On 21 February 2014, the Federal Court handed down its decision in Australian Building Systems Pty Limited v Commissioner of Taxation  FCA 116 (Australian Building Systems). The Court found that a liquidator was not legally required to retain an amount out of the proceeds on disposal of assets as part of the winding up of a company to pay tax which is or will become due in respect of a capital gain. Notwithstanding this, the Court did caution that a prudent liquidator may wish to retain some or all of proceeds until such future time as the final tax liability is known.
This issue has long been a subject of contention between liquidators, receivers and the Australian Taxation Office and was the subject of two draft Taxation Determinations in 2012. Draft Taxation Determinations TD 2012/D7 and TR 2012/D6, both issued on 19 September 2012, set out the Commissioner’s preliminary views that:
- a receiver who is an agent of a debtor is required under section 254 of the Income Tax Assessment Act 1936 (ITAA 1936) to retain from sale proceeds sufficient money to pay tax which is or will become due as a result of disposal of a CGT asset, and
- an agent or trustee has an obligation under s254 of the ITAA 1936 to retain sufficient money to pay tax even if the tax has not yet been assessed.
Finalisation of these two draft Taxation Determinations was postponed pending the outcome of this case. While it is possible that the Commissioner of Taxation may seek to appeal last week’s decision, based on this decision, it is likely that these two draft Taxation Determinations will be withdrawn or substantially re-written.
Section 254 of the ITAA 1936 imposes a number of general obligations upon agents and trustees in respect of any income, profits or gains of a capital nature derived by the agent or trustee in their representative capacity, or derived by the principal by virtue of their agency. Specifically, paragraph 254(1)(d) provides that the agent or trustee is “authorized 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.” If an agent or trustee is required to retain moneys under paragraph 254(1)(d), they become personally liable for the tax payable. In the Australian Building Systems case, Justice Logan found that the expression ‘tax which is or will become due’ requires a degree of certainty about the fact and amount of the tax liability which is not present until a notice of assessment is served. As such, s254 of the ITAA 1936 had no application to the liquidator in this case as an assessment for the relevant income year has not been made.
Interestingly, Justice Logan also stated that:
“Even though, for the reasons given, s254 does not require retention upon the mere happening of a CGT event, that does not mean that a liquidator is obliged immediately to distribute the resultant gain or part thereof as a dividend to creditors in the course of the winding up. 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. Yet further, in the event of a controversy after the issuing of an assessment as to whether the tax debt that was provable in the winding up, the liquidator would be entitled to retain the gain or some part thereof sufficient to meet the assessed tax until that controversy was resolved...”
The taxpayer and liquidator in this case also sought to argue that s254 was constitutionally invalid as it imposed an incontestable tax. Justice Logan gave his view that s254 was valid, as it did not impose tax at all, but was merely a provision in aid of the collection of tax.
This decision has profound implications for the insolvency industry. Ultimately, its full effect will not be known at least until any appeal process is completed. In the meantime, liquidators (and receivers and administrators) will need to consider how to incorporate this decision into their operating protocols around distributions to creditors.