By majority, the High Court has confirmed that the obligation imposed by subsection 254(1)(d) of the Income Tax Assessment Act 1936 (Cth) (“ITAA 1936”) on liquidators to retain funds to meet tax liabilities does not arise until after an assessment is issued by the Commissioner in respect of those amounts.
In April 2011, the creditors of Australian Building Systems Pty Ltd (“ABS”) resolved that ABS be wound up and appointed liquidators to the company. In July 2011, the liquidators caused ABS to enter into a contract for the sale of real property, giving rise to a capital gain of approximately $1,120,000.
The liquidators applied for a private ruling from the Commissioner of Taxation (“the Commissioner”), asking whether they had an obligation pursuant to section 254 of the ITAA 1936 to retain out of the proceeds of sale, monies sufficient to cover capital gains tax liability from the time the capital gains crystallised.
Subsection 254(1)(d) of the ITAA 1936 provides:
- With respect to every agent and with respect also to every trustee, the following provisions shall apply:
- He or she is hereby authorized and required to retain from time to time out of any money which comes to him or her in his or her representative capacity so much as is sufficient to pay tax which is or will become due in respect of the income, profit or gains.
For the purposes of the ITAA 1936, “trustee” is defined to include a liquidator or receiver.
The Commissioner ruled that section 254 required that monies be retained from the time of crystallisation of the capital gain. The liquidators objected to the ruling which was disallowed by the Commissioner.
The liquidators commenced proceedings in the Federal Court seeking declaratory relief in the same terms as the private ruling and the Federal Court held that section 254 did not impose an obligation to retain money, unless and until an assessment had been issued.
The Commissioner appealed to the Full Court of the Federal Court and this appeal was dismissed.
The Commissioner subsequently appealed to the High Court of Australia.
High Court Decision
Chief Justice French and Justice Kiefel of the High Court held that the phrase “tax which is or will become due” in sub-section 254(1)(d) refers to tax which has been assessed and is, or will become, payable.
Further, their Honours considered that the word “sufficient” in subsection 254(1)(d) is entirely consistent with the proposition that the retention obligation arises only upon the making of the relevant assessment.
French CJ and Kiefel J also considered that the practical difficulties involved in the Commissioner’s construction of subsection 254(1)(d) supports the contention that the retention obligation does not arise until the Commissioner issues an assessment. In particular, on the Commissioner’s proposed construction, the liquidator would be burdened with a continuing obligation to retain sufficient money to pay at any time the amount of tax which would be payable upon a notional assessment at that time. Rather, in their view losses and deductions would have to be factored into this calculation.
Justice Gageler similarly held that the content of the obligation to retain funds is fixed by the assessment made by the Commissioner. In this way, the retention obligation conforms to the tax liability. It also provides certainty as to the total amount which the liquidator is authorised and required to retain under subsection 254(1)(d).
Gageler J also highlighted that the proper construction of subsection 254(1)(d) should not provide for a fiscal distortion of legitimate commercial choice between business models. That is, a taxpayer carrying on a business alone is not ordinarily obliged to quarantine money as it is received for the future payment of tax. A business carried on through an agent would therefore be at a disadvantage were the agent required to retain money prior to the issuance of an assessment as would be the case if the Commissioner’s interpretation were adopted.
In the context of liquidators, the High Court confirmed that section 254 does not affect the operation of the Corporations Act 2001 (Cth) such that the Commissioner enjoys a form of priority in winding up over other unsecured creditors.
The High Court’s decision in the ABS Case provides a welcome degree of certainty for liquidators in respect of the scope and operation of the retention obligation contained in section 254 of the ITAA 1936.
In our view, the ABS Case appears to confirm that liquidators are not required to retain a portion of income, profits or gains in order to satisfy a potential tax liability in respect of those amounts unless and until an assessment is issued by the Commissioner. Any funds which are retained by the liquidator, however, would fall into the pool of funds to be distributed in accordance with the priorities in section 556 of the Corporations Act 2001 (Cth).
It is worth noting that the Commissioner currently has on issue two draft taxation determinations, namely TD 2012/D6 and 2012/D7, which are in direct conflict with the law as stated by the High Court in the ABS Case. These determinations have been in draft form for a number of years and we expect that the Commissioner will reconsider these determinations in light of the High Court’s decision in the ABS Case.
Cowell Clarke has significant expertise and experience in all aspects of both corporate insolvency and taxation law. If you need any assistance concerning these areas, please do not hesitate to contact us.