Two draft rulings on capital gains tax (CGT) liabilities of insolvency practitioners have been released by the Australian Taxation Office (ATO).
We believe that the rulings (TD 2012/D7 and TD 2012/D6) are the first of a total of four to be published on this topic.
The rulings confirm that a priority exists for CGT payable on assets sales by insolvency practitioners under section 254 of the Income Tax Assessment Act (ITAA). This section imposes obligations on an agent or trustee in respect of any income, profits or gains derived by the agent or trustee in their capacity.
(a) The preparation of returns in respect of that income, or those profits or gains ; and
(b) Withholding out of any money which comes to them in their representative capacity so much as is sufficient to pay tax which is, or will, become due and payable in respect of income, profit or gain.
An agent includes a receiver and liquidator, but not an agent for a mortgagee.
It was previously thought that when a receiver makes a gain on the sale of a CGT asset, the associated liability for CGT remained with the company to which that receiver was appointed. By comparison, the CGT liability on a gain made by liquidator was treated as a debt provable by the ATO in the liquidation.
TD 2012/D7 is expressed to apply to receivers. The ruling makes it clear that a receiver is required to withhold from the proceeds of sale of an asset so much as is sufficient to pay the accompanying CGT liability in full.
Although this draft deals only with receivers, we see no reason why the position would be different for liquidators and voluntary administrators.
It is expected that once officially released it will only apply from the date of its issue.
TD 2012/D6 confirms that the obligation to retain in section 254 applies not only to tax that has been assessed (i.e. the tax liability that rises when returns have been prepared and lodged with the ATO), but additionally tax will become due when an assessment is made. If this were not the case, the obligations arising under section 254 could be easily circumvented by the disbursement of money received from the sale of an asset prior to the CGT being assessed (i.e. prior to the relevant return being lodged).
The implications of such rulings mean that the ATO will have priority for CGT ahead of both secured and unsecured creditors. This will have a significant impact on secured lenders, who could be advantaged by appointing an agent rather than a receiver – which challenges the status quo. It also should sound warning bells for lenders as they may need to consider potential future tax liabilities when contemplating what they are prepared to lend. This is illustrated in the following example:
Sale of factory
ABC Pty Ltd purchased a factory for use as its trading premises in 1990. It paid $330,000 for the factory, a large part of which was funded by a loan from XYZ Pty Ltd. The loan is secured by a mortgage over the factory and a debenture.
Over time, and as the value of the factory increases, XYZ Pty Ltd makes further loans to ABC Pty Ltd to fund the expansion of its business and to meet its working capital requirements. In 2012 ABC Pty Ltd defaults on repayment of the loan and XYZ Pty Ltd appoints a Receiver to the factory. At the time of the Receiver’s appointment, the debt to XYZ Pty Ltd is $1.1 million.
The Receiver sells the property for $1.3 million (ex GST) resulting in a capital gain $970,000 and capital gains tax liability of $291,000. The Receiver is required to withhold that amount to comply with section 254. As a result, XYZ Pty Ltd can expect to receive a return of $1.009 million on its debt, which is calculated as follows:
Sale proceeds (ex GST) $1,300,000
Capital gains tax $ 291,000
As a result XYZ Pty Ltd will suffer a shortfall before accounting for costs, on what appears to be a well secured debt.
The provision also creates considerable difficulty for practitioners, particularly:
Practitioners commonly don’t have the records necessary to calculate the capital gain and/or prepare returns (particularly a receiver appointed to a single asset of a company);
There will be additional costs and delays associated with preparing returns; and
- Generally a company has a significant number of outstanding returns. Unless those returns are completed and lodged, it could be near impossible to determine whether there are any carried forward tax losses that can be off-set against the capital gain.
Lastly (but certainly not least), unsecured creditors in a liquidation are equally prejudiced by the subsequent reduction in funds available to receive a dividend and the preparation of returns will increase a liquidators’ compliance costs. Those additional costs will ultimately be recovered from property of the company.
The above serves as a useful reminder that secured creditors need to be mindful of potential future tax liabilities, and the type of appointments they are making going forward.