Australia: Commissioner of Taxation circumvents the abolition of taxation priority in liquidations

This week's TGIF considers the recent NSW Court of Appeal decision of Commissioner of Taxation of the Commonwealth of Australia v 4 Doonan Street Collinsville Pty Ltd (in liq) [2016] NSWCA 69 in which the Court considered the validity of the Commissioner of Taxation's treatment of debits and credits in an insolvency context.

Facts

Receivers were appointed to a company which was the trustee of a trading trust (Company). Shortly after the Company was placed into administration and ultimately into liquidation. In the liquidation, the Commissioner of Taxation (Commissioner) lodged a proof of debt in the amount of $50,464.52 which was in respect of BAS deficit amounts.

The receivers completed a sale of the Company's property and business assets and lodged, on behalf of the Company, a tax return recording a net capital gain of $1,400,733. This gave rise to a tax liability of $717,816.75, which was paid in full. The receivers then retired.

Six months later the Company's tax agent applied to amend the tax return lodged by the receivers to reduce the net capital gain to zero (because, as a trustee, the Company was not liable for capital gains tax).

The Commissioner acceded to the application. The difference between the amount paid previously ($717,816.75) and the re-assessed amount was $651,340.85 (Original Amount). However, only $398,472.44 was returned to the Company by the Commissioner.

The deductions made by the Commissioner

The reason the Commissioner refunded only $398,472.44, instead of the Original Amount, was a result of the Commissioner making five deductions based on sums due by the Company in respect of other tax liabilities it had incurred over successive financial years (e.g. GST, SGC).

The deductions were made pursuant to Part IIB of the Taxation Administration Act 1953 (Cth) (TAA).

Effectively, the deductions meant that the Commissioner was paid his debt in full (his proof of debt was withdrawn) and this payment was made in priority to the general body of creditors of the Company.

The Company's argument

The Company challenged the Commissioner's power to make the deductions under the TAA, arguing that the deductions amounted to an attachment, sequestration, distress or execution against the property of the Company within the meaning of s500 of the Corporations Act 2001 (Cth) (Act).

Alternatively, the Company argued that although the deductions did not fall within the set-off provisions contained in s553C of the Act, the situation was analogous and the Commissioner's knowledge of the Company's insolvency prohibited him from making the deductions.

Ultimately, the Company's submission amounted to a complaint that it was not lawful for the Commissioner to deduct tax debts owed by the Company before he repaid the Original Amount.

The decision

The Court ultimately held that Part IIB of the TAA mandated the Commissioner to deduct the tax debts before he made a repayment.

The Court held that this deduction process did not infringe the legislation which abolished tax priority in liquidations.

Comment

The impact of this decision is that in some circumstances, tax debts will receive a priority over the general body of creditors. 

However, the precedent set by this decision was questioned by the Court of Appeal itself.  This arose because the Commissioner "admitted" a state of affairs in his pleading (i.e. that all accounts were running balance accounts) but at the hearing submitted that the admission (and the state of affairs) was incorrect.  The trial judge and Court of Appeal proceeded on the basis that the "admission" was correct.

The Court noted that the "artificial basis on which the parties conducted the proceedings has affected the significance of the reasoning in this judgment for other cases."  Liquidators should be alive to the potential to challenge Part IIB deductions notwithstanding the outcome in this case.

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