On 21 February 2014, the Federal Court handed down its decision in Australian Building Systems Pty Ltd v Commissioner of Taxation [2014] FCA 116, confirming that in the absence of a tax assessment, section 254 of the Income Tax Assessment Act 1936 (Cth) (ITAA36) does not impose a retention obligation or personal liability on a liquidator.

WHAT DOES SECTION 254 SAY?

Section 254(d) of the ITAA36 provides that every trustee is “authorised and required 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 sufficient to pay tax which is or will become due in respect of the income, profits or gains.”

Subparagraph (e) imposes a personal liability on the trustee for “the tax payable in respect of the income, profits or gains to the extent of any amount that he or she has retained, or should have retained, under paragraph (d)”.

“Trustee” for the purposes of section 254 includes liquidators and receivers.

WHAT HAPPENED IN THIS CASE?

During the course of the liquidation of Australian Building Systems Pty Ltd (ABS), the liquidators disposed of company real property, which gave rise to a capital gains tax event for the purposes of the Income Tax Assessment Act 1997 (Cth) (ITAA97).

Following the sale of the property, ABS sought a private ruling from the Taxation Commissioner on whether the liquidators were required under section 254 of the ITAA36 to account to the Commissioner out of the sale proceeds any tax liability arising from a capital gain that crystallised upon the sale, in circumstances where no assessment had been issued.  A ruling was also sought on whether the liquidators were required to retain a portion of the sale proceeds, upon the crystallisation of the tax liability or upon an assessment being issued, for the purposes of satisfying the tax liability.

The Commissioner interpreted section 254 as imposing a personal liability on the liquidators, requiring them to retain monies from the proceeds upon the crystallisation of the tax liability for the purposes of satisfying it.  The liquidators disagreed with the ruling and appealed to the Federal Court for declaratory relief.  In that application, the liquidators also challenged the constitutional validity of section 254 arguing it is an incontestable tax.

WHAT DID THE FEDERAL COURT SAY ABOUT THE LIQUIDATORS’ OBLIGATIONS?

The Federal Court rejected the Commissioner’s interpretation of section 254 finding that the provision does not place any obligation on the liquidators until an assessment is issued.  Logan J relied on the decision of the High Court in Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598 to conclude that the phrase “tax which is or will become due” is to be understood as tax that has been assessed.  Accordingly, the liquidators in this case were under no obligation to retain monies from the proceeds of sale because an assessment had not yet been issued.

However, his Honour cautioned against a quick-fire distribution in advance of the ATO making an assessment.  He noted:

“A prudent liquidator, like a 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.”

IS SECTION 254 INVALID AS AN INCONTESTABLE TAX?

The Federal Court dismissed the argument that section 254 was constitutionally invalid, finding that the provision imposes no tax at all.  Rather it is solely a provision in aid of tax collection and the assessment of a taxation liability arising from the operation of other provisions of the ITAA36 or the ITAA97 is fully contestable under Pt IVC of the Taxation Administration Act 1953 (Cth).

COMMENT

Despite the Federal Court’s clear finding that insolvency practitioners are not liable for unassessed tax liabilities under section 254, Logan J’s statements about what a prudent liquidator would be entitled to do somewhat muddy the water.  In circumstances where the Tax Commissioner considered that section 254 did impose a liability on the liquidators, the prospect of retrospective amendments to the taxation legislation cannot be discounted.  Furthermore, the matter may be appealed.  In the circumstances, it is recommended that insolvency practitioners take the “prudent” approach and hold off on distributing all proceeds in circumstances where it is clear that a tax liability has crystallised.

The decision also gives food for thought on what rights or claims may arise in circumstances where insolvency practitioners have in the past retained funds in advance of an assessment for the purposes of satisfying a potential tax liability.  In this regard, the decision gives rise to some uncertainty which we expect will be given judicial and legislative consideration in the future.