On Friday 21 February 2014, Justice Logan of the Federal Court of Australia delivered his decision in Australian Building Systems Pty Ltd v Commissioner of Taxation  FCA 116. The case is significant for receivers and liquidators because it overturns the position of the Commissioner of Taxation regarding the personal liability of liquidators and receivers for capital gains under section 254 of the Income Tax Assessment Act 1936 (Cth) (ITAA36).
Australian Building Systems Pty Ltd (ABS) v Commissioner of Taxation  FCA 116
In a private ruling, the Commissioner of Taxation found that the liquidators of ABS must retain sufficient funds out of the proceeds of sale of property owned by the company before its liquidation to comply with a future tax assessment. Failure to retain sufficient funds to satisfy such a prospective liability would have resulted in a personal liability for the liquidators. The liquidators commenced proceedings challenging the correctness of the private ruling.
His Honour Logan J found that in the absence of an assessment issued by the Commissioner of Taxation, trustees (defined in the ITAA36 to include receivers and liquidators) are not required to retain from the proceeds of sale of an asset, sufficient money to pay any capital gains tax arising from that sale. His Honour found that the obligation to retain funds arises only once an assessment is issued.
In light of his Honour’s decision, Draft Taxation Determination TD2012/D6 dated 19 September 2012 will now need to be withdrawn and revised.
However, his Honour noted that a prudent practitioner would retain funds sufficient to discharge a potential capital gains tax liability even though he or she is not required to do so by law. The intention and meaning of his Honour’s comments is unclear in circumstances where such ‘prudence’ is fundamentally inconsistent with the clarity of his Honour’s findings.
Unresolved issue of priority
The case had the potential to resolve whether or not section 254 creates a priority in favour of the Commissioner. His Honour found it unnecessary to consider this question given his findings and considered that a determination should await a matter in which an assessment had been issued by the Commissioner.
The pre-appointment tax liability of liquidators and receivers is determined by sections 260-45 and 260-75 of Schedule 1 of the Taxation Administration Act 1954 (Cth), respectively. The formula prescribed by those sections for determining the tax debt (and personal liability of the insolvency practitioner) affirms the pari pasu distribution principle. However, s 260-90 states that the subdivision ‘does not reduce any obligation or liability of the receiver or receivers arising elsewhere’.
Section 254 appears to provide a priority collection mechanism for liabilities crystallised by liquidators and receivers even if those liabilities were in respect of increases in market value attributable to the period prior to appointment. Accordingly, once an assessment has issued, section 254 of the ITAA36 continues to give rise to the potential to argue that the Commissioner is entitled to a priority for unremitted capital gains tax.
If section 254 is intended to operate as a mechanism for the Commissioner to collect tax revenue from an insolvent entity, then this decision renders the section ineffective.
It also creates very different outcomes for creditors depending on the timing of when insolvency proceedings start. An insolvency that spans two separate financial years may result in an assessment being issued by the Commissioner that results in the funds available for distribution being diminished. On the other hand, an insolvency that occurs and completes within the space of one financial year may result in a distribution to creditors being possible without an assessment occurring.
As such, we would expect that this decision will be either appealed or be the trigger for legislative review.
The result for insolvency practitioners is that they enjoy a degree of comfort (for the time being) that, assuming an assessment has not issued, they may make a distribution to creditors without personal liability. However, until the priority issue around section 254 is finally resolved and the impact of this decision is considered further, the prudent course would be for insolvency practitioners to retain enough funds to pay any potential capital gains tax liabilities prior to making any distribution to creditors.