The Commissioner of Taxation is the most common unsecured creditor in insolvent estates and often the biggest. That is not surprising since Federal tax revenues are currently about 21% of GDP.
In 1993 the Commissioner lost his priority over other unsecured creditors in bankruptcy or liquidation for outstanding group tax and PPS debts.
Since then, the Commissioner has looked for other ways to gain de facto priority over unsecured creditors. One method has been to recover tax from directors personally – the “directors penalty notice” provisions of the tax law was also introduced in 1993 partly to compensate the Commissioner for the loss of priority (an excellent paper explaining these provisions in clear terms can be found here, published by Worrells).
Another device given a try by the Commissioner was to garnishee debts owed by third parties to the insolvent company, by notice under section 260-5 of the Taxation Administration Act 1953 (TAA), after a company had gone into liquidation. A notice under s 260-5 gives the Commissioner the right to recover from a third party an amount that the third party owes or may later owe to a taxpayer who is indebted to the Commonwealth for tax. The remedy given to the Commissioner by s 260-5 is available in respect of revenue obligations, which are given the character of “debts” by force of the TAA itself and without the need for a judicial determination. The third party must pay the amount demanded in the notice; failure to comply with the notice is a criminal offence. Upon payment the Commissioner has the right to give to the third party a valid receipt and discharge for money paid in compliance with the notice. In these respects, a notice under s 260-5 operates in the same manner in which a garnishee order issued by a Court operating to attach a debt.
In effect the Commissioner was issuing notices to round-up debts owed to the insolvent company that would otherwise be collected by the liquidator, putting the proceeds of the debts exclusively to payment of the Commissioner’s debt. If the debtor responded to the notice and its validity were upheld, then the Commissioner would then restore an effective position of priority, at least as far as proceeds of third party debtors recoveries are concerned.
The Commissioner’s efforts ended badly.
First, the use of garnishee notices in this way was held to be invalid by the High Court (Bruton Holdings Pty Ltd (in liquidation) v Commissioner of Taxation (2009) 239 CLR 346). In a fairly extraordinary display of litigation muscle by the Commissioner (no doubt because of the potential precedent value of a favourable outcome), no less than six related proceedings were fought in the Federal Court and High Court, over about $470,000 held in a solicitor’s trust account, the debt in question.
Second, the outcome of the final Full Federal Court appeal – Bruton Holdings Pty Ltd (in liq) v Commissioner of Taxation (austlii link) (2011) 193 FCR 442 (FCFCA) (Bruton (no 2)) was that Bruton, the insolvent corporate trustee, was allowed its full indemnity costs of the entire sequence of litigation from the trust’s funds even though it was a bare trustee of the assets. The Commissioner had argued, unsuccessfully, that a bare trustee is restricted to a “passive role” and that Bruton had no authority to conduct the litigation over the validity of the garnishee notice because, in effect, the ATO was the only unsecured creditor and would get the proceeds of the debt one way or other (no evidence to support this latter assertion was led). The Full Court rejected that argument – first on the basis that there was some evidence suggesting the existence of other creditors, and secondly by reference to the general duties of any trustee to preserve and protect trust assets when threatened, by litigation. See in particular paragraphs 19 to 27.
There has been no special leave application: just an even half-dozen cases on this occasion then!
The introduction to the joint judgment of Stone, Jacobson & Edmonds JJ in Bruton (no 2) sets out the extraordinary sequence of the litigation:
……….In 1997, by deed of trust, the appellant (Bruton) was appointed as trustee of the Bruton Educational Trust (educational trust). On 10 October 2005, Bruton applied to the respondent (Commissioner) for endorsement as a tax exempt entity as from 1 July 2006. The application was refused, as was Bruton’s objection to the Commissioner’s decision. An appeal from the Commissioner’s decision (objection appeal) was also dismissed.
Piper Alderman was the solicitor for Bruton in the objection appeal. Between October 2005 and February 2007 it was paid $470,000 by Bruton to be held in its trust account in respect of costs and disbursements of the proceedings including the endorsement application to the Commissioner. On 28 February 2007 administrators were appointed to Bruton and on 30 April 2007 the company’s creditors resolved that it should be wound up. By virtue of ss 513B(b) and 513C(b) of the Corporations Act 2001 (Cth) the winding up was taken to have commenced on 28 February 2007.
Clause 10.2(b) of the educational trust deed provided that the office of the trustee was “immediately terminated and vacated” if the trustee went into liquidation. Accordingly, from 28 February 2007 Bruton ceased to be the trustee of the educational trust and became the bare trustee of the assets comprising the trust fund (Fund). As a consequence Bruton was no longer entitled to exercise any power including the investment, management or payment of trust monies arising from the educational trust deed. Its powers were limited to those that under the general law or statute are the powers of a bare trustee.
On 26 March 2007, the Commissioner issued a notice of assessment directed to the trustee calling for payment in the amount of $7,715,873.73 in respect of tax and the Medicare levy for the 2004 income year. Furthermore, after Bruton was wound up, the Commissioner lodged a Proof of Debt with the liquidators of Bruton for the amount stated in the notice of assessment. On 8 May 2007, the Commissioner issued a notice to Piper Alderman pursuant to s 260-5 of Schedule 1 of the Taxation Administration Act 1953 (Cth) requiring the firm to pay $447,420.20 which it held in its trust account on account of the educational trust to the Commissioner.
On 30 May 2007 Bruton instituted proceedings in this Court (primary proceeding) seeking a declaration that the s 260-5 notice was void by virtue of s 500(1) of the Corporations Act. On 2 November 2007 Allsop J declared the notice was void (see Bruton Holdings Pty Ltd v Commissioner of Taxation (2007) 244 ALR 177). On 23 November 2007, his Honour made further orders including an order that Piper Alderman pay the $477,420.20 held in its trust account to the liquidators. The liquidators were to pay that money into an interest-bearing bank account and were restrained from spending that money except, inter alia, to pay expenses incurred by Bruton in respect of the primary proceeding and the appeal proceeding. His Honour ordered the Commissioner to pay Bruton’s costs as well as those of Piper Alderman.
An appeal from Allsop J’s judgment to the Full Court was allowed and Allsop J’s judgment was set aside (see Commissioner of Taxation v Bruton Holdings Pty Ltd (in liq)  FCAFC 184; (2008) 173 FCR 472. Bruton was granted special leave to appeal to the High Court. The High Court allowed the appeal with costs (see Bruton v Commissioner of Taxation  HCA 32. It set aside the orders of the Full Court and in their place ordered that the appeal to the Full Court be dismissed with costs.
A dispute followed between the Commissioner and the liquidators concerning whether the shortfall between the amount of Bruton’s solicitor and client costs and the amount of its party and party costs referable to the primary proceeding, the Full Court appeal, the application for special leave and the appeal in the High Court should be paid out of the Fund. This dispute over the payment of costs was the subject of the proceeding before Graham J (costs proceeding) and is the issue in the present appeal (emphasis added)
Recently a controversy has developed concerning whether insolvency practitioners selling CGT assets subject to mortgage security were required to remit CGT in priority to the secured creditor. The controversy developed out of a reading of s254 of the Income Tax Assessment Act 1936 as it relates to trustees of incapacitated entities, including liquidators, VAs and receivers.
Late last year I co-authored a paper with Helen Symon SC concerning the liability of insolvency practitioners whilst in office to a range of taxes. The paper concentrated on CGT, Income Tax and GST. The main issues dealt with in the paper were whether sale of post CGT assets by an insolvency practitioner gave rise to an obligation to pay CGT on the sale in priority to a secured creditor (we formed the view this was probable), and the now recognised device of appointing an agent in possession to effect a post CGT asset sale, and the circumstances and period for which practitioners are required to file tax returns for the entities to which they are appointed.
A copy of the paper is available at this link – Taxation – Common Issues.
A decision handed down since the paper contains a similar analysis of s254 in obiter (non binding) comments of the Supreme Court of New South Wales. The decision is Goldana Investments Pty Ltd (recs & mgrs apptd) v National Mutual Life Nominees Ltd & ors  NSWSC 1134. In that decision, an application was made by the debtor company to have receivers removed on the grounds that the secured debt had been paid after the sale of a shopping centre. The receivers of Goldana successfully resisted the application to have them removed because their potential personal CGT liability arising because of s254 had not yet been resolved. It was therefore appropriate to allow the receivers to stay in office and in control of surplus proceeds from the sale. According to the judgment, the receivers are in the process of seeking a private ruling from the ATO on their personal liability.
Liability limited by a scheme approved under Professional Standards Legislation
(PS Welcome to this blog!)