A bankrupt can still be liable for tax debt.
Bankruptcy annulments under section 153A of the Bankruptcy Act 1966 are an infrequent occurrence.
We were recently appointed by the court on the petition of the Deputy Commissioner of Taxation to two bankruptcies that might qualify for an annulment. The respective bankrupts own real property that may realise sufficient funds to pay all provable creditors and estate expenses in full, which can result in the bankruptcy’s annulment (under section 153A).
To certify such an annulment, bankruptcy trustees must be satisfied that all the bankrupt’s debts are paid in full. These bankruptcies raised two quirks that bankrupts, advisors, and readers may find interesting: tax return lodgment obligations, and capital gains tax implications.
Bankruptcy case #1: Taxation return lodgment obligations in bankruptcy annulment
The Australian Taxation Office (ATO) advised us that one bankrupt had not lodged personal income taxation returns for 13 out of the last 15 years. As a medical practitioner, this bankrupt is likely to have earned substantial income over that period.
Presently, we don’t know what the outstanding taxation liability may end up being if the unlodged returns were brought into play, but we believe a section 153A annulment is probably out of the picture.
Interestingly, in such circumstances the Australian Financial Security Authority (AFSA) considers it unnecessary or unreasonable to pursue the bankrupt to bring their tax affairs up to date, even when a section 153A annulment is being considered. Specifically AFSA states in its September 2009 Personal Insolvency Regulator Newsletter:
“Pursuant to section 84(1), a creditor who desires to prove a debt in a bankruptcy shall lodge, or cause to be lodged, with the trustee a proof of debt. Therefore, if a creditor wishes to prove their debt in the estate, once they are aware of the bankruptcy, the onus is on them to lodge a proof of debt. Once the ATO has lodged a claim in the estate, the trustee’s sole duty is to adjudicate on it pursuant to section 102. Due to the nature of self-assessment in the Australian taxation system, it is not necessary or appropriate for trustees to proactively pursue the bankrupt to ensure that s/he bring their tax affairs up to date for trustees to be satisfied that all their debts have been paid pursuant to subsection 153A(1).”
Accordingly, it’s possible for a person to be annulled from bankruptcy—for payment of all debts—when in fact, not all their taxation obligations are up to date. However, it should be noted that any future tax liability that arises from the eventual lodgment of the pre-bankruptcy tax returns will still have to be paid.
On a practical note, when we formally call for proofs of debt, the ATO can lodge a claim that includes any amounts payable under default assessments that it is empowered to make under section 167 of the Income Tax Assessment Act 1936.
Bankruptcy case #2: Capital gains taxation liabilities (CGT) and bankruptcy
Currently, bankruptcy trustees are under no obligation to withhold or remit payment of a CGT liability arising from the realisation of bankrupt estate assets.
By operation of section 106-30 of the Income Tax Assessment Act 1997 (ITAA), any capital gain or loss that results from the bankrupt selling a CGT asset is a capital gain or loss made by the individual bankrupt, and not by the trustee. That is, a CGT liability will not be considered a debt of the bankrupt estate, and the bankrupt is liable to remit the CGT liability—despite being bankrupt, have no say or access to the property or sale proceeds from which the CGT liability arose, and are unlikely to have substantial funds (not subject to the bankruptcy) available to pay the liability.
In this bankruptcy, the bankrupt owned a commercial property for many years and it is presently unencumbered. We are marketing the property sale for around $800,000, and if achieved, there may be sufficient funds to pay all creditors in full and therefore annul the bankruptcy. However, the bankrupt would technically still be liable for up to $400,000 in CGT, depending on what deductions are available. Not many bankrupts would have that level of funds outside of their bankruptcy! And to make it worse, the Commissioner of Taxation could theoretically re-bankrupt them for this debt.
To us that sounds a bit harsh. The property is taken away from the bankrupt’s control, and then they get slapped with a CGT liability, irrespective of the fact that they are bankrupt.
At Worrells, as bankruptcy trustees selling real property, we write to bankrupts informing them of their obligations to report in their personal tax return any capital gain or loss that occurs during the property’s sale. To assist them, we also provide them all necessary information for the tax returns, including documents such as; the sale contract, settlement statement, expense invoices, and mortgage statements.