Today, by a majority of 3-2, the High Court of Australia in Commissioner of Taxation v Australian Building Systems Pty Ltd (in liq)  HCA 48 confirmed that s 254(1)(d) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) does not impose an obligation on trustees (including administrators, receivers and liquidators) to retain sufficient moneys from the trust fund to pay tax unless a relevant assessment has been issued. The decision brings welcomed certainty to administrators, receivers and liquidators in relation to their obligations with respect to post-appointment tax liabilities.
This decision confirms that s 254(1)(d) of the ITAA 1936 does not impose an obligation on trustees (including administrators, receivers and liquidators) to retain funds sufficient to pay tax unless a relevant assessment has been issued. The Commissioner of Taxation’s (Commissioner) ability to threaten the personal liability of an administrator, liquidator or receiver will be significantly diminished as a result of this decision. Furthermore, the Commissioner’s ability to use s 254 to achieve priority over other creditors is also diminished.
The decision has particular significance for secured lenders. To date, in circumstances where the sale of secured assets may result in a significant tax liability for the borrower, secured lenders have preferred to enforce their securities as mortgagee in possession rather than by way of a receiver sale in order to avoid the risk of the ATO effectively obtaining a “super-priority” to the proceeds of sale by reason of the operation of s 254. This case opens up the possibility for secured creditors to enforce securities by way of a receiver appointment even where enforcement would result in tax liabilities for the borrower. We expect that the decision may mark an end to the current practice of security enforcements by way of a mortgagee in possession rather than by way of a receivership.
At a practical level, the Commissioner may seek to overcome the effect of the High Court’s decision by issuing companies in liquidation or receivership with special assessments following the sale of significant assets. Secured creditors may direct receivers to swiftly distribute the proceeds of sale of significant assets, before special assessments are issued, in an attempt to mitigate this risk.
Also, this decision does not impact on liquidators’ and receivers’ obligations under Division 260 of Schedule 1 of the Taxation Administration Act 1953. Liquidators and receivers will continue to be prevented from parting with any assets available for unsecured creditors before first receiving a clearance notice from the Commissioner notifying the amount which is sufficient to discharge pre‑appointment tax liabilities.
Finally, as a consequence of the decision, the Commissioner will now need to review – and arguably should withdraw with immediate effect – his previous draft guidance and practice on the application of s 254 as set out in Draft Taxation Determinations TD 2012/D6 and 2012/D7.
Following their appointment, the liquidators of the taxpayer disposed of land and thereby realised a capital gain of some $1.12 million. The liquidators sought a private ruling from the Commissioner as to whether s 254 required them to retain from the proceeds of sale an amount of money sufficient to pay, in priority to the taxpayer’s other creditors, any tax which might become payable by the taxpayer in relation to the sale, notwithstanding that no assessment had then been issued. The ruling was important to the liquidators because s 254 requires a liquidator (or an administrator, receiver or other agent or trustee) to retain sufficient money to pay tax which is or will become due in respect of the income, profits or gains and makes them personally liable in respect of any amount which they have retained or should have retained.
The Commissioner ruled that the liquidators were required by s 254 to retain from the proceeds of sale an amount of money sufficient to pay any tax which might become payable by the taxpayer in relation to the sale. The liquidators sought to challenge this ruling on the basis that s 254 could have no application where no assessment had been issued and, in any case, it did not operate to create a priority in favour of the Commissioner as against other creditors.
At first instance
At first instance, Logan J held that a liquidator was not, in the absence of any assessment, subject to any retention obligations pursuant to s 254 (Australian Building Systems Pty Ltd v Commissioner of Taxation FCA 116). Logan J relied on Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598 (“Bluebottle”), in which the High Court had considered the payment and retention obligations under a similar provision, s 255(1), stating that “content can be given to the obligation imposed by s 254(1)(d) only if an assessment has issued”. Nevertheless, Logan J commented that a prudent liquidator would at the very least be entitled to retain the gain (or a portion of it) until the tax position in respect of the relevant income year had become certain (ie. upon the Commissioner issuing an assessment or providing other advice).
For a more detailed analysis of Logan J’s decision, see: “Liquidators and receivers not required to account to the ATO under s 254 without an assessment” (2014) by Julian Roberts and Ryan May, King & Wood Mallesons.
On appeal, the Full Court of the Federal Court unanimously affirmed the decision of Logan J. Edmonds, Collier and Davies JJ confirmed that s 254(1)(d) does not impose an obligation of retention unless a relevant assessment has been issued.
Edmonds J held that no tax liability arises on the entry into a contract of sale of assets, either for the taxpayer or, more relevantly, the liquidators. Upon entering into the contract for sale, at most, the taxpayer made a capital gain that entered into the computation of its net capital gain for that financial year. That figure cannot be determined until the end of that year of income, and that figure is necessary to calculate an assessment on taxable income. Therefore, the Full Court held that “the most that could be said is that on 30 June 2012, ABS had an obligation to pay income tax in the future”. Edmonds J described the Commissioner’s contention (that the trustee would be obligated, prior to the assessment, to retain out of money coming to the trust, so much as is sufficient to pay tax to be assessed in the future) as “so bizarre as to immediately cast doubt on its propriety”.
Consistent with the approach adopted by Logan J at first instance, Edmonds J characterised s 254 as a “collection section” that facilitates the collection of tax, rather than one that imposes liabilities on the trustee. However, Edmonds J took this one step further than Logan J and held that, even if the taxpayer had an obligation to pay income tax in the future, that does not trigger a retention obligation for trustees prior to assessment. Even if, as the Commissioner argued, the word “due” in phrase “is or will become due” means “owing”, nothing is or will become owing by the liquidators prior to the issue of an assessment. Edmonds J concluded that “the words “the tax which is or will become due”…predicate nothing less than certainty, and that, in my view, cannot be predicted prior to the issue of a relevant assessment”. Consequently, no retention obligation will arise in terms on s 254 prior to that point in time.
For a more detailed analysis of the Full Court’s decision, see: “Liquidators and receivers not required to account to the ATO under s 254” (2014) by Samantha Kinsey and David Wood.
High Court’s judgment
Today, the High Court (French CJ, Kiefel and Gageler JJ, with Keane and Gordon JJ dissenting) dismissed the Commissioner’s appeal and confirmed that the retention obligation only arises after a relevant assessment has been issued.
In their leading joint judgment, French CJ and Keifel J rejected the Commissioner’s construction of s 254, which if accepted would have led to agents or trustees burdened with a continuing obligation to retain sufficient money to pay at any time the amount of tax that might become payable upon a notional assessment made at that time. Their Honours saw no reason not to follow the High Court’s prior decision inBluebottle, which reasoned that the words “tax which is or will become due” referred to a sum that has been ascertainedby assessment. The words “or will become due” were not without work to do: they encompassed tax that, although assessed, was not yet due for payment. French CJ and Keifel J found this reasoning equally applicable to s 254. They rejected the Commissioner’s submission that an agent or trustee might be so familiar with the principal’s affairs that, even without an assessment, they ought to be able to determine a sufficient amount to set aside to satisfy a potential future tax liability. However, each of the judges rejected Edmonds J’s construction of s 254 as a mere “collection provision” and confirmed that s 254 does by its own terms impose a personal liability on the agent or trustee.
Gageler J gave separate reasons but concurred with French CJ and Keifel. Gageler J similarly followed the Court’s prior approach in Bluebottle, reasoning that “The content of the retention obligation is fixed by the assessment” and that such an approach “produces certainty as to the total amount which the agent or trustee is authorised and required to retain” and “certainty as to the extent of the modification of the contractual or fiduciary rights and obligations of the agent or trustee wrought by the statutory authority to retain”. Gageler J also considered the practical aspects of a finding otherwise. His Honour noted that if the Commissioner’s arguments were accepted, a taxpayer carrying on business alone would not ordinarily be required to quarantine money for future tax payments, but a taxpayer carrying on business through an agent would be relatively disadvantaged if its agent were required to retain such monies. Finally, Gageler concluded that this approach, in its application to liquidators, “minimises the potential for disharmony between the obligations and liabilities of a liquidator under s 254 of the 1936 Act and the obligations of a liquidator and the rights of creditors under Ch 5 of the Corporations Act 2001(Cth)”.
In reasonably strong separate dissenting judgments, Keane and Gordon JJ took the view that the words “tax which … will become due” encompassed “tax which … will be assessed” and that the obligation to retain arises on and from the derivation of income, profits or gains by the trustee or agent in a representative capacity and not merely from the time of the assessment. Each of Keane and Gordon JJ considered that, as a practical matter, an agent or trustee would likely have available such information as is necessary to determine the tax payable on the income, profits or gains derived by him or her. Keane J also commented that without section 254(1)(d), the Commissioner would be “at risk of being left with a claim against an agent or trustee who has paid the funds from which his or her own liability to tax might be met, in circumstances where both the agent or trustee and the principal and beneficiary are not worth powder and shot.” Gordon J went further, stating that rejecting the Commissioner’s submissions would “lead to absurd results” and “also ignores reality”. Her Honour observed that it “would be an odd result that a trustee (including a liquidator) could meet their obligations (under both the revenue law and the general law) to prepare a return … recognise that tax is payable … but then distribute the funds sufficient to pay that tax immediately before filing the return”.
Quite so; however, as a majority of the High Court has spoken, it will now take legislative amendment to reverse that situation. Ultimately, this boils down to a policy question as to whether the Commissioner should enjoy priority over other creditors (including secured creditors) in the event of taxable events (such as capital gains) which occur after the commencement of the trusteeship, winding up or receivership. Indeed, issues of receivership and tax priority are matters which may potentially be considered by Parliament as part of the Government’s insolvency and tax reform agenda as set out in the recent Innovation Statement.