As we have just released our new internal income assessment system in Workbench, it seems like a good time to briefly review the income assessment procedure in the Bankruptcy Act.
A bankrupt is usually encouraged to earn an income during the period of bankruptcy, if for no other reason than to keep them off government benefits. But there is no logical reason why a bankrupt should not be entitled to earn an income and to benefit from those earnings.
It is also reasonable that the bankrupt should contribute some of that income to the estate to benefit their creditors. It is a right in equity that some of the rewards from the bankrupt’s efforts during the bankruptcy period should be used to satisfy their previous commitments.
The period of bankruptcy is divided into a number of twelve-month Contribution Assessment Periods (CAPs). Each CAP runs from the date of the bankruptcy (or its anniversary) and ends on the day before the next anniversary. CAPs continue until the bankrupt is discharged, even if the bankruptcy is extended by way of objection or late lodgment of the Statement of Affairs. Therefore there may be more than 3 twelve-month assessment periods in a bankruptcy commenced under a Sequestration Order.
What is income and what is ‘earned’?
Income under the Bankruptcy Act has the ordinary meaning of income under the Taxation Acts, but also includes other amounts that have not been earned from physical exertion or that may be assessable for tax purposes in the bankrupt’s hands – like loans received by the bankrupt, items that fall under the Fringe Benefit Tax provisions, annuities and pensions. All of these incomes will make up the assessable income for income assessment purposes.
Any benefit that is provided to the bankrupt by anyone that would be a Fringe Benefit if it had been provided by the bankrupt’s employer is assessable income for contribution purposes. This provision can capture loans of money or holidays funded by family members. It could also include the reasonable costs of accommodation provided by a family member or spouse. Trustees will use some discretion in determining whether a ‘benefit’ would fall under these provisions.
Any money lent to or used on the direction of the bankrupt can also be classified as income. In theory, any money given to the bankrupt by a family member to survive during the bankruptcy period could be classified as income and assessed. Obviously the thresholds apply and it is very unlikely that payments for that reason would reach that threshold and require contributions unless the bankrupt also has another income. The Act also catches income that is earned by the bankrupt but paid to somebody else, whether the intention is to avoid assessment or not.
Adjusting the amount of Income
Income earned may be increased or decreased by certain amounts. Decreasing adjustments are made for Child Support Payments and Maintenance Payments made under Family Law Orders, and tax payments. The Act also allows for some expenses to be deducted from the bankrupt’s income if the bankrupt is conducting a business and the deductions are allowable as tax deductions and were incurred in earning the assessed income.
An increasing adjustment is made for tax refunds received for tax period when the bankrupt was a bankrupt. If the refund relates to a tax year that ended before the date of bankruptcy, the amount will not be classified as income, but will vest in the trustee as an amount due in the estate.
Who is a dependent?
The level of the statutory threshold (see below) is determined by the number of the bankrupt’s dependents. A dependent is someone who is living with the bankrupt (the first major condition) and who is financially dependent upon the bankrupt (the second major condition).
In cases where the bankrupt has separated from their spouse and the spouse has care of their children, the spouse and the children will not be dependants for the purposes of determining the statutory threshold as they do not live with the bankrupt. In most cases the bankrupt will be paying some form of child support and those payments are decreasing adjustments to the assessed income.
Dependants are able to earn a small amount of income before they are no longer ‘financially dependent’ on the bankrupt. The amount at the time of writing is $3,049. This amount is indexed and updated every six months. If the person earns more than that amount, they will not be a dependant for the purposes of calculating the threshold.
Method of calculating contributions
Contributions are assessed on a surplus of the bankrupt’s income after payment of tax and other deductions. This income is called the ‘assessed income’. A contribution is payable if the assessed income is more than the statutory threshold. The amount of the threshold varies upon the number of dependents that the bankrupt has during that Contribution Assessment Period.
The trustee is entitled to receive one-half of the assessed income over the threshold. That is, the ‘over threshold after tax income’ is divided equally between the bankrupt and his trustee.
(Assessed After Tax Income – Actual Income Threshold Amount)/2
Obligation to provide information
The Bankruptcy Act sets out an obligation to the bankrupt to provide information about their income to their trustee. They also have an obligation to provide access to all books and records required by the trustee to make a proper determination of the contribution.
If the bankrupt neglects or refuses to provide the income information or the required records, the trustee may lodge an objection to the discharge of the bankrupt extending the bankruptcy period to 8 years. There are also other offense provisions that may be enacted by ITSA that may lead to the imprisonment of the bankrupt.
Whilst the trustee has the power to make an assessment on what they believe to be the income of the bankrupt from the information supplied, practically they must investigate the matter as fully as possible before making a default assessment. The trustee has the right to seek further information if what has been provided is inadequate or not believable. Non-provision of this information may lead to an objection to discharge being lodged.
When the bankrupt does not provided sufficient information or when the trustee has reasonable grounds to suspect that the bankrupt has received income that they have not disclosed, the trustee may use one of the two statutory deeming provisions to assess income. The trustee can:
(a) deem that the bankrupt has received reasonable income if the trustee believes that the income disclosed is not sufficient for the work performed; or
(b) deem income when the bankrupt claims not to be in receipt of income and the trustee believes that the bankrupt has derived income.
The first of the deeming provisions is used when the bankrupt is actively engaged in employment but did not receive what the market would consider ‘reasonable’ compensation for that work. The trustee will be able to determine that the bankrupt has derived reasonable income from that work and make an assessment on that basis. The second deeming provision is used when the bankrupt does not provide any information about income, or they claim not to have derived income and the trustee has reasonable grounds for suspecting that they actually did.
The trustee will issue an assessment for the deemed income and the bankrupt will have to prove that the assessment is incorrect. In these cases, the burden of proof lies with the bankrupt.
The Hardship Provisions
The Bankruptcy Act allows the trustee to amend an assessment in cases of hardship. These provisions are used to stop the bankrupt suffering significant financial burden from an assessment, and where there are grounds to allow a reduced assessment. A bankrupt can apply to their trustee in writing for an amended assessment if they believe that one of the statutory factors exists.
The potential hardships are extensive. Grounds outside those listed in the Bankruptcy Act will not entitle the bankrupt for an amended assessment.
Bankrupt’s obligation to make contributions at certain times
Once a determination has been made and notice of the assessment has been issued to the bankrupt, a legally binding obligation to make the contribution is created. The trustee has the power to state when the payments are to be made, and the debt can be collected from the bankrupt as a debt due to the estate, even after discharge. It is common for the payments to be made by monthly installments, commencing shortly after the assessment is made.
Review of Assessments
The Act provides a mechanism for an assessment to be reviewed by the Inspector General. It is not uncommon for bankrupt to object to part or all of the assessment, particularly if was made on an estimate or under the deeming provisions. Commonly, this objection will be resolved by the bankrupt supplying further information to the trustee. But sometimes the objection will have to be resolved by the Inspector-General.
A request for a review must be made within 60 days of receipt of the notice of assessment. If the bankrupt does not lodge it within that time, the bankrupt is deemed to have accepted the assessment. The bankrupt will have to supply the Inspector General with sufficient information to show that the trustee’s assessment of income is incorrect, and what they believe is the correct assessment.
Within 60 days after the request for the review has been made, the Inspector General must make a decision on whether to review the assessment and, if they decide to review the assessment, to conduct that review and provide their decision. If the Inspector-General has not provided notice to the bankrupt within that 60 days, the Inspector-General is taken to have confirmed the assessment by the trustee.
If the bankrupt is still not satisfied with the decision of the Inspector-General, they may made an application to the Administrative Appeals Tribunal.
Assessments are made at the beginning of each assessment period as estimates, with actual figures being received after the end of the assessment period. The obligation to provide this information for the last contribution period survives the discharge of the bankrupt at the end of their bankruptcy. Any outstanding contributions remain owing to the trustee as a debt due, and this debt also survives after the bankrupt is discharged. The trustee may re-bankrupt the discharged bankrupt on this debt if the outstanding amount is above the statutory limit.