The High Court, by a 3:2 majority, has dismissed the Commissioner’s appeals from the Full Court of the Federal Court of Australia, in Commissioner of Taxation v Australian Building Systems PL (in liq)  HCA 48. You can read the summary of the judgment published by the High Court on its website here, and the judgment in full here. Four separate judgments were written: by French CJ and Kiefel J and by Gageler J in the majority; Keane J and Gordon J each wrote separate judgments in dissent.
Last week the Federal Court declared void two s 260-5 “garnishee” notices which had been issued by the Deputy Commissioner of Taxation to NAB requiring payment of post-liquidation tax liabilities assessed against a company in liquidation and its liquidator of over $298 million and $308 million, in The Bell Group Limited (in liq) v Deputy Commissioner of Taxation  FCA 1056.
The Court held that the Commissioner had no power to issue the notices for post-liquidation tax liabilities. It held that –
- A section 260-5 notice is an attachment for the purposes of s 468(4) of the Corporations Act (see ). (Section 468(4) provides that: “Any attachment, sequestration, distress or execution put in force against the property of the company after the commencement of the winding up by the Court is void.”)
- A section 260-5 notice that relates to a post-liquidation tax-related liability does not avoid the operation of s 468(4) as a remedy specifically provided for or preserved by s 254(1)(h) of the ITAA36. It is not so preserved (see ). (Section 254(1)(h) of the ITAA36 provides that: “For the purpose of insuring the payment of tax the Commissioner shall have the same remedies against attachable property of any kind vested in or under the control or management or in the possession of any agent or trustee, as the Commissioner would have against the property of the taxpayer in respect of tax.”)
- Indeed the preferable construction of s 254(1)(h) of the ITAA36 is that it does not confer any remedy on the Commissioner against the property of a company after the commencement of the winding up of the company because such property is not “attachable property”. Thus s 254(1)(h) of the ITAA36 does not override or “trump” s 468(4) of the Corporations Act (see -),
- Nor can s 468(4) be read down to permit such an attachment even if the Commissioner has some level of priority in respect of post-liquidation tax-related liabilities (pursuant to s 556(1)(a) of the Corporations Act) (see ),
- Applying the High Court’s reasoning in Bruton Holdings with respect to pre-liquidation tax debts, the Commissioner also has no power to issue s 260-5 “garnishee” notices to a company in liquidation (or its liquidator) in respect of post-liquidation tax-related liabilities. The High Court’s reasoning as to the regime in s 260-45 of Schedule 1 of the TAA is equally applicable to the scheme in s 254 of the ITAA36. There is no relevant distinction between the two statutory schemes. “Both require the liquidator to set aside amounts to meet expected tax debts, but leave questions of payment and priority to the Corporations Act.” (see  and )
- The Commissioner had no power to issue the notices in this matter. (see )
In summary the key facts – which were not in dispute (see -) – are these –
On 24 July 1991, a liquidator was appointed to The Bell Group Company Limited (TBGL) and related entities by the Supreme Court of Western Australia. On 3 March 2000 Mr Antony Woodings was appointed an additional liquidator, and he became sole liquidator on 21 August 2014.
Back in 2000 the well-known, long-running Bell Group litigation commenced against a number of Australian and overseas banks. On 28 October 2008 in his 2,643 page judgment, Owen J found against the banks and ordered them to pay TGBL and related entities total amounts exceeding $1.5 billion. This was increased on appeal by the WA Court of Appeal to over $2 billion.
The banks then sought and obtained special leave to appeal to the High Court. However prior to hearing, a settlement was agreed. The Deed of Settlement provided, amongst other things, for the banks to pay a settlement sum of just under $1 billion plus adjustments to the liquidator Mr Woodings to be held on trust for TGBL and related entities in certain specified proportions. Broadly, the key clauses provided that Mr Woodings held the sum on trust for each of the “Bell Judgment Creditors” in specified proportions, and that the settlement sum was to be held in an interest bearing trust account or accounts, and the same parties would have a vested and indefeasible interest in their proportion of the interest earned.
TBGL’s proportion of the settlement sum specified in the Deed in 2008 had been just over $5 million, plus a share of the adjustment amounts.
Although the Deed provided for the distribution of the settlement sum, for reasons which Wigney J observed were not necessary to go into, the funds held on trust were not distributed, either pursuant to the settlement deed or in the winding up generally. His Honour noted that it appeared not to be disputed that at some stage the funds would be distributed.
At the time of this hearing, Mr Woodings held $300 million paid pursuant to the Deed of Settlement in a NAB term deposit account in the name “ALJ Woodings as Trustee for the Bell Judgment Creditors”. This investment matured on 2 October 2015.
On Wednesday 5 August 2015 Mr Woodings, in his capacity as liquidator of TBGL (as head company of a consolidated group), caused TGBL to elect to form an income tax consolidated group under Part 3-90 of the Income Tax Assessment Act 1997 (Cth) (ITAA97), and the companies entered into a tax sharing agreement for the purposes of Division 721 of the ITAA97. It was common ground that the terms of both of these had no bearing on the validity of the garnishee notices.
On Monday 10 August 2015 the Commissioner issued a notice of assessment to TBGL as head company of the consolidated group for the 2014 income year, assessing TBGL’s taxable income in the amount of over $1 billion and the tax payable in an amount of over $308 million.
On 18 August 2015, due to a calculation error in the assessment, the Commissioner issued an amended assessment to TBGL assessing the 2014 taxable income as nearly $994 million and the tax payable as over $298 million.
Corresponding assessments were also issued to Mr Woodings in his capacity as liquidator of TBGL, relating to the same income and the assessed tax payable of over $298 million.
On 14 August 2015 the Deputy Commissioner issued the two garnishee notices to NAB – one in respect of the assessment issued to TBGL and the other to Mr Woodings. The TBGL notice specified the amount originally assessed of over $308 million, although the NAB was subsequently advised that the amount due under the notice was varied to just over $298 million.
Objections were lodged by both TBGL and Mr Woodings.
Summary – Submissions
TBGL and its liquidator submitted that the reasoning in Bruton Holdings PL (in liq) v Commissioner of Taxation  HCA 32; (2009) 239 CLR 346 applied to the two garnishee notices even though Bruton Holdings dealt with the scheme for pre-liquidation tax-related liabilities in s 260-45 of Schedule 1 to the Tax Administration Act 1952 (Cth) (TAA), as opposed to post-liquidation tax-related liaiblities, and involved the operation of s 500(1) rather than s 468(4) of the Corporations Act. They argued – successfully – that –
- The Hight Court made emphatic and unequivocal statements in Bruton Holdings, in particular at ,  and , that the power conferred on the Commissioner by s 260-5 of Schedule 1 to the TAA does not extend to the case of a company in liquidation, including where there has been a court ordered winding up.
- The High Court’s reasoning applies equally to the case of post-liquidation tax-related liabilities. This is because post-liquidation tax-related liabilities are also the subject of a specific scheme, being the scheme in s 254 of the ITAA36 and Chapter 5 of the Corporations Act, in particular s 556.
- That specific scheme excludes the more general provision in s 260-5 of Schedule 1 to the TAA for exactly the same reasons as those given by the High Court in Bruton Holdings in respect of the specific scheme in s 260-45 of Schedule 1 to the TAA. (See )
Contrary to this, the Commissioner submitted that the reasoning in Bruton Holdings was inapplicable to the circumstances of this case because –
- The statutory scheme in respect of post-liquidation tax-related liabilities in s 254(1) of the ITAA36 is different to the scheme in s 260-45 of Schedule 1 to the TAA in respect of pre-liquidation tax-related liabilities.
- The main difference is that s 254(1)(h) of the ITAA36 – properly construed – specifically provides for or preserves the availability of hte Commissioner’s remedy in s 260-5 of Schedule 1 to the TAA.
- As a result, s 254(1)(h) operates to “trump” the more general provision in s 468(4) of the Corporations Act.
- The Commissioner pointed to several authorities which he argued provided support for the proposition that preference is to be given to specific schemes in taxation legislation designed to protect the revenue over “more general schemes in the Corporations Law”. Those authorities included the High Court’s decisions in COT v Broadbeach Properties PL  HCA 41; (2008) 237 CLR 473 and DCOT v Moorebank PL  HCA 29; (1988) 165 CLR 55, and the NSWCA in Muc v DCOT  NSWCA 96; (2008) 73 NSWLR 378.
Alternatively, the Commissioner submitted that –
- Even if s 254(1)(h) of the ITAA36 did not operate as he contended, the word “attachment” in s 468(4) of the Corporations Act should be read down so as to permit s 260-5 notices in respect of priority debts.
- Post-liquidation tax-related liabilities were a priority debt because they would be an expense within s 556(1)(a) of the Corporations Act.
- Given that priority status, there was no basis for reading the term “attachment” in s 468(4) of the Corporations Act so as to exclude the giving of a s 260-5 notice to enforce that statutory priority. (See -)
His Honour Justice Wigney held that the notices were void for two related reasons –
- Each notice was an attachment against the property of TBGL and therefore void by operation of s 468(4) of the Corporations Act, and
- That conclusion supports the more general proposition that the power conferred on the Commissioner to issue notices under s 260-5 of Schedule 1 to the TAA is not available where the relevant “debtor” for the purposes of that section is a company which is being wound up (or its liquidator). That is so even where the relevant debt is for tax payable on income derived after the commencement of the winding up. (See -)
His Honour observed that –
- The High Court concluded in Bruton Holdings that a s 260-5 notice is an attachment for the purposes of s 500(1) of the Corporations Act. (Section 500(1) provides: Any attachment, sequestration, distress or execution put in force against the property of the company after the passing of the resolution for voluntary winding up is void.”) While in some respects this finding was secondary to the broader finding as to the Commissioner’s power to issue a notice in respect of a tax debt of a company in liquidation, it was nonetheless an unequivocal and unqualified finding.
- It applies equally to s 468(4) of the Corporations Act, which is in identical terms to s 500(1) (save that the latter applies to voluntary liquidations, and the former to Court-ordered liquidations).
- The High Court’s conclusions in Bruton Holdings at both  and  refer to winding up by court order, “thus clearly indicating that the court saw no relevant distinction between ss 468(4) and 500(1) of the Corporations Act”.
Wigney J noted that the Commissioner “in effect” accepted that a s 260-5 notice was an attachment for the purposes of s 468(4) of the Corporations Act. He referred to the Commissioner’s arguments that s 468(4) did not however render such a notice void if the notice related to post-liquidation tax-related liabilities, because either s 254(1)(h) of the ITAA36 “trumped” s 468(4), or because s 468(4) should be read down. His Honour’s assessment of these arguments at  was crisp and succinct: “Neither contention has any merit.”
Construction of s 254(1)(h) of the ITAA36
His Honour took issue with the Commissioner’s contentions as to the proper construction of s 254(1)(h) of the ITAA36 – see -. He discussed the use of the word “attachable” in s 254(1)(h), and took the view that it evinced a legislative intention to avoid any potential conflict between s 254(1)(h) and provisions such as ss 468(4) and 500(1) of the Corporations Act, that prevent attachment of certain types of property. Wigney J observed that a construction of s 254(1)(h) which allows it to operate harmoniously with ss 468(4) and 500(1) of the Corporations Act is to be preferred to one that potentially puts the provisions of two Commonwealth statutes in conflict, or results in a provision of one statute overriding (or “trumping”) a provision in another statute.
His Honour noted at  that this meant s 254(1)(h) effectively has no application in the case of a company in liquidation, but found that that does not militate against its availability. The subsection still has significant work to do, even if it does not apply to liquidators, because it operates also in the case of all agents and trustees who derive income in a representative capacity, or by reason of their agency. Subsection 254(1)(h) still has work to do in the case of other agents or trustees, where attachment of property under their control or management is not prevented by provisions equivalent to ss 468(4) and 500(1) of the Corporations Act.
Wigney J held that “the preferable construction of s 254(1)(h) of the ITAA36 is that it does not confer any remedy on the Commissioner against the property of a company after the commencement of the winding up of the company because such property is not attachable property.” See )
Whether s 468(4) of the Corps Act should be read down to permit s 260-5 notices for post-liquidation tax debts
Wigney J discussed the Commissioner’s submission that s 468(4) of the Corporations Act should be read down to permit s 260-5 notices for post-liquidation tax debts and noted that it seemed to rely on two propositions: (1) that ss 468(4) and 500(1) of the Corporations Act only operate to render void an attachment if the effect of the attachment is to secure priority for the payment of a debt that is not otherwise a priority debt; and (2) that the Commissioner has priority in respect of post-liquidation tax-related liabilities. His Honour again crisply dispatched these too: “Neither proposition is correct.” (See )
Whether the Commissioner has priority for post-liquidation tax debts
- It is not strictly correct to say that the Commissioner has priority in respect of post-liquidation tax-related liabilities by reason of s 556(1)(a) of the Corporations Act.
- Subsection 556(1)(a) gives priority to expenses incurred by, relevantly, a liquidator, in preserving, realising or getting in property of a company, or in carrying on the company’s business.
- By reason of s 254(1)(e) of the ITAA36, a liquidator is personally liable for the tax payable in respect of post-liquidation income to the extent of any amount that he or she has, or should have, retained under s 254(1)(d) of the ITAA36. **Sidenote: See below under the heading “Comments” – there is an important appeal that has just been heard by the High Court on ss 254(1)(d) and (e) of the ITAA36.
- If, for whatever reason, the liquidator does not discharge the company’s tax-related liabilities from its available assets, but instead personally pays (or is required to personally pay) that amount, it might well be regarded as an expense in getting in property of the company or carrying on its business.
- The liquidator would have priority in recovering that expense by reason of s 556(1)(a) of the Corporations Act.
- That does not mean however, his Honour observed, that the Commissioner has priority in respect of post-liquidation tax-related liabilities.
- Wigney J noted that in any event, that expense would not rank any higher than other expenses incurred by the liquidator that might also fall within s 556(1)(a) of the Corporations Act. If there are a number of these but insufficient assets to meet them all, they would rank equally and be met proportionally. His Honour noted that this proportionate system of entitlement would be subject to potential disruption if the Commissioner had full garnishee rights in relation to post-liquidation tax debts in those circumstances.
No Power to issue the Notices
Wigney J referred to the High Court in Bruton Holdings‘ conclusion that the power to issue garnishee notices conferred by s 260-5 of Schedule 1 to the TAA does not extend to a company in liquidation. This is expressed three times in the judgment – at ,  and  in clear, unequivocal and unqualified terms.
His Honour took the view that the reasoning of the High Court in Bruton Holdings, insofar as it involved consideration of the regime in s 260-45 of Schedule 1 to the TAA in respect of pre-liquidation tax-related liabilities, is equally applicable in cases which involve the scheme in s 254 of the ITAA36 in relation to post-liquidation tax-related liabilities. There is no relevant distinction between the two statutory schemes. “Both require the liquidator to set aside amounts to meet expected tax debts, but leave questions of payment and priority to the Corporations Act.”
Accordingly, Wigney J held that the Commissioner had no power to issue the notices in this matter. (See -)
Trustee Capacity Issue
Whilst noting it was strictly unnecessary, Wigney J addressed the submission for TBGL and its liquidator that the notices were either invalid or not engaged, because the funds held in the NAB account were held by Mr Woodings in his capacity as trustee for the Bell Judgment Creditors. By reason of the definition of “entity” in the relevant provisions of the ITAA97, Mr Woodings is taken to be a different entity in that trustee capacity, than his capacity as liquidator of TBGL.
His Honour took the view that this argument had some merit in the case of the notice referable to the liquidator Mr Woodings, having regard to the applicable proviisons of the ITAA97. NAB did not owe money to Mr Woodings in his capacity as liquidator of TBGL, but in his capacity as trustee. Therefore, even if the Woodings Notice was not void by reason of s 468(4) of the Corporations Act, it would nevertheless have no application to the NAB account. His Honour took the view that this capacity issue did not, however, affect the validity of the TBGL Notice, if it were not otherwise void by reason of s 468(4). (See -)
Tax Laws v Insolvency Laws – Another current case – COT v Australian Building Systems
As many of you will know, this is not the only significant case before the courts at present, involving a clash of sorts between provisions of the tax legislation and insolvency provisions of the Corporations Act.
Just last month the High Court heard the Commissioner’s appeal from the decision in Commissioner of Taxation v Australian Building Systems Pty Ltd (in liq)  FCAFC 133, a CGT case largely concerned with s 254(1)(d) and (e) of the ITAA36. For my previous posts discussing the first instance decision of Logan J in that case and the High Court’s hearing of the special leave application, see here and here respectively. The transcript of the hearing in the High Court can be read here.
At first instance this case was, at least in part, more squarely run as a clash between these provisions of the ITAA36 and the scheme of priority laid down by the Corporations Act; particularly notable given that the former crown priority for unpaid tax debts was abolished in the early 1980’s with the passing of legislation. However the appellable issues were narrowed by the reasons for judgment given at first instance. On appeal to the High Court, the submissions filed for the parties show that of the 3 issues raised in the appeal by the Commissioner, only one was contested by the liquidators. (The parties’ submissions may be read here.) That issue was this:
Whether, following the derivation by a trustee or agent of income profits or gains in a representative capacity, but prior to a tax assessment, s 254(1)(d) requires and authorises the agent or trustee to retain moneys then in their hands or thereafter coming to them so much as is sufficient to pay tax on it; or whether s 254(1)(d) only authorises and requires a trustee or agent to retain such moneys after an assessment for tax on the income profits or gains.
Note that the personal liability imposed upon agents and trustees (including liquidators by s 254(1)(e) applies to the extent of any amount that he or she has retained, or should have retained under paragraph (d).
It will be interesting to see the extent to which the High Court grasps the opportunity in COT v Australian Building Systems to clarify the operation of both ss 245(1)(d) and (e) in its decision in this case, and provide certainty for liquidators as to their potential scope for personal liability under s 245(1)(e). That is, as to how s 245(1)(e) operates – in light of the conclusions the Court may reach as to the proper construction of s 245(1)(d) – and the extent to which s 245(1)(e) might (as the Commissioner argued in Bell Group vis a vis s 245(1)(h)) serve to override or “trump” certain provisions of the Corporations Act; here the scheme of priorities laid down in the Corporations Act. It is unfortunate but it may be the case that as events have transpired, it may not turn out to be the ideal test case vehicle for this issue.
The Bell Group Collapse – 20+ years and counting – mixed messages as to handling of distribution
You may recall in the chronology above that the Deed of Settlement was reached in 2008 and we presume that payments made thereunder in about 2008. The next step in the chronology recited above is the activity in August 2015 in relation to taxation matters.
Between those points in the chronology, I ought to interpose the observation that reportedly there had been other litigation both threatened and run about the distribution of money from the pool both in the WA Supreme Court and in the British High Court. In May 2015, it was reported by ABC news that according to the WA State Government, the total $1.7 billion settlement sum was going to be disbursed through a statutory authority. ABC News reported that WA Treasurer Mike Nahan had mentioned the introduction of legislation to ensure there was certainty about the process of distributing funds to treasurers. They reported that a bill had been introduced to Parliament by Dr Nahan to dissolve the companies and place the assets under the control of a statutory authority that would administer and distribute them. Dr Nahan reportedly said that the four major creditors owed money were the Insurance Council of WA, the ATO, and two other legal parties. Dr Nahan, it was reported, said that “the bill would ensure an expeditious end to the Bell litigation and the equitable distribution of the pool of funds.” One cannot know all that transpired thereafter. Perhaps the forming of the consolidated group for taxation purposes may have triggered the ATO’s actions. However it would appear possible that the Commissioner may not have concurred with the approach put forward in the bill.
This is a brief heads up for those who have been waiting for this. Last week the High Court granted special leave to the Commissioner to appeal the decision of the Full Court of the Federal Court in Commissioner of Taxation v Australian Building Systems Pty Ltd (in liq)  FCAFC 133. For my discussion of the first instance decision of Logan J, see my earlier post here.
It will indeed be interesting to see the High Court’s decision on this, after the appeal is heard. For those interested, the transcript of the special leave hearing may be read here. It can be seen that the Commissioner emphasised several matters in oral submissions, including the Commissioner’s propounded construction of section 254 of the ITAA 1936, and what the Solicitor-General described as “the radical differences” between sections 254 and 255, the construction of the latter having been decided previously by the High Court in Bluebottle UK Ltd v Deputy Commissioner of Taxation  HCA 54; (2007) 232 CLR 598. The High Court’s decision in Bluebottle was relied on heavily by the primary judge in his reasoning.
In oral submissions, the Solicitor-General advanced the argument that section 254(1)(a) creates a taxation liability in the trustee or agent. This, of course, is contrary to what the Full Federal Court had held. See, for instance, at  where Edmonds J observed (with whom Collier and Davies JJ agreed):
“That s 254 is a “collecting section” and has no operation to render a trustee liable to be assessed to tax if the trustee is not otherwise liable to be assessed under the provisions of Div 6 of Pt III of the 1936 Act, comes out of two more recent High Court authorities.”
The Solicitor-General argued that this taxation liability which he said is created by s 254(1)(a) is ancillary to the primary liability which, he acknowledged, will rest somewhere else in the Act. But he submitted that it was a true creation of a liability as well as then being a collection mechanism. He submitted that s 254(1)(b) makes that liability more explicit, that the trustee or agent must lodge returns and “be assessed thereon” in the representative capacity. And, so he submitted, then the critical paragraph (d), which is the collection mechanism, should be read in the light of what has gone before so that it is an authority and duty to “retain from time to time out of any money which comes to him or her in his or her representative capacity so much as is suffficient to pay tax which is or will become due in respect of the income, profits or gains.“
This is a brief heads up for those of you who have been awaiting this appeal judgment as I have. Yesterday the Full Federal Court dismissed the Commissioner’s appeal in Commissioner of Taxation v Australian Building Systems Pty Ltd (in liq)  FCAFC 133. In short, the judgment confirmed that s 254(1)(d) of the Income Tax Assessment Act 1936 (Cth) (the ITAA) only imposes an obligation upon “trustees” (including liquidators) to retain funds to pay an anticipated CGT liability once a relevant tax assessment has issued.
Edmonds J who wrote the principal judgment went so far as to say that he was “firmly of the view” that the primary judge was correct in that conclusion (at ). For my discussion of the first instance decision of Logan J, see my earlier post here. There is more to be said about the significance of this conclusion of the Full Federal Court, which some of you will have heard me speak about following the first instance decision. My review of this appeal judgment to follow. ***Time has beaten me as Christmas now approaches. My review is part-written, and will now follow in the New Year.
The Federal Court portal shows that the Commissioner of Taxation has appealed to the Full Court of the Federal Court of Australia the decision of Logan J in Australian Building Systems Pty Ltd v Commissioner of Taxation  FCA 116.
At first instance, the Federal Court allowed the liquidators’ objection to the Commissioner’s private ruling on the issue. It ordered that the private ruling be set aside and in lieu thereof, the first question in respect of which that ruling was made, was to be answered as follows (the other questions fell away as the answer to 1 became “no”):
Question 1: Is the liquidator required under s 254 of the Income Tax Assessment Act 1936 (Cth) (the ITAA) to account to the Commissioner out of the proceeds of sale, any CGT liability that crystallises on the sale of an asset that belonged to the company before liquidation?
Answer: No, given the [then] present absence of an assessment.
In that case, the company had been placed in voluntary administration on 2 March 2011, and entered a creditors voluntary liquidation on 6 April 2011. Subsequently, the liquidators caused the company to dispose of a property, which constituted a “CGT event” under the ITAA.
Logan J considered the interaction of s 254 of the ITAA with key provisions of the Corporations Act 2001 (Cth) including s 501 as to distribution of property of a company in liquidaiton, s 555 as to the pari passu rule, that except as otherwise provided by the Corporations Act, all debts and claims proved in a winding up rank equally and are paid proportionately, s 553 as to debts or claims that are provable in a winding up, and s 556 as to priority payments.
The Commmissioner’s submission was that, in the circumstances of that case, the effect of s 254(1)(d) of the ITAA was that the liquidators became liable to retain from the proceeds of sale of a particular property, when those proceeds came into their hands an amount sufficient to pay the tax that would become due in respect of the net capital gain arising from the disposal of that property. The Commissioner contended that it was not necessary for there to be a notice of assessment before the retention obligation could arise (see ).
The liquidators submitted that, in the absence of an assessment, there could be no obligation. In that case, no assessment had yet been issued.
His Honour agreed. He reviewed the authorities and accepted that s 254 is “but a collection provision” not one that itself triggers the taxation liability (which may arise by the operation of other provisions of the ITAA36 or ITAA97). It follows, his Honour observed, that s 254 does not provide for an “incontestable tax” in the sense described by Gibbs CJ, Wilson, Deane and Dawson JJ in MacCormick v Commissioner of Taxation  HCA 20; (1984) 158 CLR 622 at 639-640.
His Honour held in favour of the liquidators, and noted at  that the liquidators were not subject to any present retention and payment liability, and that he would so declare.
However, his Honour then added the following remarks, perhaps sensible of the potential for this decision to be construed as applying more broadly than it ought, at :
“I should also add the following. Even though, for the reasons given, s 254 does not require retention upon the mere happening of a CGT event, that does not mean that a liquidator is obliged immediately to distribute the resultant gain or part thereof as a dividend to creditors in the course of the winding up. A prudent liquidator, like the prudent trustee of a trust estate or executor of a will, would be entitled to retain the gain for a time against other expenses which might arise in the course of the administration. Further, in relation to income tax, the liquidator would at the very least be entitled to retain the gain until the income tax position in respect of the tax year in which the CGT event had occurred had become certain by the issuing of an assessment or other advice from the Commissioner that, for example, no tax was payable in respect of that income year. Yet further, in the event of a controversy after the issuing of an assessment as to whether the tax debt that was provable in the winding up, the liquidator would be entitled to retain the gain or some part thereof sufficient to meet the assessed tax until that controversy was resolved. Whether there proves to be such a controversy in the present case must await the course of future events. If it comes to pass, the liquidators would be entitled to seek declaratory relief from the Court to resolve it.”
Where does that leave liquidators?
Pending the appeal, caution would be wise. Clearly the prudent course is that while there may be no obligation on a liquidator to retain funds in anticipation of a potential CGT liability upon disposal of an asset, a liquidator ought bear in mind the judicial remarks that a liquidator is entitled to retain the gain until assessment.
Note too that the decision at first instance does not resolve the question of the extent to which s 254 does or does not disturb the distribution priority provisions of the Corporations Act referred to above.
Earlier this week, the Federal Court gave judgment in Deputy Commissioner of Taxation v Bayconnection Property Developments Pty Ltd (no 2)  FCA 208 (link). The case is a handy illustration of the fact that where the Commissioner applies to wind up a company, it may proceed to obtain the order even though a company has lodged an appeal as to the tax liability upon which the statutory demand was founded.
The Commissioner had served a statutory demand in April 2011. The company filed a s 459G application for an order setting it aside. It argued it had a genuine dispute as to the amount or existence of the debt, pursuant to s 459H(1). It had lodged an objection to the Commissioner’s assessment, the objection had been disallowed, and the company had taken steps to challenge the objection decision in the Administrative Appeals Tribunal. On that occasion, Barrett J in a pithy and emphatic 8 paragraphs, dismissed that proceeding in September 2011 – see In the matter of Bayconnection Property Developments Pty Ltd  NSWSC 1048.
Then in November 2011 the Commissioner filed an application under s 459P to winding up the company on the ground of insolvency. This was first heard in April 2012. It was common ground that the Court was required to presume that the company was insolvent, pursuant to s 459C(2)(a), as it had not complied with the Commissioner’s statutory demand.
On that occasion (link), Robertson J adjourned the Commissioner’s winding up application, pending the outcome of the defendant company’s challenge to the Commissioner’s assessment of its tax liability. It had issued proceedings under s 14ZZM of Pt IVC of the Taxation Administration Act 1953 (Cth), in the Administrative Appeals Tribunal. The Commissioner conceded, as he had in Broadbeach at , that:
“Notwithstanding the presumption of insolvency that would apply under s 459C(2)(a)…upon the hearing of such winding up applications the court might properly have regard to whether the taxpayer had a “reasonably arguable” case in proceedings under Pt IVC of the Administration Act, if those proceedings then still be on foot…”.
Robertson J accepted that the company had a “reasonably arguable” case in those proceedings. The company submitted, and it was accepted, that it was insolvent only by reason of the alleged tax debt – it had no other third party creditors. It was no longer trading and had not been for some years. On that occasion, Robertson J exercised his discretion in s 459A of the Act (“On an application under s 459P, the Court may order that an insolvent company be wound up in insolvency.” ) and adjourned the winding up application. His Honour also made an order under s 459R(2) extending the period within which the wind up application must be determined (the specified period being within 6 months of the application being made).
The Tribunal then heard the tax matter over five days in August 2012 and reserved its decision. The Tribunal handed down its decision on 29 January 2013. The company (and its related defendant companies) lodged a notice of appeal to the Federal Court within time, and the tax appeal was listed for first directions on 14 March 2013. (Robertson J was hearing this winding up application on 8 March 2013.)
Before Robertson J, the defendant companies again contended that there was and would be no debt to the Commonwealth by virtue of their tax appeals. While the Court was required to presume they were each insolvent, pursuant to s 459C(2)(a) of the Act, each company was insolvent only by reason of the tax debt in question.
Robertson J turned to the fresh exercise of his discretion, on this occasion, under s 459A. His Honour took into account the general principles set out in Southgate Investment Funds Ltd v Deputy Commissioner of Taxation  FCAFC 10 at , bearing in mind that that was a case about whether or not execution of a judgment debt should be stayed and a case where there had been no hearing on the merits, the appeal under Pt IVC of the Taxation Administration Act not having been hard.
His Honour identified the following factors which he took into account at , in refusing the adjournment application on this occasion –
- It is the taxpayer which bears the onus of persuading the Court that a stay ought be granted in the particular circumstances
- That great weight must be given to the clear legislative policy which gives priority to the recovery of taxation revenue notwithstanding that the taxpayer has a Pt IVC proceeding on foot
- That it is too narrow a view of the discretion to grant a stay merely because Pt IVC proceedings are pending or because on review of those proceedings there appears to be an arguable case
- That in cases where the Court considers that it is in a position to assess the merits of pending Pt IVC proceedings and that it is appropriate to do so, the weight to be attached to those merits will vary according to the relative strength of the merits but the taxpayer needs to have more than merely an arguable case
- That irrespective of the merits of pending Pt IVC proceedings, a stay will not usually be granted where the taxpayer is party to a contrivance to avoid liability to pay the tax
- That more weight would be given to the merits factor if the case is one where the Deputy Commissioner has abused his position.
Robertson J found it significant that the tax appeal from the AAT to the Federal Court was on, and limited to, questions of law. Whereas he had held in April 2012 that each company had an arguable case which extended to the facts, the position now was that each defendant company was limited to questions of law. His Honour considered the grounds, and found that they were not reasonably arguable (at ). His Honour found that even if he was wrong on that and the grounds of the tax appeal were reasonably arguable, they were not strong, and the clear legislative policy which gives priority to the recovery of taxation revenue, would outweigh any merits of the appeal to this Court. Perhaps even the highly esteemed tome, Fary on Adjournments, would not have aided the defendant companies in staving off the result, in this case.
His Honour ordered that the companies be wound up.
For those interested, I refer you to my case review last month of HC Legal Pty Ltd v Deputy Commissioner of Taxation  FCA 45, a most interesting case involving the dismissal of an application by a company to set aside a statutory demand issued by the Commissioner (link).
On Tuesday the Federal Court dismissed an application by a company trading as a law firm to set aside a statutory demand issued by the ATO. It is an interesting case and the judgment provides a useful reminder that even though a company may have challenged a tax assessment and an objection or appeal proceedings are pending, this is no bar to the Commissioner issuing a statutory demand, and does not of itself provide grounds to have one set aside. The judgment of Murphy J is that in HC Legal Pty Ltd v Deputy Commissioner of Taxation  FCA 45.
In applications to set aside a statutory demand, the ATO is in a privileged position compared with anyone else. This is because even where the taxpayer disputes the tax debt, the ATO has the benefit of several legislative provisions which have the effect of deeming notices of assessment and declarations as conclusive evidence that the amounts and particulars are correct and due. The Hight Court has held that the operation of those provisions cannot be sidestepped by an application by a taxpayer under s 459G of the Corporations Act to set aside a statutory demand by the Commissioner: Deputy Commissioner of Taxation v Broadbeach Properties Pty Ltd  HCA 41; (2008) 237 CLR 473 (Broadbeach Properties).
Before turning to the substantive part of the case, I will first briefly address two other aspects.
Applications for review of a Federal Court Registrar’s decision
HC Legal Pty Ltd v DCOT was in fact a rehearing de novo of the set-aside application which had first been made to a Registrar and dismissed. The plaintiff (HCL) had then made application for a review of the Registrar’s decision pursuant to s 35A(5) of the Federal Court Act 1976 (Cth). His Honour said the following in relation to the nature of applications for review of a Federal Court Registrar’s decision, at  –
“It is uncontroversial that the application involves a rehearing de novo, at which the parties may adduce further evidence. The Court is to exercise its discretion afresh, unfettered by the decision of the Registrar: Martin v Commonwealth Bank of Australia  FCA 87; (2001) 217 ALR 634 at  and ; Mazukov v University of Tasmania  FCAFC 159 at -; Callegher v ASIC  FCA 482; (2007) 239 ALR 749 at .”
Background – The contractual arrangement
This case involved a rather curious contractual arrangement, which lead directly to the tax liability and statutory demand that followed. The law firm in question Hambros and Cahill Lawyers (HCL) was a small one, with two lawyers as its directors. In December 2011, HCL entered into an agreement with an entity related to the winemaker Andrew Garrett (Holy Grail). Under the agreement, for a fee, Holy Grail granted HCL the exclusive rights to provide legal services to Mr Garrett’s associated entities. Not only might it be thought unusual for a law firm to purchase the rights to represent clients, but the size of the fee HCL agreed to pay for this right was staggering: $45m plus GST – a total of $49.5m. HCL was to pay this fee pursuant to a vendor finance agreement, the vendor being Holy Grail and the borrower being HCL. The effect of this was that HCL did not need to advance any funds at the time.
In early 2012, when HCL came to lodge its BAS for that last quarter in 2011, it stated it had made a capital purchase in the sum of $49.5m in the last quarter of 2011, and claimed input tax credits from the Commissioner in the sum of $4.5m for the GST paid on that purchase. After deductions for GST amounts it owed, the input tax credits it claimed came to $4,491,954, which the Commissioner then remitted to HCL. There was no evidence as to what then happened to that money in the hands of HCL, but HCL’s counsel informed the Court that it had been used to pay certain expenses of the firm, pay a deposit to purchase Seabrook Chambers in Melbourne, and the balance of $2m each was distributed to the two directors, posted in the books as a loan, although each director had paid back $350,000 to HCL.
As Murphy J put it: “The Commissioner’s concern regarding the transaction and the claim for input credits of $4.491 was immediately apparent.” Shortly thereafter the Commissioner froze HCL’s bank accounts and moved to audit the firm.
In May 2011, following the audit, the Commissioner assessed HCL as liable to pay $4.5m in GST. However, although the ATO’s Running Balance Account (RBA) statement for the company showed that GST liability as relating to the last quarter of 2011, the notice of assessment referred to the first quarter of 2012. Under a separate notice, with the correct tax period cited, there was also a penalty imposed of $2.5m.
On 19 June 2012 HCL lodged its objection to the assessment and penalty.
On 4 July 2012 the Commissioner served the statutory demand, seeking payment of $6.95m – $4.5m in GST, $2.25 penalty and interest charges.
On 11 September 2012 the Commissioner sent a letter enclosing a new, revised assessment to HCL, asserting the first notice had contained a typographical error and that the correct tax period was the last quarter of 2011. This was followed by an email from the Commissioner’s office referring to the error in the first assessment.
The Statutory Demand – Was there a “genuine dispute” such that it should be set aside?
The Court may set aside a statutory demand on the basis that there is a genuine dispute about the existence or amount of the debt to which the demand relates: s 459H(1)(a) and (3) of the Corporations Act 2001 (Cth) (the Act).
In the hearing before the Registrar, HCL had not contended that there was a genuine dispute under s 459H because, said Murphy J in his judgment, of the statutory protection afforded to debts arising from tax assessments. In the Broadbeach Properties case referred to above, the High Court said this at - –
“Section 459G applications by taxpayers are not Pt IVC proceedings and production by the Commissioner of the notices of assessment and of the GST declarations conclusively demonstrates that the amounts and particulars in the assessments and declarations are correct ([Taxation] Administration Act, Sch 1, s 105-100 [now s 350-10]; [Income Tax] Assessment Act, s 177(1)). That being so, the operation of the provisions in the taxation laws creating the debts and providing for their recovery by the Commissioner cannot be sidestepped in an application by a taxpayer under s 459G of the Corporations Act to set aside a statutory demand by the Commissioner.
“The matter was explained, with respect, correctly by Williams J in Bluehaven Transport Pty Ltd v Deputy Federal Commissioner of Taxation (2000) 157 FLR 26 at 32. The use by the Commissioner of the statutory demand procedure in aid of a winding up application is in the course of recovery of the relevant indebtedness to the Commonwealth by a permissible legal avenue. The phrase “may be recovered” in ss 14ZZM and 14ZZR of the Administration Act applies to the statutory demand procedure. That state of affairs places the existence and amounts of the “tax debts” outside the area for a “genuine dispute” for the purposes of s 459H(1) of the Corporations Act.”
To consider that for a moment: In other words, the effect of the legislative provisions cited in the first of these two paragraphs is that when it comes to debt recovery, the ATO’s claims are in a sense “bulletproof” – the notices of assessment and declarations they issue are treated as conclusive evidence that they are correct as to the amount and particulars of the tax liabilities. The effect of the provisions in the second paragraph is that the Commissioner can continue with recovery actions even if a review on objection or an appeal pending, as if no such review or appeal were pending.
While HCL did not run it before the Registrar, before Murphy J, HCL advanced the argument that there was a genuine dispute under s 459H(1). HCL argued that the Commissioner had conceded the first notice of assessment was flawed, pointing to the issue of the second notice, and the ATO correspondence about the error. HCL argued that this negated the first assessment on which the statutory demand was predicated.
His Honour rejected these arguments, on a number of grounds –
- The Commissioner had not discharged the first assessment made, as evidenced by the RBA statement showing no adjustment;
- The contentions of HCL were misconceived as they equated an “assessment” with a “notice of assessment”, the former being the official act or operation of the Commissioner, the second being the piece of paper informing of it (see - and the authorities and provisions there cited);
- The first notice of assessment with its error as to the relevant tax period did not affect the assessment itself. Indeed under s 105-20(1), Schedule 1 of the Taxation Administration Act 1953 (Cth), the assessment would remain valid even if notice of the assessment was not given at all (-);
- It was clear, including from HCL’s objection and submissions, that HCL was not mislead by the error in the first notice ();
- In any event, the Commissioner corrected the error by way of the second notice of assessment, which was provided prior to the hearing. The existence of a genuine dispute must be determined at the time the Court hears the application (see  and the authorities there cited);
- The Commissioner also has the benefit of s 8AAZI of the Taxation Administration Act, which provides that the production of an RBA statement is prima facie evidence that the RBA was duly kept and that the amounts and particulars in the statement are correct. The relevant RBA was in evidence before the Court and showed that the amount reflected in the statutory demand was the amount of HCL’s debt to the Commissioner as at the date of the statutory demand (see - and -);
- Various other legislative provisions have the effect that the amounts set out in the RBA statement were now due and payable by HCL: see subsection 8AAZH(1) of the Taxation Administration Act 1953 (Cth), and s 255-5 and 255-1 of Schedule 1 of that Act (see );
- The Commissioner also relied upon the above-mentioned s 350-10 of Schedule 1 of the Taxation Administration Act, which provides that the production of a notice of assessment is conclusive evidence that the assessment was properly made, and the amounts and particulars of the assessment are correct. His Honour was not persuaded that in the circumstances of this case that provision operated as the Commissioner contended, with regards to the first notice of assessment. However in light of his conclusions above, it was unnecessary to decide this question (see ).
The Court found that HCL’s contentions raised a spurious rather than bona fide or real ground of dispute. His Honour did not accept that the error in the first notice of assessment gave rise to a genuine dispute under s 459H of the Act as to the existence or amount of the debt to which the statutory demand related. The assessment itself was unchanged. (See  and the authority there cited.)
Whether the Statutory Demand should be set aside for some other reason
HCL also argued that the statutory demand should be set aside as there was “some other reason” which would justify the Court’s exercise of its discretion to do so pursuant to s 459J(1)(b) of the Act. HCL based this upon the Commissioner’s conduct, upon the fact that HCL had disputed the assessment by lodging an objection, and upon the contention that it had a reasonably arguable case on its objection.
In Hoare Bros Pty Ltd v Deputy Commissioner of Taxation (1995) 19 ACSR 125 at 139, the Full Federal Court observed that the discretion might be exercised where it is “shown that the Commissioner’s conduct was unconscionable, was an abuse of process, or had given rise to substantial injustice.”
Later judgments have indicated that the discretion is of broad compass, and Murphy J expressed the view that he did not consider the Court in Hoare Bros was seeking to exhaustively set out the situations it comprehends (although I suggest it provides a useful guide). HCL argued, and his Honour accepted, that it was not necessary to show that substantial injustice would be caused if the discretion were not exercised, although he qualified that, noting that in Broadbeach the High Court had overturned one of the decisions HCL relied upon in this submission. In other words, it indeed might be necessary to demonstrate substantial injustice would follow were the statutory demand allowed to stand.
HCL argued that the existence of proceedings disputing a tax assessment may be relevant to the exercise of the discretion, and pointed to a line of authority in support of that view (see ). However, as his Honour noted –
- Section 14ZZM of the Taxation Administration Act provides –“The fact that a review is pending in relation to a taxation decision does not in the meantime interfere with, or affect, the decision and any tax, additional tax or other amount may be recovered as if no review were pending.”
- Section 14ZZR provides – “The fact that an appeal is pending in relation to a taxation decision does not in the meantime interfere with, or affect, the decision and any tax, additional tax or other amount may be recovered as if no appeal were pending.”
- In 2008 in Broadbeach, subsequent to the authorities HCL relied upon, the High Court observed at - that – “[T]he hypothesis in the present appeals must be…that there is no “genuine dispute” within the meaning of s 459H(1). Both the primary judge and the Court of Appeal emphasised the importance of the disruption to taxpayers, their other creditors and contributories that would ensure from a winding up, together with the absence of any suggestion that the revenue would suffer actual prejudice if the Commissioner were left to other remedies to recover the tax debts. But these considerations are ordinary incidents of reliance by the Commissioner upon the statutory demand system….The “material considerations”…which are to be taken into account, on an application to set aside a statutory demand, when determining the existence of the necessary satisfaction for para (b) of s 459J(1) must include the legislative policy, manifested in ss 14ZZM and 14ZZR of the Administration Act, respecting the recovery of tax debts notwithstanding the pendency of Pt IVC proceedings.”
- His Honour considered that the legislative policy in ss 14ZZM and 14ZZR is that tax assessments are to be paid, even though a review or appeal is on foot;
- His Honour also pointed to the judgment of Olney J in Kalis Nominees Pty Ltd v Deputy Commissioner of Taxation 91995) 31 ATR 188 at 193 where Olney J – with a note of regret at the end – said: “…The policy of the law would be defeated if a demand were set aside under s 459J(1)(b) simply because a review of an objection decision is pending. A taxpayer must, in the context of a case of this nature, demonstrate more than the fact that he disputes his liability for the tax as assessed and that he is actively pursuing his remedies. It is both unnecessary and undesirable to endeavour to list the circumstances which would justify the exercise of the discretion under s 459J(1)(b) except to say that in the case in which the Commissioner is not shown to have acted oppressively or to have treated the applicant in a manner different from other taxpayers in a similar position, it is not appropriate that the discretion to set aside the demand should be exercised. Section 459J(1)(b) does not provide an occasion for the Court to express its views on the reasonableness or otherwise of the taxation legislation.”
In response, HCL pointed to the concession the Commissioner had made in Broadbeach that upon the hearing of a winding up application, the court might properly have regard to whether the taxpayer had a “reasonably arguable” case in pending proceedings in which it was objecting to the tax assessment. HCL argued that there was no reason why the existence of a “reasonably arguable” case cannot be taken into account at the statutory demand stage, rather than at the winding up stage as suggested by their Honours in Broadbeach.
His Honour rejected this also. In Broadbeach at  the Hight Court had said –
“…Such consideration [of the time which has elapsed and the progression of the Part IVC proceedings towards determination], if it were supported by evidence of the state of progression of the Pt IVC proceedings, would be relevant in the operation of Pt 5.4 of the Corporations Act, if at all, at the later stage of the hearing of any winding up application.”
In any event, Murphy J could not be satisfied on the evidence before him that HCL had a reasonably arguable case, and HCL did not seek to develop its submissions beyond a mere assertion that its acquisition of the right to provide legal services was a “creditable acquisition” within the meaning of the GST Act, and that it was therefore entitled to the input tax credit of $4.5m claimed.
In relation to conduct of the Commissioner which it argued justified the Court exercising its discretion under s 459J(1)(b) to set aside the statutory demand for “some other reason”, HCL pointed to –
- the Commissioner’s freezing of HCL’s accounts – which lasted for 1 day,
- an alleged breach of undertaking to defer recovery proceedings – his Honour found that the agreement was only for the Commissioner to defer them until after an extension for HCL to lodge its objection had expired, which the Commissioner did,
- a refusal to agree to defer recovery until after the determination of HCL’s objection and any appeals – the Commissioner refused to do so unless HCL was prepared to provide acceptable security for the debt, which HCL declined to provide,
- the garnishee notice the Commissioner issued and directed to HCL’s bank – which resulted in recovery of a small amount and which was rescinded after a short time, and
- HCL’s suspicion that the assessments were tainted by bad faith. It had made several FOI requests for the Commissioner’s documents relating to the freezing of accounts and the audit, and had received documents in response – his Honour found none of the documents he was taken to evidenced any bad faith on the part of the Commissioner.
His Honour held that in all the circumstances of the case he did not consider the Commissioner’s actions, considered individually or collectively, were unconscionable, oppressive, abusive, or productive of substantial injustice. There was nothing to justify the exercise of his discretion.
His Honour noted, perhaps wryly, that 11 months later, HCL and its directors still had the benefit of the almost $4.5m remitted to it by the Commissioner. He dismissed the application to set aside the statutory demand and awarded costs of the application, and of the hearing before the Registrar, against HCL.
I will endeavour to monitor the Federal Court portal to see if the judgment is appealed, and if so will post an update to that effect.
**Update 26 June 2013: The decision was not appealed, and the company is now in liquidation.
** This article was subsequently republished with my permission in CCH’s online Insolvency and Bankruptcy news service in the week commencing of 5 November 2012 -http://www.cch.com.au/au/News/ShowNews.aspx?PageTitle=The-High-Court-on-GST-in-Qantas-—-What-it-may-mean-for-Liquidators-and-other-external-administrators&ID=38989&Type=F
This morning the High Court handed down what is perhaps the most important Australian judgment yet in the area of GST law, in Commissioner of Taxation v Qantas Airways Ltd  HCA 41. It addresses a question which is the most fundamental issue in GST law – what is a “taxable supply”, so as to trigger liability to pay GST under the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). I will come to the potential significance of this decision for liquidators and other external administrators in a moment.
This was an appeal by the Commissioner from a judgment of the Full Federal Court which had found in favour of Qantas (link). It concerned whether GST was payable by Qantas on airline tickets which it had sold to passengers who, for whatever reason, had not taken their flight – specifically the appeal concerned non-refundable tickets, and tickets where the passengers had a right to claim a refund which they had not pursued. Significant sums of GST were involved – in excess of $34m.
Put simply, the argument before the High Court boiled down to this – what is a “taxable supply”? In the context of airline tickets, is it the air journey, as argued by Qantas (and accepted by Heydon J)? Or is it the entry into obligations under the contract – here the conditional promise by the airline to use its best endeavours to carry the intending passenger and his or her baggage, as argued by the Commissioner? The majority found in favour of the Commissioner.
For liquidators and other external administrators who take appointment, the potential significance of the decision is with respect to contracts that a company has entered into but has not yet completed, at the time of appointment. Today’s judgment in Qantas may mean that the GST liability triggered by those contracts, which had previously been thought to fall upon the liquidator or other external administrator who completes the contract, may now fall upon the company itself. In the case of a liquidation, that would leave the Commissioner to prove in the liquidation for that GST liability, rather than be able to look to the liquidator personally for the GST.
Division 58 of the GST Act makes “representatives” (defined to include inter alia a trustee in bankruptcy, liquidator, administrator and receiver) of “incapacitated entities” liable to pay GST that would be payable by the entity, to the extent that the taxable supply is made in the course of the representative’s responsibility.
However in the wake of Qantas, if the taxable supply (which triggers GST liability) occurs upon the entry into obligations under a contract, rather than upon the actual supply of the goods or service or other obligation which is the core object of the contract (or to use the words of Heydon J, “the bargain”), then it may be open to liquidators and other external administrators to complete contracts entered into prior to their appointment, without incurring personal liability for the GST triggered by the transaction.
I suggest that this is a perhaps unintended consequence of the High Court’s decision. The majority’s judgment does not appear to confine itself, in its conclusions as to what is a “taxable supply”, to particular types of contracts such as those which are not completed.
For completeness, I note that this issue that I now raise, was addressed last year by the AAT in The Trustee for Naidu Family Trust and Commissioner of Taxation  AATA 910. In that case a mortgagee in possession had contended that it was not required to pay GST on the sale of real property because the supply occurred at the time of the company’s entry into the contract of sale, rather than at the mortgagee in possession’s completion of the sale. In finding against the mortgagee in possession, the Tribunal held that the taxable supply occurred at settlement, when the sale was completed, not when the vendor executed the contract of sale. I suggest that, in light of the decision of the majority of the High Court that Qantas made a supply at the time of contract, and subject to other complexities, the Tribunal’s decision may now be doubted.
* I must thank junior counsel for Qantas for drawing this important GST case to my attention.
Last Friday the Full Federal Court handed down its much anticipated decision in Commissioner of Taxation v Kassem and Secatore  FCAFC 124. The judgment addresses the interesting and commercially significant issue of third party preferences. It also addresses the even more interesting issue of the ATO’s practice of unilaterally reallocating payments made by taxpayers of tax liabilities from one account (such as the integrated client account) to another (such as the superannuation guarantee or “SGER” account), and whether that enables the Commissioner thereby to avoid the reach of the unfair preference provisions.
In short, like the judgment at first instance, the result again was a comprehensive loss for the Commissioner. The appeal was dismissed with costs. The joint judgment of Jacobson, Siopis and Murphy JJ may be read in full here. My analysis of Nicholas J’s judgment at first instance in March, with more details of the facts of the case, may be read here.
Briefly, third party preferences are where an insolvent company’s debt is paid by a third party (often 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 s 588FC) of the Corporations Act 2001 (Cth) (“the Act”).
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. This gave rise to the first substantial argument run on appeal. The Commissioner contended that what took place by Antqip paying Mortlake’s tax debts for it, was a substitution of a new creditor of Mortlake’s (Antqip), for the existing creditor (the Commissioner). On this basis, so the Commissioner argued, there was no unfairness, thus there was no “unfair preference” and therefore the payments were not caught by the provisions.
The second substantial issue concerned the purported exercise of power by the Commissioner to allocate payments received from, or on behalf of, Mortlake to an account other than that to which the funds were initially credited. The payments totalling $70,000 had been made by EFT into an ATO account, the integrated client account, for Mortlake’s indebtedness for its primary tax debts which were said to consist of income tax, GST and other related liabilities and exceeded $600,000. Four months later, the ATO had unilaterally reversed the payments made into that account and reallocated the payments to the superannuation guarantee or SGER account. Their Honours described this as a purported exercise by the Commissioner of his power under s 8AAZD of the Taxation Administration Act 1953 (Cth) (“the Administration Act”).
Tellingly, their Honours noted that this reallocation was made shortly before the commencement of the winding up of Mortlake [at 7]. What lead to this action was revealed by a file note dated 31 July 2007 made by an ATO employee. The employee had telephoned the New South Wales Supreme Court to ascertain the hearing date for a winding up application that had been filed against Mortlake. The employee was told the hearing date was set for 23 August 2007 [see 23].
At first instance, his Honour made what the Full Court described as several critical factual findings [see 25-37] –
1. That although the funds were physically transferred to the integrated client account by Antqip, they were funds lent by Antqip to Mortlake and paid to the ATO at Mortlake’s direction;
2. That the moneys borrowed by Mortlake were applied by it in payment of a pre-existing debt;
3. That the relevant “transaction” for the purposes of s 588FA of the Act was a bipartite transaction between Mortlake and the Commissioner, not a tripartite transaction which included Antqip;*
4. That the “reallocation” by the Commissioner had the effect of increasing the balance recorded in the integrated client account and reducing the indebtedness recorded in the SGER account. The Full Court observed that Nicholas J’s use of the word “reallocate” suggested he was of the view that the funds had been initially allocated to the integrated client account;
5. That the evidence established there was little prospect of the Commissioner receiving any dividend out of the winding up.
* Respectfully, I suggest that the Full Court were wrong in this. They say that this conclusion is “clear from what his Honour said at ”. Respectfully, in my view, it is not. His Honour had at  expressed that he was “satisfied that Mortlake and the Commissioner were parties to transactions whereby the Commissioner received $70,000 from Mortlake”. Those are conditions which must be met before the preference provisions can apply – see ss 9 and 588FA(1)(a) and (b) , and see the discussion below. What Nicholas J said does not, in my view, suggest there were no other parties to the transactions, which of course Antqip was as the third party which actually made the payments, from its own funds, on Mortlake’s behalf.
First issue – “Substitution”, “transaction” and “unfairness”
“Substitution” and “Transaction”
On appeal, the Commissioner argued that Antqip was substituted as creditor for the Commissioner, as it stepped into the Commissioner’s shoes by paying Mortlake’s debt. Counsel cited no authority for this argument, and it was rejected by the Full Court as contrary to the proper characterisation of the transaction in question (see [38-39]).
The source of the payments was the bank account of Antqip, and this was said to be a clear example of a lender paying moneys advanced to a borrower’s creditor in accordance with the borrower’s directions. The Full Court observed that the position was no different than if Mortlake had borrowed the funds on overdraft from its bank and paid the creditor with those funds (see ).
Even if the payments were not properly characterised as a loan from Antqip to Mortlake, the Full Court noted that the payments by Antqip to the ATO were made by or on behalf of Mortlake  . Their Honours said that: “the transaction which s 588FA then looks at is the transaction between Mortlake and the Commissioner. That was the approach taken by Gordon J in Burness v Supaproducts Pty Ltd  FCA 893; (2009) 259 ALR 339 [link] where payments were made to a creditor by a related company of the insolvent debtor.”
I pause here to suggest, respectfully, that the brevity with which the Full Court summarised Gordon J’s approach in Burness to what is a “transaction” in this context, coupled with the other matter referred to above, could create problems for Courts – and indeed companies engaging in commercial activity – seeking to apply this judgment. In my view, respectfully, it over-simplifies the analysis that her Honour undertook in Burness and often falls to be undertaken by the Courts in evaluating whether a third party payment of a company’s debt to a creditor can be treated as part of one multi-step dealing that is caught by the definition of a “transaction” in s 9 and 588FA of the Act. And it glosses over the analysis as to whether that transaction can be treated as one by the company, in the sense that (1) the company must be a party to the transaction (ss 9 and 588FA(1)(a); (2) the unfair preference must be “given by the company” under s 588FC; and (3) the creditor must have received more “from the company” than it would if it had to prove for its debt in the winding up (s 588FA(1)(b)) . (There are many cases, but the principal authority is Re Emanuel (No 14) Pty Ltd (in liq); Macks v Blacklaw & Shadforth Pty Ltd (1997) 147 ALR 281; see also Capital Finance Australia Ltd v Tolcher  FCAFC 185; (2007) 245 ALR 528 (link))
In Burness, Gordon J’s analysis on this focussed primarily on the question of whether before a payment made by a third party of a failing company’s debt can be taken to be a payment “accepted” or “made” by the debtor company, there must be evidence of an arrangement between the debtor and third party whereby the debtor directed or authorised the third party to make the payment, or the third party was under an obligation to the debtor to do so. Her Honour’s view was that the evidence did not need to go so high; “where the third party payment is authorised by the debtor, nothing more is required. The debt is discharged by the third party at the request of or with the acceptance of the debtor” (see [45-46] and indeed [34-47] of Burness). The reason the problem arises is that if the third party payment is unauthorised by the debtor, in law the debt is not necessarily discharged (although it may be subsequently ratified or accepted by the debtor). Without the debtor’s act making the third party’s payment effective to discharge the debtor’s debt owed to the creditor, it is more difficult for a Court to find that the debtor was a party to the transaction (as required by s 588FA) and in effect made the payment to its creditor, using the third party as its instrument.
To return to the present judgment – The Full Court noted that the conditions required for the transaction to fall within s 588FA(1) were satisfied – the company Mortlake and the creditor the Commissioner were parties to the transaction, the transaction resulted in the Commissioner receiving from Mortlake more than he would receive if the transaction were set aside and he were to prove in the winding up [at 44-46].
The Commissioner then submitted that the payments could not fall within the definition of an unfair preference in s 588FA(1), because “unfairness” is a necessary element of the definition and, in his submission, there was nothing in the payments that satisfied this requirement. Their Honours reviewed the authorities and at [54-55] said this –
“[T]he observations of the plurality in Airservices and the doctrine of ultimate effect, as applied by Ormiston JA [in Dye] to the present statutory regime, provide a short answer to [the Commissioner’s] submissions. This is because in the present case there are only two transactions between the debtor and the creditor, each of which consisted of a payment which had the ultimate effect of extinguishing the indebtedness of Mortlake to its creditor. That is to say, each transaction had the effect of paying the Commissioner 100c in the dollar in respect of Mortlake’s indebtedness of $70,000…[T]he payments constituted an unfair preference because the Commissioner received full payment of the debt whereas other creditors would receive nothing in the winding up. As Ormiston JA explained in Dye at , s 588FA was intended to strike down transactions that would dislocate the statutory order of priories among creditors…That is what happened in the present case.”
The Commissioner ran the submission there was no unfairness because the payments did not result in a decrease in the net value of assets available to meet the demands of other creditors. The Full Court held there was such a decrease and stated that they did not then need to determine whether there must be a diminution in the value of the debtor’s assets for a payment to be caught by the provision (see [58-61]). (See the similar argument run by the defendant in Burness at , although advanced in a different way.)
Second issue – Allocation of payments by the Commissioner
The Commissioner pointed to his power to allocate payments to the SGER account by virtue of the provisions of Div 2 of Part IIB of the Administration Act. Section 8AAZD confers power on the Commissioner to allocate a primary tax debt to an RBA, such as the SGER account, which had been established for that type of tax debt. In exercising the power of allocation, the Commissioner is not required to take account of any instructions from a tax payer: see s 8AAZLE (at ).
The Liquidator submitted that the two payments in question were allocated to the integrated client account. He pointed to the crediting of the two payments to the integrated client account, and relied on the fact that interest charged by the ATO on the balance of that account had been calculated taking account of the reduction of the balance by virtue of the two payments.
Once so allocated, he submitted, they constituted the relevant transaction for the purposes of s 588FA(1) (see ). The Full Court agreed , holding that the transactions that fell to be considered under s 588FA(1) were the two payments made in March and April 2007. On this approach, the Commissioner’s reallocation was irrelevant to the question of whether the transactions fell within s 588FA(1).
On the evidence, their Honours could not determine whether there was an actual agreement between Mortlake and the ATO to appropriate the $70,000 to the integrated client account . Therefore, their Honours said, the rule in Clayton’s Case would apply and the payments are presumed to be appropriated to the debts in the order in which the debts were incurred. However there was no evidence to establish that sequence.
Nevertheless, the Full Court saw considerable force in the Liquidator’s submission that the ATO Tax Agent Portal, recording the payments and the interest charge referred to, gives rise to a strong inference that the payments were allocated to the integrated client account. This was reinforced by the fact that the payments remained credited to that account, in full satisfaction of the pre-existing debt of $70,000, until the reversal on 1 August 2007 . As noted above, their Honours concluded that the two payments were the relevant “transaction” and thus the ATO’s later reallocation and the argument they sought to mount as to the priority accorded the Commissioner for payments of superannuation guarantee charge liabilities was irrelevant.
Their Honours noted at [80 onwards] that even if they were wrong on that, the allocation or reallocation on 1 August 2007 did not change the result, in that the Commissioner still received more than he would were he to prove for the debt in the winding up, and thus received an unfair preference.
The Full Court observed that it was also implicit in the Liquidator’s submissions that on the proper construction of s 8AAZD of the Administration Act, the power of allocation does not extend to a power of reallocation to another ATO account. Thus the Commissioner had no power to so reallocate ). The Full Court took the view that it did not need to determine this question .
However in the final two paragraphs of their judgment, the plurality went on to observe that there was a further answer to the Commissioner’s claim to be able to rely upon the purposed (re)allocation which took place on 1 August 2007. The Full Court went further than the judge at first instance had done, and made a specific finding that it was plain the Commissioner took the step of reversing and (re)allocating the payments to the SGER account “with a view to obtaining a priority over other unsecured creditors in the event that [the petitioning creditor] obtained a winding up order when the matter was due to come before the Supreme Court on 23 August 2007” . Their Honours observed at  that –
“It is a fundamental principle of the law of unfair preferences that the present statutory regime, and its predecessors are…intended to render void any transaction which, if allowed to stand, would dislocate the statutory order of priorities amongst creditors.”
Yet, so their Honours specifically held, “that is precisely what the Commissioner intended to achieve”.
An extraordinary case. The Commissioner’s appeal was dismissed. The fact that costs were awarded against the Commissioner, suggests that despite the fact that only $70,000 was at stake and that the principles are clearly of some importance, the Commissioner has not been funding the Liquidator’s costs as is sometimes done in “test cases”. One cannot help but wonder how the Commissioner will respond to this loss at Full Federal Court level – whether he will bat on and seek special leave to appeal, or call it a day. We await any further developments with interest.
Postscript: A final word on unilateral reallocation of payments between accounts by the ATO
The argument that the Commissioner sought to mount, relying upon his office’s unilateral reallocation, warrants a moment of slower scrutiny: that the effect of the reallocation was to elevate the priority of the debt in the winding up of Mortlake in accordance with the provisions of s 556 of the Act, so as to give it priority over other unsecured debts. The Commissioner contended that this had the consequence that the payments could not constitute unfair preferences because, at the time of the allocation to the SGER account, there were no other outstanding debts with priority equal to or higher than that which applies to the superannuation guarantee charge under s 556(1)(e) of the Act.
If this argument had succeeded, it would mean that for each corporate taxpayer sinking towards liquidation, the Commissioner could take steps to artificially circumvent the operation of the preference provisions and stride ahead of other unsecured creditors. All the ATO need do is reverse the allocation of payments made into the taxpayer’s integrated client account, reallocate them to the SGER account, and then claim the payments were thereby out of the liquidator’s reach.
If the Commissioner is unconstrained in purporting to exercise his allocation power under s 8AAZD of the Administration Act in this way, and rely upon it to seek such an advantage, one wonders what the answer might be to this rhetorical question:
Now that directors can be made personally liable for the unpaid and unreported superannuation guarantee charge liabilities of their companies (since 30 June 2012), what is to stop the Commissioner from purporting to exercise his allocation power to reallocate in the other direction? That is, what is to stop the ATO from enlarging the company’s SGC liability balance by reversing payments already made against it and reallocating them instead against GST liability recorded in the integrated client account, thereby artificially enlarging the debt that can be claimed personally against the directors? I note that the ATO has previously sought to have the DPN regime extended by the legislature to other tax liabilities including GST liabilities, however Parliament (or rather, the Parliamentary committee) has declined, and limited the extension of the DPN regime beyond a company’s PAYG to now also its super guarantee charge liability. Conceivably, the ATO could skirt around that legislative constriction too, to enlarge the size of the personal liability it can sheet home to directors. Troubling.
Yesterday the Assistant Treasurer released draft legislation which will introduce revisions to the existing director penalty regime – although not as severe as originally sought. In November last year an earlier version of the legislation had been before Parliament, but was withdrawn by the Government in light of some strong criticisms that it had gone too far – see my post from last year here.
Last year’s version of the proposed legislation would have allowed the ATO to issue proceedings against directors personally for certain company tax liabilities without first issuing a DPN (Directors Penalty Notice), once the liability had remained unpaid and unreported for more than 3 months after the due date. In addition, the tax liabilities for which a director could become personally liable was to to be extended from only unpaid PAYG, as before, to also include superannuation guarantee liabilities.
The latter change has been retained in the new version of the draft legislation, however the former has not. DPNs are still required to be issued to directors before the ATO may issue proceedings against directors personally to recover the relevant company tax liaibilities. Another change to the draft Bill is intended to ensure that new directors have time to familiarise themselves with corporate accounts before being held personally liable for corporate debts. There is also proposed a new defence for directors liable for penalties for superannuation debts where, broadly, they reasonably thought the worker was a contractor and not an employee.
The latest exposure draft of this legislation is again intended to amend the tax law to better protect workers’ entitlements to superannuation and strengthen director obligations, but in a more measured manner. It is also intended to assist in countering phoenix behaviour. The main aspects of the amendments are –
- extending directors’ potential personal liability for company tax debts to unpaid superannuation guarantee amounts;
- ensuring that directors cannot have their director penalties remitted by placing their company into administration or liquidation when unpaid PAYG withholding or superannuation guarantee amounts remain unpaid for 3 months; and
- restricting access to PAYG withholding credits for directors and their associates where the company has failed to pay withheld amounts to the ATO.
You can read the Assistant Treasurer’s press release here and the announcement on the Treasury website here. Note that on the latter webpage, there are links to the exposure draft bill and explanatory memorandum, as well as a “summary document” which sets out industry concerns raised in relation to the previous version of the Bill, and what Treasury’s response has been on each point in the new version. Treasury has called for public consultation and submissions, which are due on 2 May 2012.