House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer, the Hon Stuart Robert MP)

Chapter 1

Background to the reforms to address corporate misuse of the FEG scheme

Outline of chapter

1.1 Corporate misuse of the FEG scheme by adopting sharp corporate practices is contributing to the increasing costs of the taxpayer funded scheme.

1.2 Corporate misuse of the FEG scheme should be deterred to ensure the costs due to improper reliance on the scheme are reduced, so that the scheme remains sustainable.

1.3 This chapter provides background on corporate misuse of the FEG scheme, and why reforms are required.

Corporate misuse of the Fair Entitlements Guarantee scheme

1.1 On 17 May 2017, the Government released its consultation paper on options for law reform to address corporate misuse of the FEG scheme.

1.2 The consultation paper outlined that certain corporate employers and associated parties are increasingly adopting a range of inappropriate practices that rely on the protections for the payment of outstanding employee entitlements contained in the Fair Entitlements Guarantee Act 2012 (Cth). Relying on these protections allows employers to shift the cost of payment of those entitlements from their businesses to the FEG scheme, and ultimately to Australian taxpayers.

1.3 The practices adopted are broadly termed sharp corporate practices. Sharp corporate practices are a range of methods used by certain company representatives, company owners, pre-insolvency advisers, or other parties involved in corporate transactions, to prevent, avoid or reduce the payment of obligations to creditors (including employees and other creditors such as the ATO).

1.4 Sharp corporate practices includes phoenix activity. Phoenix activity involves the transfer of assets from an existing company to a new company without paying market value, before placing the first company in liquidation. The same business is continued under the new company, leaving any debts (such as taxes, amounts owing to creditors and employee entitlements) with the existing company, which is liquidated. Whilst not all phoenix activity is unlawful, what separates a legitimate business rescue from illegal phoenix activity is the business operators' aim to avoid paying debts and liabilities of the company.

1.5 The consultation paper also noted that corporate misuse of the FEG scheme is not isolated, with the relevant sharp corporate practices occurring across most industries.

1.6 The cost of these behaviours were also found to be significant, contributing to increasing costs for the FEG scheme. Average annual costs under the FEG scheme has more than tripled from $70.7 million in the four year period between 1 July 2005 and 30 June 2009, to $235.3 million in the four year period between 1 July 2014 and 30 June 2018.

1.7 In this context, it is important to note that the costs imposed on the FEG scheme from just a few select instances, by those attempting to avoid their employee entitlement payment obligations through using sharp corporate practices, equated to more than $100 million of taxpayer funded money in the last few years.

Addressing corporate misuse of the FEG scheme using current mechanisms

1.8 While the use of sharp corporate practices are not always illegal, they place an unfair burden on Australian taxpayers where those practices result in improper reliance on the FEG scheme.

1.9 These practices hurt all hard-working Australians - including small business creditors through lost payments for goods and services already supplied, employees through lost wages and superannuation entitlements, and ultimately all Australian taxpayers through not only the drain on the FEG scheme, but through lost taxation revenue.

1.10 In addition, those who pursue these practices gain an unfair advantage over their honest competitor businesses who comply with their legal obligations to pay their debts, which has a broader economic impact.

1.11 Further, the use of sharp corporate practices can also impact the recovery of FEG payments through the insolvency process. There are many reasons for this including that there is insufficient clarity around the circumstances and scenarios in which the existing civil recovery provisions should operate and as such, relevant parties such as liquidators and employees believe the provisions are too difficult to use.

1.1 The current legal framework does not adequately mitigate the risks and costs imposed on the community, nor does it appropriately deter or sanction the behaviours of:

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those involved in agreements or transactions to prevent, avoid, or reduce the recovery of employee entitlements, causing inappropriate reliance on the FEG scheme;

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those using a corporate group structure to avoid or reduce their exposure to employee entitlement obligations, also causing an inappropriate reliance on FEG; and

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company officers and directors who have a history of involvement in corporate contraventions and insolvencies where FEG is inappropriately relied on.

1.2 The reforms in this Bill build upon other Government actions to address these types of behaviours, including:

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announcing law reforms to combat illegal phoenix activities; and

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introducing legislation to tackle non-payment of the Superannuation Guarantee by targeting employers that fail to meet their obligations.

1.3 Government departments and agencies have adopted a range of administrative actions and legal approaches to assist in mitigating the impacts of sharp corporate practices on the FEG scheme and other unsecured creditors within the current legal framework. These include:

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undertaking recovery and legal action under the FEG Recovery Program to enforce the Commonwealth's rights in court against various parties to insolvencies;

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engaging with industry stakeholder bodies to build awareness of the prevalence of relevant practices, and seek their assistance to correct misunderstandings of the law and to appropriately sanction conduct of members adopting inappropriate methods; and

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pursuing relevant matters through the Government's Phoenix Taskforce and Serious Financial Crimes Taskforce to combat illegal phoenix activity and other fraudulent corporate operations.

1.4 While these administrative actions assist in mitigating the impact of some sharp corporate practices, they are largely targeted at illegal activities after they have occurred. They do not necessarily address all of the sharp corporate practices adopted by select corporate employers, their representatives and other parties to insolvencies, such as pre-insolvency advisers.

1.5 To better address these behaviours, and deter inappropriate and repeated use of the FEG scheme, it is necessary to make the reforms contained in the Bill.

Development of the Bill

1.6 The amendments to the Corporations Act contained in Schedule 1 to the Bill are the result of extensive public consultation processes conducted during 2017 and 2018, aimed at ensuring the reforms are appropriate and sufficiently targeted to address the corporate misuse of the FEG scheme that has been identified.

1.7 The public consultation processes included:

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releasing the Government's consultation paper on 17 May 2017, seeking stakeholder views on a number of options to reform the law aimed at addressing corporate misuse of the FEG scheme;

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considering submissions received on the consultation paper;

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holding stakeholder roundtable meetings in Sydney and Melbourne to discuss and develop the reform options outlined in the consultation paper;

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releasing an exposure draft of the Bill and draft supporting materials on 12 June 2018;

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considering submissions received on the exposure draft Bill and materials; and

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holding stakeholder roundtable meetings in Sydney, Melbourne and Brisbane to discuss and obtain feedback on the exposure draft.

12.8 The Government considered feedback from stakeholders throughout the consultation processes. The Bill has been tailored to achieve a targeted and balanced outcome.