Introduction

Recently, the Full Federal Court of Australia (Queensland District Registry) handed down a decision on whether the Commissioner of Taxation was entitled to payment of a tax debt, in priority to a registered mortgagee’s right to repayment of money advanced to a taxpayer when the taxpayer’s property was sold.

The majority of the Court held that once the mortgage was released to allow settlement, the Commissioner’s garnishee notice attached to the purchase price payable to the vendor taxpayer, and the Commissioner was entitled to payment in priority to the mortgagee.

Facts

The taxpayer was the registered proprietor of property over which two mortgages were registered. The taxpayer entered into a contract for sale of the property, but the purchase price was not sufficient to pay out the loans secured by both mortgages in full.

The Commissioner of Taxation served notice under section 260-5 of the Taxation Administration Act 1953 (Cth) on the purchasers’ solicitor and subsequently on the purchasers personally, requiring payment of an outstanding tax debt owed by the taxpayer. The notice stated that the purchasers were required to pay the tax debt, or, if the money they owed to the taxpayer was less than the amount of the tax debt, the whole of the available money. The notices acted as garnishee notices, and the tax debt had to be paid immediately when the money became owing to the taxpayer.

Prior to the notices being served, a trustee was directed to take control of the taxpayer’s property under the Bankruptcy Act 1966 (Cth) and a sequestration order was made subsequent to settlement of the sale. The vendor’s bankruptcy was not an issue in the proceedings.

As settlement approached, a disagreement arose as to how the proceeds of sale would be apportioned to the various parties. The Commissioner refused to release the purchasers from the section 260-5 notices unless the tax debt was paid. The first mortgagee was to receive the total amount owing to it. The second mortgagee refused to provide a release of its mortgage unless it was paid the full amount owed to it under the facility.

As a result of the disagreement, settlement was delayed and eventually took place some days later. The first mortgagee provided a full release of its mortgage in exchange for payment of the total amount secured by its mortgage. The second mortgagee provided a release of its mortgage on the condition that the balance proceeds of sale were held in its trust account pending resolution of the disagreement.

The Commissioner consented to settlement going ahead under the arrangements which included the second mortgagee’s release and the balance proceeds being paid into the second mortgagee’s trust account, but made clear that its consent was not to be interpreted as a surrender of its claim to the tax debt.

Prior to the proceedings being heard at first instance, the amount of the tax debt was paid into court and the balance remaining in trust was paid to the second mortgagee in partial satisfaction of the amount secured by its mortgage and assigned to the trustee in bankruptcy all of its right, title and interest in the disputed amount paid into court.

The Commissioner and the trustee were the only parties left disputing entitlement to the disputed amount of the tax debt, the trustee standing in the shoes of the second mortgagee.

The decision at first instance

The Federal Magistrate determined that the trustee in bankruptcy (as assignee of the second mortgagee) was entitled to the disputed amount, reasoning that the relative interests of the Commissioner and the second mortgagee were akin to those that would arise where the s260-5 notice had been served after crystallisation of a floating charge over the debts due or to be due to a company.  His Honour relied on authority to the effect that, after crystallisation, the debts were owing to the chargee rather than to the taxpayer, such that the s260-5 notice would not operate with respect to those debts, stating that:

Here the relevant charge is a registered mortgage securing a loan in respect of a crystallised amount. The facts here present a much plainer case than [the] case involving company charges where questions of crystallisation of debt arise for consideration.

The decision on appeal

The Commissioner appealed to the Full Court of the Federal Court.

By a two to one majority the Full Court held that the Commissioner was entitled to the disputed amount of the tax debt.

The majority found that the Federal Magistrate erred in deciding the case on the floating charge analogy. They found that a mortgage over real property in a Torrens Title system relates not to moneys owed by third parties but to the land itself:

Moneys owed by a third party – even someone who had contracted to purchase the land – are not the subject of the security. There was nothing which the mortgagee could, or need, do to convert himself or herself into a person to whom those moneys were owed, in place of the debtor. His or her security remained always on the land as such, and his or her protection was the ability to foreclose, by whomever the land might be owned, so long as the mortgage remained on the register.

The purchaser’s obligation to pay the tax debt to the Commissioner became absolute under s260-5 when the purchasers came under a contractual obligation to tender the purchase price to the taxpayer. This could only happen after the taxpayer obtained releases of the mortgages and offered the purchasers unencumbered title to the property. At the instant that the purchasers owed money to the taxpayer, the purchasers fell under a statutory obligation to pay that money to the Commissioner.

Therefore, the second mortgagee compromised its position when it released its mortgage over the property, even though the balance proceeds of sale were held in trust pending resolution of the dispute with the Commissioner.

Minority decision

The dissenting judge found for the trustee in bankruptcy (as the assignee of the second mortgagee), on the ground that once a registered mortgage is discharged, a mortgagee has an equitable charge over the proceeds of sale of the mortgaged property, so that the taxpayer never gained any beneficial interest in the proceeds of the sale to which the s260-5 notice could attach.

Conclusion and lessons for mortgagees

Firstly, never release a registered mortgage without receiving payment of the amount secured by the mortgage. The second mortgagee agreed to release the mortgage and allowed the proceeds to be held in a trust account pending resolution of the dispute—this was ultimately fatal to the second mortgagee’s position. Had the second mortgagee insisted that it receive payment of the debt secured by the mortgage at the time the mortgage was discharged, the Commissioner’s notice would not have attached to any proceeds. Of course, failure to release the mortgage may have other effects, including the failure of completion of the contract for sale.

Secondly, the principles in issue in this case do not arise in the case of a sale by the mortgagee, as the proceeds of sale are payable to the mortgagee in such a sale.