Last week the Federal Court handed down an interesting decision on third party preferences in Kassem and Secatore v Commissioner of Taxation [2012] FCA 152. The Commissioner was wholly unsuccessful, and may be concerned at what this case means for his ability to continue to resist liquidators’ demands that he disgorge payments made by failing corporate taxpayers, or rather, made to the Tax Office on their behalf by third parties.

Third party preferences are where an insolvent company’s debt is paid by a related entity, and the recipient creditor – here, the ATO – defends an unfair preference claim by the liquidator by pointing to the fact that the payment was made not by the company but by a third party, and arguing that the payment is not voidable as an unfair preference as it falls outside the reach of s 588FA (and 588FC) of the Corporations Act 2001 (Cth).

In this case, the tax debts of the insolvent company Mortlake Hire Pty Ltd were paid to the Tax Office by a related company Antqip Pty Ltd. The two companies shared the same sole director and shareholder, a Mr Russell, until at one point Mr Russell resigned as director of Antqip in favour of his daughter, although he continued to control Antqip’s business and bank accounts. The accounts of the companies were poorly kept, and indeed the computer in which the accounting records for the relevant financial years were stored had been disposed of. It appears that, as often happens, the liquidators had had to reconstruct the ledgers using what could be established by other records.

Mortlake’s liabilities to the Commissioner were recorded by the ATO in two separate accounts – the integrated client account (also known as the Running Balance Account) which recorded Mortlake’s primary tax liabilities to the Commissioner, and the Superannuation Guarantee Account which recorded its superannuation guarantee charge liabilities. The two payments in question were initially applied to reduce the balance of the Running Balance Account, but the Commissioner some months later reallocated the two payments to the Superannuation Guarantee Account in reduction of that liability. I will come back to this aspect of the case.

Mr Russell gave evidence that the two payments to the ATO were made by electronic funds transfer from Antqip’s bank account. Mr Russell’s evidence was that it was his intention that these payments were made by Antqip by way of a loan to Mortlake; indeed he said he instructed Mortlake’s bookkeeper to record the amount of those payments as a loan from Antqip to Mortlake.

The liquidators’ evidence was that there were not expected to be any distribution to any class of creditor of Mortlake, after allowing for costs of the voluntary administration and subsequent liquidation of Mortlake.

Section 588FA(1) of the Act provides –

“A transaction is an unfair preference given by a company to a creditor of the company if, and only if:

(a) the company and the creditor are parties to the transaction (even if someone else is also a party); and

(b) the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company;

even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.”

It should be noted that previously the authorities have established that a “transaction” for the purposes of s 588FA(1), and as defined by s 9 is a word of wide connotation and can include a composite or multi-step dealing involving a third party. Where the third party payment is made with the authority of the company it can extinguish the company’s debt to the creditor, such that it can be treated as part of a multi-step transaction to which the company is party. This may amount to the giving of a preference by the company to the creditor. (See Re Emanuel (No 14) Pty Ltd (in liq); Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281; 24 ACSR 292; Capital Finance Australia Ltd v Tolcher [2007] FCAFC 185; (2007) 164 FCR 83; 64 ACSR 705 – note that special leave was granted in Capital Finance, and the High Court heard the appeal, but the parties settled prior to judgment.)

The ATO’s arguments were that the payments in question were not caught for these reasons –

• The company (Mortlake) and the creditor (ATO) were not “parties to the transaction” as required by s 588FA, as the money came from a different entity (Antqip);
• The company’s asset pool was not depleted by the making of the payments, as they came from the funds of another entity (Antqip). Thus, so the argument went, there was no preference over other creditors as the other creditors were not deprived of assets that would otherwise have been available on a disbtribution;
• As the ATO applied the money to the Superannuation Guarantee Charge debt (a priority payment under s 556), there was no unfair preference to the ATO, as it would have received the same priority over other creditors in any event.

Nicholas J of the Federal Court in Kassem gave all three arguments short shrift –

• His Honour was satisfied that the payments were made by or on behalf of Mortlake using moneys borrowed by Mortlake from Antqip and advanced to the Commissioner in accordance with Mortlake’s directions. Hence Mortlake and the Commissioner were “parties to the transaction”. [At 23-27, 36]
• Mortlake borrowed from one creditor to pay another. The payments to the Commissioner made possible by that new borrowing were applied towards a pre-existing debt. Thus there was no enlargement or enhancement of the pool of assets available to satisfy the claims of Mortlake’s other unsecured creditors. It is clear the Commissioner would not have received $70,000 by way of dividend in respect of the superannuation charge debt if he had proved for it in the winding up instead of accepting the impugned payments as he did. It follows that he has received an unfair preference. [At 42-46]
• The SCG argument failed also, on the basis that the priority the Commissioner claimed it would have would not obtain in the circumstances of this case. The Court must assess the unsecured creditor’s likelihood of recovery in the context of the actual winding up that eventuated, rather than a hypothetical winding up postulated to take place at the time of the impugned transaction. The evidence established that even as a priority creditor there was little prospect of the Commissioner receiving any dividend at all in the winding up of Mortlake. Therefore, contrary to the Commissioner’s argument on this too, he has received money which he would not receive if instead he was to prove for that amount in the winding up of Mortlake. It followed, so held Nicholas J, that he had received an unfair preference. [At 36-41, 45-47]

I refer to the last argument raised by the Commissioner. As noted above, the argument was that the money received was applied to the Superannuation Guarantee Charge debt (a priority payment under s 556 of the Act). As there were no other unsecured creditors of equal or higher priority, the Commissioner received no “unfair” preference, as he would have been accorded priority over the other unsecured creditors in any event. The Court rejected that argument on the basis given above, but at [47] his Honour noted that it was “unnecessary for [him] to consider whether or not the Commissioner would have been entitled to the priority he claimed to be entitled to under s 556(1)(e)”.

I query whether his Honour there was referring to the merit of the legal argument, or alluding to whether the Commissioner would have been entitled to the claimed priority, given the fact that the ATO had first credited the payments to the integrated client or Running Balance Account, and subsequently reversed that and reallocated the payment to the Superannuation Guarantee Account. I suggest it would seem extraordinary if the ATO could rely upon that reallocation, as it sought to do here, to escape the operation of Part 5.7B of the Act. It would mean that the ATO could simply reallocate payments it had previously received to pay off PAYG or GST liabilities to taxpayers’ SGC accounts, or allocate them to a different liability to that for which they were paid by or for the taxpayer, thereby circumventing any later claims for repayment by a liquidator.

This case does not involve a large amount of money, but it does involve arguments the Commissioner may want to test further. It will be interesting to see if the decision is appealed.