Nobody likes paying tax, particularly when they believe they’re entitled to pay less. Yet, a belief that your tax liability is too high will not stop the Commissioner of Taxation (Commissioner) from getting your money. The traditional view is that the Commissioner can collect tax debts, even when you dispute the amount is owing. In this article, we examine some recent cases that challenge this traditional view and outline some practical steps to prevent the Commissioner from getting your money before you’ve had the chance to put your case.

Tax debts are recoverable even when disputed

Our tax system is a “pay now and argue later” system. Whilst you are entitled to challenge a tax liability imposed by the Commissioner through lodging an objection to a tax assessment and, if the objection is disallowed, by seeking a review of that decision in the Administrative Appeals Tribunal (AAT) or lodging an appeal to the Federal Court of Australia, the Commissioner is entitled to recover the outstanding tax notwithstanding that you are disputing the liability.

It’s been said that “[t]he Commissioner is placed in a position of special advantage and is, in general, free to pursue recovery of proceedings, despite outstanding appeals and reviews against disallowance of an objection[1]The result of this system is that a taxpayer is unable to dispute the amount of an assessed tax liability in tax recovery proceedings commenced by the Commissioner; any challenge to the assessment must be brought via the objection and appeals process. The notice of assessment is conclusive evidence that the debt is due and owing in any recovery proceedings.

That taxation debts are due and owing irrespective of whether the taxpayer wishes to challenge the correctness of the tax liability surprises and, in some cases, angers many. This is because it can lead to a person being made bankrupt or a company being wound up despite the tax assessments being excessive. Once a person is made bankrupt or the company is wound up, they’re not able to pursue their rights to challenge the liability – that right now belongs to the bankruptcy trustee or company liquidator. Liquidators and trustees are rarely prepared to pursue such rights.

However, with appropriate action, this outcome can be avoided and taxpayers do have some ability to head off the Commissioner before it’s too late.

A stay of enforcement of taxation debts

Despite the fact that our system is in favour of the Commissioner, the courts still retain a discretionary power to stay enforcement of taxation debts in appropriate circumstances. In the past, it’s been said that such circumstances must be special or exceptional. However, some important recent developments suggest a shift in the approach of the courts to a greater willingness to exercise such discretion.

Genuine hardship to the taxpayer

In Deputy Commissioner of Taxation v Denlay [2010] QCA 217 (Denlay), the QCA upheld a decision ordering a stay of enforcement of a judgment debt on the basis that the proceedings commenced by the taxpayers challenging the tax assessments were progressing to a hearing, and it was highly likely that, absent a stay, the taxpayers would be made bankrupt. In coming to this conclusion, the Court made the following observations on the power to grant a stay:

“But the Supreme Court's power to stay such judgments is undoubted. While the power should be exercised "sparingly" or "with great caution" it is a power that can be exercised in appropriate circumstances. It is not to be surrendered.”

In upholding the decision to stay enforcement of the taxation debts, the QCA considered the following factors to be relevant:

  • the delay by the Commissioner in enforcing the debts;
  • the impact of enforcement on the taxpayers in that they would likely be made bankrupt, in which case they would also lose their chance to demonstrate the assessments were wrong;
  • that the proceedings commenced by the taxpayers challenging the tax liabilities were progressing to a hearing; and
  • there was no evidence that delay would hinder the Commissioner’s recovery of the taxation debts.

Hardship and corporate taxpayers

However, since Deputy Commissioner of Taxation v Bayconnection Property Developments Pty Limited [2012] FCA 363 (Bayconnection), there now appears to be more hope for the corporates. In Bayconnection, the Commissioner sought to wind up a company. The company could not oppose a winding up; as the assessments were conclusive evidence of a debt owing it couldn’t dispute the debt or say that it was not insolvent. Instead, it asked the Court to extend the time for the determination of the winding up application until the completion of the proceedings it had commenced in the AAT challenging the tax liabilities.

The Court agreed to exercise its discretion to extend time for the hearing of the winding up application. The factors relied upon by the Court included that the delay would not prejudice the Commissioner because the company didn’t have any assets, that the company’s challenge to the tax assessments was reasonably arguable, and that it had no other creditors.

Bayconnection is a significant case as it is the first time that the existence of meritorious tax appeal proceedings has been considered to be relevant to whether a court should refuse to order the winding up of a company. Importantly, and a good illumination of the limits on attempting to defer recovery, the same judge more recently refused to extend further time for Bayconnection following the completion of the AAT proceedings, despite the fact that Bayconnection had appealed the adverse AAT decision to the Federal Court.

The triumph of merits

Southgate Investment Funds Limited v Deputy Commissioner of Taxation [2013] FCAFC 10 (Southgate) is the most recent decision and it’s likely to have a more significant long term impact for the Commissioner’s recovery powers. Southgate is an authoritative statement of the Full Federal Court that the merits of proceedings commenced by a taxpayer challenging a tax liability is a relevant factor to be taken into account by the courts in considering whether to stay the enforcement of taxation debts.

Prior to Southgate, the law was not entirely clear but the position appeared to be that when seeking to stay enforcement of taxation debts, the merits of a taxpayer’s argument that the tax liabilities are excessive were either not relevant or were only relevant where those merits were “particularly striking”.

In Southgate, the Full Court moved away from such limited approaches and endorsed the merits as being a relevant consideration to a court’s discretion to grant a stay. The Full Court still placed limitations on referring to merits – there needs to be sufficient material before the court and the taxpayer must have more than an arguable case – but the decision represents a clear shift and provides greater guidance for future cases.

Implications of the recent developments

Despite the significance of the decision in Southgate, and the impact of Denlay and Bayconnection, there is still no general rule that tax recovery proceedings will be stayed where a taxpayer has a pending objection or has commenced proceedings to challenge the liabilities. This will just be one factor, amongst many, that the court can consider in the exercise of its discretion.

It’s unlikely that a court would be willing to exercise such discretion where:

  • the taxpayer had delayed in exercising their rights to challenge the tax liabilities;
  • the merits of the basis on which the liabilities are disputed do not have sufficient strength; or
  • there is a risk of dissipation of the taxpayer’s assets or there are other creditors of the taxpayer.

Whilst the decisions outlined above have placed a check on the Commissioner’s powers to enforce taxation debts, and provide a reasonable restraint on the Commissioner from using his powers to curtail a taxpayer from challenging a tax assessment, it is not accurate to say that we no longer have a “pay now, argue later” system.

Other considerations in managing taxation debts

Seeking a stay of enforcement of taxation debts is a last resort. Other ways of ensuring that the Commissioner doesn’t take all your money and assets prior to you having had your day in court include the following:

  • Open communication with the debt sections of the Australian Taxation Office (ATO). So long as the ATO is kept informed of your attempts to reduce your taxation debts, they will generally be very reasonable and understanding of your circumstances.
  • Whilst open communication is the key, you should never rely on oral representations of ATO officers. Most people you with speak with over the phone in the ATO have limited authority. You should obtain any assurances in writing and from persons with the appropriate level of authority.
  • The ATO is legally obliged to consider any request for an instalment arrangement to pay the debt. If you don’t have the capacity to meet the debt in full by the due date, you should seek to obtain the agreement of the ATO to an instalment arrangement. Any such agreement needs to be in writing. However, note that interest will continue to accrue on the debt.
  • If you can pay some of the debt but not all of it, you should consider entering into a 50/50 arrangement with the ATO as this will stop recovery action and will reduce interest charges.
  • If you aren’t certain that you are liable for the tax, you should immediately obtain advice to see whether the liability can be challenged. Subject to that advice, you should then proceed to challenge it at the earliest possible opportunity. Such steps will, in most cases, be enough to stop the ATO from taking firmer enforcement action.
  • You should ensure that any postal address you have given to the ATO is up to date. The ATO is entitled to send any notices to you at your last known address. It’s not unknown for the ATO to commence legal proceedings against taxpayers without the taxpayer realising they have any liability.
  • If proceedings are commenced for recovery of a taxation debt, you should immediately obtain legal advice. Preferably advice should be obtained from lawyers who have expertise in managing tax disputes with the ATO. Tax disputes are a special type of litigation and specialist expertise is required.

As a final observation, we note that seeking to hold off the Commissioner is only advisable where you’re not able to pay the debt from available money. This is because the interest rate charged by the Commissioner is higher than the interest rate on loans you will get from the bank. If you don’t pay your taxation debts because you are challenging them, and you’re ultimately unsuccessful with your challenge to the amount of the liability, you will also be liable for a significant additional amount in interest. Accordingly, appropriate advice will also need to give consideration as to whether it’s worthwhile contesting recovery of the debt at all.