A recent Full Federal Court decision has held that the Commissioner of Taxation may rank above other unsecured creditors of a company even after the company is placed into liquidation by serving what is known as a 'garnishee notice' on debtors of a company to recoup taxation debts.
In the 2008 case of Commissioner of Taxation v Brunton Holdings Pty Ltd, Brunton Holdings was the trustee of the Brunton Educational Trust. Administrators were appointed to Brunton in February 2007 and in late April 2007 Brunton was placed into liquidation.
On 26 March 2007 the Commissioner issued Brunton with a Notice of Assessment for the year ended 30 June 2004 for a debt of more than $7.5 million.
In May 2007, after Brunton was placed into liquidation, the Commissioner served 3 garnishee notices on a third party which held in trust approximately $450,000 of Brunton's funds. The garnishee notices directed the third party to pay to the Commissioner the money held in trust rather than return it to Brunton. The liquidators argued that the money held in trust by the third party should properly be available to pay the costs and expenses of the liquidators in winding up Brunton.
The key question for the appeal court concerned the rights of the Commissioner to apply trust money to the payment of Brunton's tax debt versus the rights of the liquidators to apply the trust money to cover expenses they had incurred in the liquidation proceedings.
The Decision
The Commissioner's appeal was upheld and the Full Federal Court held that the Commissioner can serve a garnishee notice on a third party debtor of a company in liquidation and direct that any debts owing to the company be paid to the Commissioner. This is despite section 501 of the Corporations Act which provides that the property of a company (on its winding up) must be used to satisfy all of the company's debts equally.
The Practical Implications of the Decision
The key feature of this case is that the power of the Commissioner to redirect debts owing to a company to satisfy tax debts of the company in liquidation exists whether the garnishee notice is served before or after the company is placed into liquidation and that this process is not inconsistent with the structure of the Corporations Act.
The fact that the Taxation Commissioner would even seek to gain a priority over other creditors in these circumstances is somewhat surprising.
Prior to 1993 the Commissioner did in fact have a priority in liquidations for PAYG amounts amongst other things as it was, and still is, relatively common for small to medium companies experiencing financial difficulty to have significant PAYG debts in difficult economic times.
Concerns regarding the unfairness of the ATO priority, particularly the impact it had on other creditors who are likely to be unaware of the extent of debts owed to the Commissioner, and the tendency of the Commissioner to allow tax debts to increase unchecked, led to the priority being removed in 1993. As a trade off for losing this priority the Commissioner received extraordinarily wide powers to make directors personally liable for PAYG debts of companies. This personal liability is automatic under the director penalty taxation legislation, although the Commissioner is required to send a notice to directors before legal action to recover the claimed amounts is commenced. As the Commissioner only has to send the notice, and the director does not have to receive it, the first time many directors become aware of this personal liability is when they are served with a court claim.
While the Brunton decision raises important considerations for insolvency practitioners and company creditors (in some circumstances), it also serves as a timely reminder that in tough economic times the Commissioner is aggressively pursuing company tax debts, as well as chasing company directors personally.
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