would much rather deal with individual directors or businesses through conversation, building a plan which works for you to fulfill your obligations in a timely manner.
The first step for any director with tax debt would be to ring the ATO. They can arrange a payment plan or advise options. The next step would be to reach out to a tax and insolvency expert. They can help guide you through the next steps you might need to take to save your businesses. Ideally, you take these steps while you are still trading in a solvent position.
If not, you will be forced down the route of administration, liquidation, or receivership. Finally, it is important to know all your options, so get in contact with private lenders if you have assets you can refinance to pay out your tax debt or ask a tax expert for a viable option.
Tax debt is not the end of the world, but it is something which should be on everyone’s radar. This isn’t like doing the laundry or washing dishes; putting off your debt will come back to haunt you. Act promptly and you’ll save yourself a lot of money and hassle in the long run.
Ulrika Lobo is the Director of Sparrow Loans, a private property lender in Australia. Ulrika has nearly a decade of experience in finance, underpinned by an MBA and a Master of Finance. She was also recognised as Western Sydney Women’s Entrepreneur of the Year in 2021 and awarded ‘Finalist’ for Director of the Year in Women in Finance’s 2020 and 2021 awards.