The decision of the Full Court of the Federal Court handed down this week in Commissioner of Taxation v Australian Building Systems Pty Ltd (in liq)  FCAFC 133 offers welcome certainty to administrators, receivers and liquidators in relation to their obligations with respect to post-appointment tax liabilities.
This decision confirms that s 254(1)(d) of the Income Tax Assessment Act 1936 (Cth) (“ITAA 1936”) does not impose an obligation on trustees (including administrators, receivers and liquidators) to retain funds sufficient to pay tax unless a relevant assessment has been issued. The Commissioner of Taxation’s (“Commissioner”) ability to threaten the personal liability of an administrator, liquidator or receiver will be significantly diminished as a result of this decision. Furthermore, the Commissioner’s ability to use s 254 to achieve priority over other creditors is also diminished.
The decision has particular significance for secured lenders. To date, in circumstances where the sale of secured assets may result in a significant tax liability for the borrower, secured lenders have preferred to enforce their securities as mortgagee in possession rather than by way of a receiver sale in order to avoid the risk of the ATO obtaining an effective “super-priority” to the proceeds of sale by reason of the operation of s 254. This case opens up the possibility for secured creditors to enforce securities by way of a receiver appointment even where enforcement would result in tax liabilities for the borrower. As a consequence, we expect that the decision may mark an end to the current practice of security enforcements by way of a mortgagee in possession rather than by way of a receivership.
Nevertheless, we expect that administrators, receivers and liquidators will exercise caution by retaining relevant funds until it is clear whether the Commissioner will seek special leave to appeal this decision to the High Court. Also, at a practical level, the Commissioner may seek to overcome the effect of the Court’s decision by issuing companies in liquidation or receivership with special assessments following the sale of significant assets.
Also, this decision does not impact on liquidators’ and receivers’ obligations under Division 260 of Schedule 1 of the Taxation Administration Act 1953. Therefore, liquidators and receivers will continue to be prevented from parting with any assets available for unsecured creditors before first receiving a clearance notice from the Commissioner notifying the amount which is sufficient to discharge pre-appointment tax liabilities.
Following their appointment, the liquidators of the taxpayer disposed of land and in so doing, realised a capital gain of some $1.12 million. The liquidators sought a private ruling from the Commissioner as to whether s 254 required them to retain from the proceeds of sale an amount of money sufficient to pay, in priority to the taxpayer’s other creditors, any tax which might become payable by the taxpayer in relation to the sale, notwithstanding that no assessment had then been issued. The ruling was important to the liquidators because s 254 requires a liquidator (or an administrator, receiver or other agent or trustee) to retain sufficient money to pay tax which is or will become due in respect of the income, profits or gains and makes them personally liable in respect of any amount which they have retained or should have retained.
In his private ruling, the Commissioner held that the liquidators were required by s 254 to retain from the proceeds of sale an amount of money sufficient to pay any tax which might become payable by the taxpayer in relation to the sale. The liquidators sought to challenge this ruling on the basis that s 254 could have no application where no assessment had been issued and, in any case, it did not operate to create a priority in favour of the Commissioner as against other creditors.
Decision at first instance
At first instance, Logan J held that a liquidator was not, in the absence of any assessment, subject to any retention and payment obligations pursuant to s 254 (Australian Building Systems Pty Ltd v Commissioner of Taxation  FCA 116). In arriving at this decision, Logan J relied on Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598, which considered the payment and retention obligations found in s 255(1)(a) and s 255(1)(b) respectively of ITAA 1936, stating that “content can be given to the obligation imposed by s 254(1)(d) only if an assessment has issued”. Nevertheless, Logan J commented that a prudent liquidator would at the very least be entitled to retain the gain (or a portion of it) until the tax position in respect of the income year had become certain (ie. upon the Commissioner issuing an assessment or providing other advice).
For a more detailed analysis of Logan J’s decision, see:
Liquidators and receivers not required to account to the ATO under s 254 without an assessment(2014) by Julian Roberts and Ryan May, King & Wood Mallesons.
Decision on appeal
In the unequivocal lead judgment of Edmonds J, the Full Court of the Federal Court affirmed the decision of Logan J, confirming that s 254(1)(d) of the 1936 Act does not impose an obligation of retention unless a relevant assessment has been issued.
Justice Edmonds held that no tax liability arises on the entry into a contract of sale of assets, either for the taxpayer or, more relevantly, the liquidators. Upon entering into the contract for sale, at most, the taxpayer made a capital gain which entered into the computation of its net capital gain for that financial year. The most that could be said is that this results in an obligation to pay income tax in the future. Justice Edmonds described the Commissioner’s contention that the trustee would be obliged, prior to the assessment, to retain out of money coming to the trustee, so much as is sufficient to pay tax to be assessed in the future as “so bizarre as to immediately cast doubt on its propriety”.
Consistent with the approach adopted by Logan J at first instance, Edmonds J characterised s 254 as a “collection section” that facilitates the collection of tax, rather than one which renders a trustee liable to be assessed to tax if the trustee is not otherwise liable. However, Edmonds J took this one step further than Logan J and held that even if the taxpayer had an obligation to pay income tax in the future, that does not trigger a retention obligation for the liquidators as trustees pursuant to s 254 for the simple reason that no tax will become due in the sense of owing by them. The retention obligation imposed by s 254 applies to tax due or to become due by the liquidators in their representative capacity. It did not embrace tax due, or to become due in the future, under an assessment of the taxpayer.