Does the ATO have priority over secured creditors in a liquidation? Is a receiver required to account to the ATO for any tax payable out of funds received on the sale of an asset before accounting to the secured creditor? Are receivers and liquidators personally liable for the tax payable from funds received by them? Can receivers and liquidators avoid such personal liability by distributing funds received to creditors before a tax assessment arises? These issues were at the centre of a Federal Court judgment handed down on 21 February 2014.
In 2012 the ATO issued two draft taxation determinations (TD 2012/D6 and TD 2012/D7) designed to establish the ATO’s priority ranking in respect of tax payable out of funds received by a receiver or liquidator. These rulings were to be finalised in April 2013, but were delayed by the test case Australian Buildings Systems (in liq) v DCT QUD555/12; QUD540/12 (ABS (in liq) v DCT).
The unsettled issue addressed by the draft determinations is the interaction of:
- provisions of the Corporations Act 2001 which set out the rules regarding the distribution of the property of a company on a winding up and the relevant priority of debts and claims proved in a winding up; and
- section 254(1)(d) of the Income Tax Assessment Act 1936 (ITAA36) which requires an agent or trustee (trustee is defined to include a receiver or liquidator) to retain, out of any money which comes to him or her in his or her representative capacity, an amount sufficient to pay tax that is or will become payable in respect of that money. The agent is personally liable for the tax but only to the extent of any amount that the agent has retained or should have retained.
Issues arising from the draft determinations
Under its recent draft determinations the ATO has asserted that section 254 gives it priority over secured creditors, which is in conflict with the Corporations Act and indeed historical insolvency practice and understanding. The resulting personal liability of the liquidator or receiver for the tax payable under section 254 is obviously a critical issue for liquidators and receivers.
Draft determination TD 2012/D6 indicates the Commissioner’s opinion that section 254(1)(d) of the ITAA36 has application even if no tax assessment has been issued. That is, the obligation to retain funds on account of tax arises on crystallisation of the gain and liquidators and receivers are personally liable for the tax even in the absence of a tax assessment.
Draft determination TD 2012/D7 specifically considers the circumstance where a receiver is appointed by a secured creditor and disposes of a CGT asset of the debtor company. The ATO view set out in that draft determination is that, in the normal course of events where the receiver is appointed as agent of the company, the receiver derives the gross proceeds of sale as agent of the company and is obliged by section 254(1)(d) to retain sufficient of those gross proceeds to satisfy any capital gains tax before accounting to the secured creditor for the balance.
The practical effect of the draft taxation determinations is problematic in that it requires liquidators and receivers to retain an unascertained amount in respect of a debtor’s income, profit or gain, or risk personal liability, often in circumstances where the liquidator or receiver has inadequate records to reliably determine the debtor’s income, profit or gain.
Facts of the test case
The test case involved a company to which liquidators had been appointed. The liquidators caused the company to enter into a contract of sale for a property, thus triggering a capital gain in the company’s hands. There was a secured creditor in respect of the property and a number of unsecured creditors. The liquidators estimated that there would be a shortfall such that the creditors would not be able to be paid in full in the winding up.
Therefore a critical issue was whether section 254 had priority over the relevant provisions of the Corporations Act such that the capital gains tax on the sale of the property had to be paid to the ATO before distributions were made to the creditors of the company.
A private ruling had been applied for by the company and issued by the ATO stating that the liquidators were bound to retain the monies on crystallisation of the capital gain and pay the capital gains tax to the ATO from those monies before attending to creditors’ claims.
The company objected to the private ruling and the matter thus came before Logan J in the Federal Court. In a judgment handed down on 21 February 2014, Logan J overturned the private ruling issued by the ATO in holding that section 254(1)(d) only had application where an assessment had been issued and therefore in the absence of an assessment a liquidator or receiver had no obligation to retain funds and to forward the tax payable to the ATO from those funds.
Unfortunately, Logan J considered that, because of his finding that section 254 had no application to the liquidators in the absence of a tax assessment, it was unnecessary to reconcile section 254 of the ITAA36 with the application of the Corporations Act. Logan J stated “the resolution of that question can and should await the issuing of an assessment”.
Accordingly, questions remain as to the ATO’s priority in relation to secured creditors. However, the judgment may mean that a liquidator or receiver is not personally liable for the tax payable if, by the time an assessment issues, there are insufficient funds to meet the liability. Given that the question of Corporations Act priority remains up in the air, there probably remain some risks associated with distribution of sale proceeds prior to resolution of the tax priority. It is to be hoped that the test case will be revisited once an assessment is issued so that this question can be finally resolved. Subject to any appeal, of course.