Extended ATO Repayment Plans Are Back– Be Careful

Businesses suffering from rising fuel costs may consider the attractive terms of the ATO’s Fuel Response Payment Plan as quick and relatively easy way to improve cashflow, but there can be significant downstream risks to the business and Directors.

Business Risks

Payment plan proposals are often prepared from a mind-set of what the ATO is likely to accept rather than what will best support future viability of the business. Often the forecast used to support payment plan proposals are simple profit and loss projections that do not provide for funding requirements for debt amortization, monthly fluctuations in working capital, future capital expenditure and director remuneration.

While the cash impact of debt amortisation can often be easily overlayed on a basic financial forecast model, working capital cycles can be more complex to model. For example - a retail business with extended supplier terms (say 45 days) that turns over its stock every 30 days self-funds its operations. By comparison a wholesale importer that purchases and pays for stock before shipping is likely to require significant working capital funding.

Any business that pays suppliers before it receives payment from customers will necessarily absorb cash while growing. During periods of economic boom, it is not uncommon for profitable businesses to experience cashflow distress, simply due to rapid growth in the business. This of course creates a great deal of avoidable stress for business executives seeking to convince financiers the business is indeed on sound footing and the cashflow pressure is only temporary.

Similarly, most businesses can expect to incur varying extents of capital expenditure over the course of a triennium, whether that be replacing degraded plant and machinery, or strategic purchase of new plant and machinery to support expansion of the business. Standing still is rarely a successful strategy in business.

It’s therefore important that the obligations to repay legacy debt are not so onerous that it impairs a business’ ability to fund both organic growth and strategic capital expenditure.

Finally, Directors of SME’s are often very hard working and need to be adequately remunerated to ensure they remain motivated in growing the business. In SMEs it is not uncommon for Director remuneration to be structured as a humble base salary supplemented by a combination of loan drawings/ profit distributions. Repayments of legacy debts will necessarily limit the ability of Director’s to enjoy these supplementary sources of income. The absence of a reasonable ‘carrot’ can demotivate business leaders over time, although there are some ‘sticks’ (see below discussion of personal risks) to be aware of.

Personal Risk

Directors that have reason to doubt their Company’s ability to meet its future commitments should be aware they may be at risk of becoming personally liable for Company debts as a result of:

• Director Penalty Notice (DPN) liability for tax debts;
• Insolvent Trading liability for unpaid liabilities;
• Personal Guarantees provided to landlords/ lenders and suppliers.

Director Penalty Notices

Under the director penalty regime, directors can become personally liable for unpaid PAYG withholding, GST and superannuation obligations. These obligations generally represent the majority of outstanding tax debt for distressed businesses (which are ordinarily unprofitable and rarely owe income tax). While the ATO may exercise discretion to refrain from issuing a DPN, the use of DPN’s has become increasingly routine in recent years where tax debts remain unpaid.

We have experienced matters where the ATO has issued DPN notices contemporaneously with approving Payment Plans. From the ATO’s perspective this is a simple way to test Directors’ confidence in a Company’s ability to satisfy the Payment Plan obligations. In such circumstances, Directors with low levels of confidence may consider taking steps to remit the DPN (by appointing an external administrator or small business restructuring practitioner within 21 days of the DPN) a more prudent course of action than betting their personal wealth on an ambitious repayment plan.

Insolvent Trading Exposure

Contrary to popular belief and perhaps sound logic, in law an ATO repayment arrangement does not legally alter when a debt is due and payable. Ironically, while it may assist cashflow, the courts do not consider it a cure for insolvency.

For example: despite the fact the ATO may have approved repayment of a $3m legacy tax debt in equal monthly instalments over 3 years, for the purpose of determining the date the Directors liability for insolvent trading commenced, a Liquidator could treat the full $3m as being due.

If the Company ultimately fails, Directors may be exposed to liability for unpaid debts (including future tax debts) incurred during the period the company traded insolvent. For this reason, the date of insolvency matters. Being able to treat the full tax debt as due and payable when determining the date of insolvency, certainly makes it easier for Liquidators to demonstrate a Company was insolvent for a longer period than may otherwise be considered the case.

Personal Guarantees

More often than not, Directors of SME’s are required to provide personal guarantees to borrow money, lease premises and arrange supply of key equipment and products. If corporations fail, the counterparties of such guarantees have significant claims against Directors which are relatively simple to legally enforce. Whilst ordinarily these liabilities reduce with the passage of time, they can increase where Directors enter new financing arrangements, exercise lease options or expand supplier credit lines.

Short vs Long Term Thinking

When feeling the pressure of ATO collection activity, Directors focused on short term business preservation may see no harm in securing a long-term payment plan propped up by ambitious forecasts.

The problem is that payment plans defer rather than compromise debt. Interest continues to accrue and when combined with amortization of the principal debt, can become a significant strain on business cashflow. This can result in suboptimal levels of working capital and restricting capacity to fund operations and essential capital expenditure. Paradoxically, what seemed logical in the short term can prove to be detrimental for the Company in the years to come. And that ignores the risks borne by Directors during this period.

But what else can I do?

As a starting point, ensure the forecast is prepared on a conservative set of assumptions, buffered for unknown contingencies.

Consider what funding the business will require to support fluctuations in operating performance and capital expenditure necessary to achieve its strategic objectives. Explore and document how this funding will be committed. For businesses with qualifying ANZIC codes, interest free loans up to $5m available under the Economic Resilience Program may be attractive. Otherwise explore options to increase existing credit lines or leverage specific assets such as debtors.

If the quantum of legacy debt is so large that it simply is not reasonable to attempt amortisation over a 3 year period, there may be merit in exploring options to compromise the debt either through an informal or formal process. When properly planned and executed, this option can be delivered with minimal disruption to the business and significantly reduce the need for fresh funding, When there are genuine concerns as to solvency, consider engaging a restructuring professional to seek ‘safe harbour’ protection while the preferred restructuring initiatives are implemented.

How can we help?

WCT Advisory’s friendly team are experts in:

• Preparation and stress testing of financial forecasts
• Supporting businesses source new lending facilities
• Negotiating compromise of legacy debt through both informal and formal processes.
• Formulating and assessing safe-harbour restructuring plans

We like problems, so feel free to give us a call and see if we can help.