The Final Say: High Court rules that liquidators are not obliged to retain funds until a notice of assessment is issued

On 10 December 2015, a majority of the High Court of Australia ruled in Commissioner of Taxation v Australian Building Systems Pty Ltd (In Liquidation)¹ that liquidators are not obliged to, and are not personally liable for, failing to retain sufficient funds for the purpose of discharging a tax liability until the Commissioner issues a notice of assessment.

What does this mean for practitioners?

• The Commissioner must issue a notice of assessment in respect of a tax liability before the related retention obligation and personal liability can take effect. Consequently, unless the Commissioner utilises his broad powers and issues notices on an accelerated schedule, liquidators will likely have access to more funds during a winding up.
• Secured lenders often prefer to enforce their securities as mortgagee in possession rather than by a receivership, to avoid of the risk of the receiver being obliged to retain sufficient funds to discharge the tax liability and giving the Commissioner a super-priority. This risk is now significantly reduced, because funds only need to be retained once a notice of assessment is issued. This may may lead to a resurgence in receivership appointments over agents for the mortgagee in possession.
• The availability of assets for unsecured creditors remains constrained by Division 260 of the Tax Administration Act 1953, which prevents disposal until the Commissioner issues a clearance notice specifying the amount sufficient to discharge pre-appointment tax liabilities.
• The requirement for a notice of assessment to be issued will provide certainty as to the amount that must be retained for tax purposes.
• It remains unclear whether proceeds related to a retention obligation form part of a liquidator's expenses in a winding up (which hold the highest ranking priority under section 556 of the Corporations Act 2001) or merely rank alongside other unsecured debt. Although Gordon J in dissent considered that proceeds were such an expense,² the matter was not an issue on appeal and hence not accepted by the majority.
• The Commissioner is unable to receive priority payment in respect of post-liquidation tax liabilities before a notice of assessment is issued (an issue discussed in our garnishee notices update).
• We anticipate that the Commonwealth Government may consider legislative reform in response to the decision in order to protect existing revenue from the insolvency sector. In the meantime, the Commissioner may utilise his broad powers to issue notices of assessment as soon as possible after an asset sale, leading to insolvency practitioners (particularly receivers) attempting to pre-emptively disgorge sale proceeds.

Framing the issue

Australian Building Systems Pty Ltd (in liquidation) became subject to a capital gains tax (CGT) event when its liquidators (Liquidators) entered into a contract to sell property. By way of private binding ruling, the Commissioner of Taxation (Commissioner) ruled that the Liquidators were obliged from the time of sale to retain sufficient funds from  proceeds to discharge the associated CGT liability when it was eventually assessed.

The Commissioner relied on section 254(1)(d) of the Income Tax Assessment Act 1936 (Cth) (1936 Act) which provides that a trustee or agent (including a liquidator or receiver):

… is hereby authorised 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.

This is known as the "retention obligation", for which section 254(1)(e) makes a trustee or agent personally liable to discharge to the extent that funds should have been retained. Throughout the case, the Commissioner held the position that the provision in effect created a tax liability upon a trustee or agent, as well as a means to collect monies pursuant to that tax liability.

The Liquidators successfully appealed the private ruling to the Federal Court, which held that the Liquidators were not obliged to retain the sale proceeds until the Commissioner issued a notice of assessment in respect of the CGT liability. The Commissioner's appeal to the Full Court of the Federal Court was dismissed, however special leave was granted to appeal to the High Court.

High Court decision

By way of a 3:2 decision, the High Court dismissed the Commissioner's appeal (French CJ, Kiefel and Gageler JJ; Keane and Gordon JJ dissenting). French CJ and Kiefel J ruled in the leading judgment that section 254's text, context and purpose lead to a conclusion that the retention obligation does not arise until a notice of assessment is issued.³ The Justices considered that the Commissioner's interpretation, if accepted, was impractical because:

… the agent or trustee would be burdened with a continuing obligation to retain sufficient money to pay at any time the amount of tax that would be payable upon a notional assessment made at that time. Losses and deductions would have to be factored in to avoid the agent or trustee exceeding the retention authority conferred by s 254(1)(d). Linked to the continuing obligation would be a continuing and variable personal liability defined by reference to the difference between what the agent or trustee has retained and what would have been sufficient to pay the relevant tax at that time.⁴

In a concurring opinion, Gageler J also noted practical benefits of the High Court’s interpretation:

• it creates certainty as to the amounts trustees and agents need to retain; and
• it results in "lesser fiscal distortion" because taxpayers carrying on a business alone (rather than via a trustee or agent) are not ordinarily obliged to quarantine funds to discharge future tax liabilities.⁵

The majority also found that the High Court's reasoning in Bluebottle UK Ltd v Deputy Commissioner of Taxation [2007] HCA 54 (Bluebottle) was persuasive and "equally applicable to the retention requirement in s 254(1)(d)".⁶ Bluebottle interpreted the similarly worded section 255(1)(b) of the 1936 Act that created a retention obligation for controllers of non-residents' assets. In interpreting the words "is or will become due" in that case, the Court stated that:

Until the tax payable by the non-resident has been assessed it is not possible to say more than that there may be tax due by the non-resident. It is not possible to say that tax is due or that tax will become due.⁷

The Commissioner did not challenge that interpretation in Bluebottle, however sought to distinguish it from section 254(1)(d) on the basis that trustees and agents (as compared to controllers of non-residents’ assets) could more readily conclude whether tax "will become due". However, French CJ and Kiefel J considered that contention was merely a "statement of likelihood" that did not necessarily apply to all trustee and agent relationships contemplated by section 254(1)(d).⁸ In any case, that argument did not answer the key question of when the retention obligation arises.⁹

In separate dissenting judgments, Keane and Gordon JJ favoured the Commissioner's submissions primarily on two bases. Firstly, section 254(1)(d) has unique textual and contextual factors that distinguish it from the conclusions in Bluebottle.¹⁰ Secondly, the majority's interpretation leads to "absurd results" in practice, such as a trustee or agent being able to distribute income, profits or gains that would generate a tax liability before the obligation to pay arises.¹¹

¹Commissioner of Taxation v Australian Building Systems Pty Ltd (In Liquidation) ; Commissioner of Taxation v Muller and Dunn as Liquidators of Australian Building Systems Pty Ltd (In Liquidation) [2015] HCA 48.
²[2015] HCA 48 at [207].
³[2015] HCA 48 at [57].
⁴[2015] HCA 48 at [40].
⁵[2015] HCA 48 at [60-61].
⁶[2015] HCA 48 at [26].
⁷Bluebottle UK Limited v Deputy Commissioner of Taxation [2007] HCA 54 at [44].
⁸[2015] HCA 48 at [35].
⁹[2015] HCA 48 at [33].
¹⁰[2015] HCA 48 at [125, 198, 218-219].
¹¹[2015] HCA 48 at [213-214].