The Full Court of the Federal Court of Australia has handed down the appeal decision in Commissioner of Taxation v Park  FCAFC 122, a case that raised some eyebrows because the court found a garnishee notice issued by the Commissioner of Taxation pursuant to section 260-5 of Schedule 1 of the Taxation Administration Act 1953 (Cth) had priority over the rights of a mortgagee to the proceeds of sale from the secured property.
The central question, however is this: does the decision mark a considerable change in the law, or does the case turn on its specific facts?
The taxpayer was the registered owner of real property located in Queensland, over which two mortgages were registered. The taxpayer was indebted to the Commonwealth for unpaid tax and interest in an amount of approximately AU$75,508.64.
A contract for the sale of the property was entered into by the taxpayer for an amount of AU$1,675 million (insufficient to satisfy the amounts owed to both the first and second mortgagees). Prior to the sale settling, the Commissioner served a garnishee notice on the purchasers and their solicitors, requiring the amount of the tax debt to be paid to the Commissioner.
At settlement of the sale, the first mortgagee provided a release of its mortgage and was paid in full. The second mortgagee provided a release of mortgage on the basis that:
- The amount claimed by the Commissioner was paid into its lawyer's trust account pending determination of the Commissioner's entitlement; and
- It received the balance of the proceeds of sale, in partial satisfaction of its second mortgage debt.
Thereafter, the taxpayer became a bankrupt and the second mortgagee assigned its interest in the amount claimed by the Commissioner to the trustee in bankruptcy.
The Court's decision
The Commissioner argued that the moneys paid by the purchasers were owed at all times to the taxpayer and were, therefore, payable to the Commissioner in accordance with the garnishee notice.
The majority of the Full Court of the Federal Court held that the second mortgagee's mortgage was over the freehold interest in the property only and did not extend to an equitable charge over the proceeds of sale. Accordingly, because the Commissioner's notice required the purchasers to settle, in part, the amount owed to the taxpayer by way of payment to the Commonwealth against the taxpayer's debt, the Commissioner was entitled to the moneys held in court.
The Court came to this conclusion on the basis that the purchasers owed money to the taxpayer, not the second mortgagee. The Court noted that the purchasers may not have owed the taxpayer such moneys until she was able to convey unencumbered title to the purchasers, but that "there was never a point at which, in the words of Connolly J [in Tricontinental Corporation Ltd v Commissioner of Taxation  1 Qd R 474], the amount to be received from the purchasers was 'no longer in reality owing to the taxpayer but to the [mortgagee]'".
It is clear that the position would have been different had the second mortgagee refused to provide a release of its mortgage and exercised powers as mortgagee; in that case, the moneys would have been payable by the purchasers to the mortgagee rather than to the taxpayer. In those circumstances, the Commissioner's notice would not have been able to attach to the moneys. In providing a release of mortgage, the second mortgagee effectively compromised its claim.
The result in practice
The Court found that once a registered mortgage is released, the Commissioner's notice will attach to the moneys payable to the taxpayer and, accordingly, the Commissioner will be entitled to moneys to discharge the tax debt in priority to the mortgagee.
The decision appears to give priority to the Commissioner's garnishee notice over mortgagees, but, in reality, this case turned on its specific facts: in particular, the fact that the second mortgagee provided a release of its mortgage, thereby enabling moneys to be paid by the purchasers to the taxpayer.
This decision, however, does create a risk for secured parties. Until the position is clarified by the Court, when dealing with securities in Australia, particularly when you have concerns about the security provider's solvency, when you are aware of an outstanding taxation liability or when a garnishee notice has been issued, it is important that you seek advice from an Australian practitioner before the security is released. There are a number of alternatives, such as exercising powers as mortgagee, available to secured parties to avoid the potential consequences of a case like this one.
This article was first published in Global Insight, our e-newsletter which includes news, views and analysis from our Global Restructuring Group, Please click here to view the latest issue of Global Insight.
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