A question which is quite often asked of trustees by bankrupts or their accountants is, “Do I get to keep my tax refund if I am due one while a bankrupt”? In other words, will the tax office keep a tax refund if I owe money to the tax office at the beginning of my bankruptcy?
The answer to this is found in Part E of the ATO Receivables Policy titled Chapter 72 – Offsetting of Refunds and Creditors against Taxation and Other Debts. The relevant paragraphs are 112 – 114. In summary they provide that:-
112. When debtors are discharged from bankruptcy, they are released from the debts that were provable in the bankruptcy. This has an important effect on the application of credits arising from assessments relating to income years after the date of the sequestration order. Until a bankrupt is discharged, any excess credits, such as credits for amounts withheld under the PAYG system, can be applied in reduction of any liability (both pre and post-sequestration) before any remaining balance is refunded to the debtor ( Taylor v. DFC of T 87 ATC 4441). However, once a bankrupt has been discharged, the pre-sequestration debt is considered to be irrecoverable at law and is written off. Any excess credits arising after the bankrupt’s discharge will be refunded, assuming there are no other debts.
113. The only exception to this is when an assessment relating to a pre-sequestration year results in a credit. This would be offset against the bankrupt’s debt regardless of whether or not the bankrupt has been discharged because section 86 of the Bankruptcy Act requires the Commissioner to set off the provable debt with any credit entitlements pertaining to the pre-sequestration period.
114. If a taxpayer is an undischarged bankrupt, the Commissioner will firstly allocate or apply any entitlement to a tax credit relating to the post-sequestration income period, to any post-sequestration tax debt (including additional charges for late payment). This credit would then be allocated to any tax due in respect to the pre-sequestration income period.
In summary, if you are an undischarged bankrupt, owe the tax office money (either for the period prior to bankruptcy and/or for during the bankruptcy period up until discharge) and are due a refund, the tax office will apply that refund against the monies owed. Once however the individual is discharged from bankruptcy any further tax refund due cannot be applied against a previous tax office debt.
This occurs because the tax debt still exists while the bankrupt is undischarged. It is not released until the date of discharge (and that date may be some time in the future if an objection to discharge is lodged). While the debt exists, the offset provisions – whether in the Tax Act or the Bankruptcy Act – will still apply.
One further note – any tax refund received by the undischarged bankrupt needs to be disclosed to their trustee in their annual assessment of income as the receipt of a tax refund is classified as income and will form part of their assessment.