Corporate Australia is bracing for the long-awaited surge in insolvencies.  As Australia’s largest creditor and, according to creditor reporting bureau Creditor Watch, responsible for the greatest number of company windups prior to the pandemic in 2019, the ATO can fairly be described as an influential, if not dominant, player in the restructuring and turnaround space and in corporate Australia more broadly.

The ATO effect

Although ASIC bears the title of Australia’s “corporate regulator”, one only needs to look to the ATO’s response to the COVID-19 pandemic to see the influence of Australia’s tax office in shaping the Australian corporate landscape.  As part of the Federal Government’s strategy to support companies through the pandemic, the ATO almost wholly deferred debt collection for two years.  Citing a “lighter touch compliance approach”, the ATO was responsible for initiating only three corporate windups during the period of 1 July 2020 to 31 March 2021, resulting in a ballooning debt balance (reported as reaching a collectable debt of $38.5 billion owing for the 2020-2021 financial year). The ATO was also responsible for administering a range of support and stimulus measures, including the critical “JobKeeper" scheme.  The result, which is largely attributable to the ATO’s response, was a reduction in insolvency appointments by almost 50% to pre-pandemic levels. Put simply, half of the companies that would have likely faced collapse in the absence of intervention and initiatives by the ATO during the pandemic, were arguably able to stay afloat.

It should then come as no surprise that the ATO’s recommencing its recovery action this year has coincided with a steep rise in external administrations in the calendar year to date CreditorWatch has reported an increase of debt collection back to pre-pandemic levels with external administrations rising by 46% in the financial year to 31 July 2022. In May 2022, the ATO confirmed that it had recommenced its debt recovery activity and was taking “firmer” action, including garnishees, recovery of director penalties, disclosure of business tax debts, and legal actions including summons, creditors petition, wind-up and insolvency action.

As at May 2022, the ATO reported issuing 20 to 30 Director Penalty Notices (DPN) per day, with that number expected to increase. Effectively, piercing the corporate veil that protects directors from personal liability, a DPN allows the ATO to pursue directors personally for a penalty equal to the value of a company’s outstanding superannuation, PAYG withholding and GST obligations.  Anecdotally, the receipt of a DPN is often the catalyst for a board of directors taking proactive action to avoid personal liability, often by way of seeking legal advice in respect of insolvent trading risk, contingency planning and safe harbour protections.   

The ATO itself has acknowledged its influence in the space and in an address given by Second Commissioner, Jeremy Hirschhorn, at The Tax Institute Tax Summit on 20 October 2022, Mr Hirschhorn said that “many stakeholders have also made clear to us [the ATO] the system-wide role that the ATO has in helping struggling businesses understand that they should move to finalisation of the business rather than struggle on as ‘zombie businesses’”.

Looking to the future: Tax 3.0

With its recently announced plan to create “a future where tax just happens”, the ATO has the potential to lift its status from influencer to change maker and alter the corporate landscape in Australia as we know it.

While the full details of the plan are yet to be made public, ATO Commissioner Chris Jordan revealed that the ATO’s executive group had “endorsed a new digital strategy” coined “Tax 3.0”, which would see the ATO become a “fully digitalised tax office by 2030”. Describing the plan as the ATO’s “North Star”, the digitalisation strategy is aimed at automating reporting, payment and real-time compliance checks which are to coincide with the taxable event.  Commissioner Jordan even went as far as to foreshadow a “BAS-free future”.

It will be interesting to observe what the flow on effects of a fully digitalised tax office may be.  In the corporate insolvency space, we may see the below.

Loss of #1 ranking

If payments to the ATO happen automatically, this may see the ATO lose its position as Australia’s largest creditor.  Despite being an ostensibly unenviable title, holding the prime position comes with power.  For example, during a voluntary administration, the fate of a company is decided by a majority of creditors voting in both value and number.  In circumstances where the ATO is the largest creditor in value, it is essential to have the ATO’s buy-in for any restructure including by way of Deed of Company Arrangement (DOCA) proposal to sell or recapitalise a company to be successful (or indeed any vote by creditors).  Whilst the Commissioner has gone to print confirming that the ATO will generally support DOCA proposals which have no adverse features and would result in a greater and more timely recovery than would be achieved in a liquidation, it is also less likely to support certain DOCA terms, including non-cash items (such as shares or other property) being offered to creditors and in some circumstances, the use of a creditors’ trust. Time will tell whether the ATO’s proposed digitalisation will see its participation in voluntary administrations reduce, as well as influence on DOCA terms, paving the way for new influential creditors to emerge.

Fostering early intervention

As a means to continue trading and stay afloat, many distressed businesses delay or fail to pay tax. The automation of payments to the ATO will make it increasingly difficult for already struggling businesses to retain the cashflow necessary to continue trading.  This should ideally motivate directors to take action and engage with turnaround professionals at an earlier juncture to address any cashflow issues in their business.  One of the biggest challenges to business recovery and turnaround is a crippling ratio of leverage which cannot be addressed through a restructure.  If companies are prevented from accruing large amounts of debt, at least to the ATO, at first instance and, at the same time, directors are prompted to address cashflow issues in their company, the outcomes may be more positive.  Alternatively, the forced application of cash to payment of tax debts may accelerate distressed businesses towards external administration rather than continuing to trade and survive by accruing tax debts (and thereby incurring more debts in the process).

Reduction in director liability

Automation of tax payments may also correspond with a reduction in DPNs being issued by the ATO.  If tax is automatically remitted to the ATO, there will be no outstanding debt for which directors can be held personally liable (at least in respect of the tax categories to which the DPN’s apply), providing of course, that a company has sufficient funds in the first place to make the automatic payments.

Unfair preference claims: “The computer did it”

There is little doubt that the ATO is the most common defendant to statutory “unfair preference” claims brought by company liquidators. This is in part due to the ATO presenting as an attractive counterparty to litigation; both solvent and having model litigant obligations.  Unfair preference claims allow liquidators to claw back certain transactions which have resulted in an unsecured creditor receiving a greater amount from an insolvent company than it would in a winding up of that company.  Practically speaking, these transactions confer a priority on unsecured creditors over other equally ranking creditors.  

It is conceivable that the digitalisation may bolster the ATO’s defence to such a claim.  The “good faith” defence is the most commonly argued defence to an unfair preference claim whereby a creditor argues that:

• they were party to the transaction in good faith;
• at the time of the transaction:
  • they did not have reasonable grounds for suspecting the company was insolvent or would become insolvent; and
  • a reasonable person in the creditor’s circumstances would also have had no such grounds for suspecting the company’s insolvency.  

Whilst it is beyond the scope of this article to examine the potential interplay between the good faith defence and ATO digitalisation, it is foreseeable that the ATO may seek to deny having the requisite knowledge of a company’s insolvency, having outsourced its debt collection to digitisation - although  this does not overcome the objective “reasonable person” limb of the defence which may see the ATO argue that a “reasonable person” in the ATO’s circumstances is one with fully digitalised systems.  The Federal Court of Australia has previously considered the impact of ATO automation in the case of Pintarich v DCT (2018) 262 FCR 41, where it found that a taxpayer remained liable for interest charges on a tax liability despite receiving a computer-generated letter from the Deputy Commissioner of Taxation purportedly remitting the general interest charges (GIC). The Court held that the ATO did not make a decision to remit the GIC because a decision required a mental process of reaching a conclusion.  Perhaps when faced with a preference claim, the ATO will seek to argue that knowledge, like a decision, also requires a mental process which is not present in computer generation. 

ATO Key takeaways

Any forecasting regarding insolvency activity in Australia must include consideration of the activities of the ATO which plays a key role in insolvencies and restructurings.  The ATO's policy and strategy will continue to influence decision making of players in the space and determine outcomes of external administrations and turnarounds.  What is also yet to be seen is how the ATO’s digitalisation will fit with broader reforms the industry may undergo, particularly with respect to the preference regime, which may result from the Federal Government’s Parliamentary Joint Committee on Corporations and Financial Services newly announced inquiry in corporate insolvency in Australia.  Whilst any predictions at this stage can only be conjecture as to what a fully digitalised ATO could mean for corporate insolvency and turnaround, it can be expected that, based on what we now know, the impact is likely to be sizeable and far reaching.