Who is responsible to pay?
Capital gains tax has been a major topic in the upcoming federal election. While any changes are unlikely to impact how insolvency practitioners deal with capital gains tax, it is worthwhile covering how capital gains tax is treated in insolvency administrations.
When an insolvency practitioner ‘realises’ (i.e. sells) assets under an insolvency administration, the sale itself can create a liability under the capital gains tax (CGT) legislation. Insolvency practitioners are concerned with three main issues:
- Who is responsible to pay capital gains realised in an insolvency administration?
- What happens to capital losses available at the date of the appointment?
- What are the tax implications on a holding company when a solvent wholly-owned subsidiary is wound up?
1. Who is responsible to pay capital gains realised in an insolvency administration?
The Income Tax Assessment Act 1997 (ITAA) provisions deal with capital gains that relate to bankruptcy, liquidation, or a secured creditor taking action under a valid security. The provisions protect insolvency practitioners by removing personal liability when creating a CGT liability through realisations or ‘other actions’ and places the liability to be done by the company, or a person (being the original asset owner).
Section 106.30 has two effects on bankruptcy and CGT.
First, the vesting of property in the bankruptcy trustee is not deemed an asset disposal, so no CGT liability is automatically created from the vesting of assets. Second, any actions a bankruptcy trustee takes under a bankruptcy, section 73 arrangement, or personal insolvency agreement that give rise to a CGT liability are deemed to have been done by the individual (i.e. the bankrupt or debtor) and not the bankruptcy trustee. Therefore, the individual is required to pay that debt, outside of their current bankruptcy. This may mean that the individual becomes bankrupt a second time if unable to pay the liability.
Under section 106.60 of the ITAA, secured creditors holding a security over assets are protected. Exercising a security, appointing an agent or receiver is not a change in ownership (and therefore does not give rise to a CGT liability). Usually, controllers only act as agents for the owner, with powers to sell under the security.
Secured creditors who take actions that give rise to a CGT liability, are actually done by the entity that gave the security (the original asset owner), not the entity that exercises the security. This extends to a controller appointed to assist a mortgagee in exercising a security. The High Court decision of FCT v Australian Building Systems Pty Ltd (in liq)  HCA 48 affirmed there is no personal obligation on a receiver to retain and pay the original asset owner’s CGT liability that arises from sale, until such assessment has been raised by the Australian Taxation Office (ATO). A mortgagee in possession would not be accountable to this effect as it does not act as agent for the original asset owner, but rather the secured creditor.
Under section 106.35 of the ITAA, the vesting of company’s assets in a liquidator does not give rise to a CGT liability. The CGT liability arising from a sale of an asset by the liquidator is made by the company, and not the liquidator personally. Similar rules imposed on receivers apply to a liquidator regarding how proceeds from CGT asset sales are treated. The liquidator is still required to seek tax clearance from the ATO when distributing to unsecured creditors, at which point, may give rise to an assessment that the ATO can claim as an unsecured creditor.
2. What happens to capital losses available at the date of the appointment?
Section 102.5 of the ITAA sets out how to calculate an individual’s capital gains for tax purposes. Any capital losses accrued before personal insolvency administration are lost at the end of that administration.
For example, a person cannot bring forward capital losses into the year they become bankrupt or are released from their debts. Discharge from such debts occurs at the end of bankruptcy, or at the end of a Part X or section 73 arrangement. For these reasons, debtors must consider the timing of either becoming bankrupt or starting a personal insolvency agreement and its end date.
However, when a bankruptcy is annulled under section 153B and 153A through payment of all debts, it eliminates the bankruptcy as if it had never occurred and reinstates capital losses.
3. What are the tax implications on a holding company when a solvent wholly-owned subsidiary is wound up?
When a subsidiary is solvent and is being wound up the ITAA gives specific tax relief for a holding company that receives an asset (i.e. a roll-over of an asset) from the liquidator under a members’ voluntary winding up. This relief may only be a reduction in the CGT liability, not a full exemption. This is partially because the liquidated company is solvent and can pay its outstanding tax liabilities, including any CGT liability.
Under section 126.85 of the ITAA, CGT relief only applies if the roll-over of the asset was transferred due to the cancellation of the shareholding in the 100%-owned subsidiary that is being wound up. Effectively, the holding company receives the asset in consideration for the cancellation of the shares.
Because post-CGT shares in its 100% owned subsidiary are cancelled on the liquidation of the subsidiary, the capital gain that a holding company makes from the roll-over of the asset is reduced if certain conditions are satisfied. Those conditions are:
- There must be a roll-over of at least one ‘CGT asset’ (i.e. acquired on or after 20 September 1985) and the asset must be disposed of (transferred) by the subsidiary to the holding company in the course of its liquidation.
- The disposal must either be part of the liquidator’s distribution in the course of the liquidation or have occurred within 18 months of the dissolution of the subsidiary (if they are part of an interim distribution).
- The liquidated company must be a 100% owned subsidiary from the time of the disposal until the cancellation of the shares.
- The market value of the asset must comprise at least part of the capital proceeds for the cancellation of the shares.
- One or more of the shares that were cancelled must have been acquired by the holding company on or after 20 September 1985 (i.e. they must be post-CGT shares).
There is a procedure to calculate this relief, outlined in section 126.85 of the ITAA.
Tax matters are always best left to tax specialists; however, your local Worrells partner is available to discuss any scenarios your clients might be considering before or during an insolvency administration.