Delay in tax evasion crackdown is costing the taxpayer billions

The federal government’s glacially slow pace in delivering the tools to combat phoenixing and money laundering has delivered benefits to an unlikely constituency: organised crime.

Revenue lost from money laundering, tax evasion schemes and phoenixing of companies – often orchestrated by unscrupulous accountants and lawyers – is costing Australian taxpayers tens of billions each year.

And there is growing evidence that organised crime syndicates are now making these a central part of their criminal enterprises.

Yet the federal government has been extremely slow in delivering the tools and funding that regulators need to combat it because of resistance from conservative members of cabinet, who argue it would impose increased regulation on businesses and the professions.

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The government finally passed anti-phoenixing laws in February after years of debate, and in June passed laws that will provide a key weapon in the fight against the practice: a lifetime identification number for company directors (known as the DIN).

The commissioner of the Australian Securities and Investments Commission (Asic), John Price, said in a speech in October 2019: “The DIN can provide traceability of a director’s relationships across companies, enabling better tracking of directors of failed companies and preventing the use of fictitious identities. The introduction of a DIN will assist Asic and other regulators in the vital work of detecting, deterring and disrupting phoenix activity.”

The federal government says the new identity system will be rolled out in the first half of 2021, once new systems are developed and deployed.

But so far only about a third of the money required to overhaul the 31 ageing databases that currently make up Asic’s system has been allocated, raising questions about when the DIN will truly be operational.

Concerns also remain that regulators – Asic in particular – do not have the investigative staff and the prosecutors required to take on the wrongdoing that the DIN will help them identify.

The shadow assistant minister for treasury, Andrew Leigh, told Guardian Australia: “For years Labor has been calling on the Coalition to implement a director identification number. It’s simple, effective and backed by stakeholders across the political spectrum. Yet despite all their promises, the Coalition has failed to act.”

Old-school sleuthing

In the meantime, regulators are using old-school sleuthing techniques. The interagency taskforce that tackles phoenixing includes 37 law enforcement and revenue agencies that manually share intelligence on the practice.

Often the first red flag of illegal phoenixing is raised by an employee whose wages are late. The fair work ombudsman has become an early warning system and shares data with the Australian tax office and Asic as a way of catching “phoenixes in flight”.

There have also been successes where tax officials and law enforcement share intelligence.

But whether the largely manual sharing of information can cope with the expected post-Covid explosion in company collapses remains to be seen. Authorities are expecting an avalanche of insolvencies once the moratorium on companies being wound up expires in December.

Some company collapses will be legitimate and caused by the economic downturn. But there will also be a new wave of phoenixing as unscrupulous businesses take advantage of Australia’s lax laws and deliberately liquidate their companies, leaving creditors – including the tax office – out of pocket for millions.

The Australian Criminal Intelligence Commission (ACIC) estimates organised crime costs the Australian community $36bn each year. A report by PwC in 2018 put the losses through phoenixing – a practice that is often at the end point of money laundering schemes – at $5.13bn a year.

On top of that is the cost of the government-funded fair entitlements guarantee, which compensates employees who are left out of pocket for wages and entitlements after a corporate collapse. It went from $60.8m in 2007-08 to $284.1m in 2015-16.

Divisions in cabinet

Insiders say the go-slow on reforms is due to deep ideological divisions within the Coalition cabinet. The former minister Kelly O’Dwyer pushed hard for more investment and the introduction of the DIN. But, according to insiders, conservatives in cabinet, notably the finance minister, Mathias Cormann, and the home affairs minister, Peter Dutton (responsible for Australia’s response to money laundering), resisted her plans.

In contrast, the government has been quick to implement schemes aimed at welfare recipients, such as its disastrous robodebt program for clawing back social security debts.

The slow response has left Australia facing a new wave of tax evasion allegedly being driven by accounting firms that the ATO claims are promoting schemes similar to the “bottom of the harbour” schemes of the 1970s.

In broad terms, illegal phoenixing involves sending a company into voluntary liquidation, leaving the tax office and other creditors scrambling to collect money owed from an empty shell. More often than not, the real controllers of the company will have been replaced by dummy directors.

Step one

Dodgy Enterprises Pty Ltd is set up by unscrupulous accountants, Sly and Wily. It appears to be a real construction business and trades for a few years. Fake paperwork is created by Sly and Wily to cover for cash injections from illegal activities. Assets are sold multiple times between its clients to allow Dodgy Enterprises to make claims for tax credits such as GST.

Step two

Dodgy Enterprises Pty Ltd stops paying contractors, employees’ entitlements and superannuation. It owes a large tax bill.

Step three

Sly and Wily help directors set up a similarly named company, Dodgy Brothers Pty Ltd, and begin transferring assets (vehicles, equipment, trademarks and cash) to the new company, as well as to family members and friends. It runs up more debts often with friendly parties. Transfers are backdated to avoid the six month “look back” period.

Step four

The directors appoint new straw directors. Sly and Wily recruit students, homeless people and backpackers to fill these roles. The new directors don’t understand what they are agreeing to. Paperwork is backdated or lodged late so creditors and banks aren’t aware of the changes.

Step five

The company is declared insolvent. Sly and Wily refer the company to a friendly liquidator, who should act in the interests of creditors. But at the creditors meeting, creditors friendly to the company owners outnumber the tax office (to change a liquidator requires a vote of creditors).

Step six

The company is wound up. The liquidator finds few assets and does not inquire too deeply into transactions.

Step seven

The taxpayer foots the bill. The tax office is often the biggest creditor. Outstanding wages are also paid by the taxpayer under the Fair Entitlements Guarantee.

Step eight

Dodgy Brothers continues trading, often with the same directors and at the same premises. Directors avoid bans.

Often these phoenixing operations are the final chapter in elaborate tax evasion and money laundering schemes.

Cash made through illegal activities finds its way into a “legitimate” business – restaurants, labour hire companies, construction and logistics companies are popular – before unscrupulous accountants create fake transactions to move the money and assets out of reach. When the tax bills and creditors mount up, the companies are phoenixed.

The biggest failure by the Morrison/Turnbull government in tackling this scourge has been the failure to fund major upgrades to Australia’s corporate databases.

Asic’s companies database is hosted on a system called Ascot, which is now nearly 30 years old. In all, it is running 31 separate registries. In the ATO the situation is not much better, with numerous separate databases on different systems.

The government began talking about “the Modernising Business Registers program” to fix the decades of neglect in these crucial IT systems back in 2014.

But government investment was put on hold while Cormann attempted to put Asic’s registry out to tender to the private sector. The idea was abandoned in 2017 after the private sector bids came in low – mainly due to the high capital cost required to modernise the system.

The 2019-20 midyear economic and fiscal outlook in December finally provided $58.9m over four years to the ATO and $4.7m over four years to the Asic to continue the government’s efforts to modernise the system.

But this is still a long way short of the estimated $200m needed to fully modernise Australia’s business registers.

Without this upgrade, the implementation of the DIN – which experts say is essential to curb phoenixing – will be very difficult.

The need for stronger anti-phoenixing laws was first identified in 2015 during a Senate committee inquiry into insolvency in the Australian construction industry.

Shonky developers were claiming GST rebates on inputs into their buildings and subdivisions, but winding up the companies when they sold the units and failing to remit the GST that was payable.

A budget measure was introduced from 1 July 2018 to deal with the immediate problem of loss of GST through phoenixing in the construction industry. Instead, purchasers of new units or land in new subdivisions were required to remit the GST payable on their property directly to the tax office.

But other legislation announced by the then Turnbull government in 2016 designed to tackle the problem more comprehensively has taken years.

It includes specific phoenixing offences to better enable regulators to take decisive action against those who engage in it: extending penalties that apply to those who promote tax avoidance schemes; preventing directors from backdating their resignations to avoid personal liability; and prohibiting related entities to the phoenix operator from appointing a liquidator.

The 2016 bill lapsed but was reintroduced in late 2019 and was finally passed on 17 February 2020.

“The bill includes new criminal offences and civil penalty provisions targeting those who engage in illegal asset stripping and prevents directors from improperly backdating resignations,” the assistant treasurer, Michael Sukkar, told Guardian Australia. “The bill also provides more tools to assist the ATO in identifying and preventing illegal phoenixing behaviour.”

On par with Haiti

When it comes to the bigger picture of tackling money laundering and the involvement of accountants, lawyers and real estate agents in schemes, the Morrison government has been equally slow.

In its latest report, the international Financial Action Task Force found that Australia had fallen well behind in its obligations, was non-compliant or partially compliant on 14 of the 40 recommendations and now ranks alongside Haiti and Madagascar in terms of its anti-money laundering protections.

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The main issue is Australia’s failure to enact the so-called “Tranche 2” anti-money laundering laws, which would compel real estate agents, lawyers and accountants to report suspicious transactions.

New Zealand implemented them in 2018, as did the UK and Canada.

But in Australia, the proposed laws have been fiercely resisted and the subject of intense lobbying by the real estate sector and law firms, leading to a years-long delay in delivering a tougher compliance regime.

Instead, Dutton has now opted for what experts say is a “1.5 option” that goes part of the way but does not implement the rules compelling disclosure of suspicious transactions by lawyers and real estate agents.

This is despite mounting examples of unexplained wealth from China being channelled into real estate and unexplained revenue being washed through accounting firms. The Senate legal and constitutional affairs legislation committee recommended in March that the “1.5 option” bill be passed.

A spokesperson for the home affairs department said: “The Australian government is committed to continually improving Australia’s anti-money laundering and counter-terrorism financing laws and working with industry to ensure that Australia’s financial system is hardened against criminals and terrorists.” However, the government does not want to put “an undue burden on industry”.