Jurisdiction - Australia
Australia – When Does The Commissioner Of Taxation Have Priority Over A Secured Lender?

20 October, 2012



In brief


Two recent tax developments have important implications for secured lenders:

  • In the recent case of Commissioner of Taxation v Park [2012] FCAFC 122 (“Park“), the Commissioner successfully used a garnishee order over the proceeds of sale of a property to achieve the payment of a tax debt owed by the vendor, even though the property had been mortgaged.
  • In Draft Determination TD 2012/17, the Commissioner asserts that a receiver who sells an asset of a debtor is obliged not only to retain an amount equal to the tax on any gain accruing to the debtor from the sale of the asset, but also to reserve that amount for the payment of the tax, in priority to the payment of other claims including the claims of secured creditors.


These two developments are particularly important where a liquidator or receiver is appointed and sells assets of the company in the expectation that the proceeds of sale will be available to repay secured lenders.


Garnishee notice


If a taxpayer owes the Commonwealth a “tax-related liability” (and certain other related amounts) and another person owes money or might owe money to the taxpayer, the Commissioner can issue a garnishee notice to that person under s 260-5 of Schedule 1 to the Taxation Administration Act 1953 (Cth). The s 260-5 notice requires that person to pay all or part of the amount owed to the taxpayer to the Commissioner, up to the amount of the taxpayer’s outstanding tax debt.


Payment to Commissioner instead of to the secured lender


In Park, the Full Federal Court considered the Commissioner’s ability to garnishee money due to a taxpayer under a contract for the sale of real property pursuant to a s 260-5 notice. The issue was whether amounts payable by the purchaser of the property should be paid to the Commissioner pursuant to the s 260-5 notice or a mortgagee of the property. The effect of the decision is that the Commissioner was paid outstanding tax liabilities in priority to a party that had a registered mortgage over the taxpayer’s real property.


In Park, a trustee for the bankrupt owner of Torrens title real property sold the property with the permission of two lenders who had a first and second registered mortgage over the property. The intention of the mortgagor and the mortgagees was that at settlement part of the proceeds of sale would be paid to the mortgagees in (partial) repayment of the secured loans.


After the contract of sale was signed and before settlement, the Commissioner served a notice on the purchasers under s 260-5 requiring them to pay part of the proceeds of sale to the Commissioner in satisfaction of tax owed by the property owner. As secured creditors, the mortgagees expected that the purchase monies would be paid entirely to them, as the amount secured by the mortgages was more than the purchase monies. However, the Commissioner asserted that he was entitled to be paid the amount referred to in the s 260-5 notice from the purchase monies.


At settlement, the amount specified in the s 260-5 notice was paid into a trust account maintained by the solicitors for the second mortgagee, pending resolution of the issue, and was then paid into Court while the matter was litigated. The proceeds in excess of that amount were sufficient to satisfy the debt owed to the first mortgagee and part of the debt owed to the second mortgagee. The second mortgagee assigned its claim over the amount paid into Court to the trustee in bankruptcy of the vendor, and so the proceedings were between the trustee and the Commissioner.


Before the Federal Magistrate, the trustee argued successfully that the s 260-5 notice did not operate in respect of the moneys paid at settlement under the contract of sale. This was on the basis that the mortgagees were the beneficial owners of the proceeds of sale, so the proceeds were not relevantly owed by the purchasers to the vendor. That is, the amounts attributable to the secured debt were not monies “due” to the vendor pursuant to the s 260-5 notice.


The Federal Magistrate drew an analogy to the situation that would arise where the Commissioner had served a s 260-5 notice after the crystallisation of a floating charge over the debts due, or to be due, to a company. The Federal Magistrate then referred to authority (namely the comments of Connolly J in Tricontinental Corporation Ltd v Commissioner of Taxation [1988] 1 Qld R 474) that indicates after the crystallisation of the floating charge, the debts were owed to the chargee, rather than to the taxpayer company. The Federal Magistrate therefore found that the vendor did not have a beneficial interest in the moneys payable by the purchaser of the property on settlement. The beneficial interest in the moneys was held by the mortgagees and the monies were not therefore “due” to the vendor. In respect of the settlement, there were therefore no amounts “due” to the vendor in respect of which the s 260-5 notice could operate.


The Commissioner appealed to the Full Federal Court. A majority of the Court, Jessup and Katzman JJ, accepted the Commissioner’s argument that the proceeds of sale of the property were owed by the purchasers to the vendor (not the mortgagees) under the contract of sale, and the mortgagees had no proprietary interest in the proceeds. The Court found that the vendor was obliged to deliver unencumbered title to the purchaser and in order to allow the vendor to do so the mortgages were discharged immediately before delivery of title. This left the mortgagees with no proprietary interest in the property or the proceeds of sale of the property.


In summary, the Court:


  • Held that the Federal Magistrate’s analogy to the crystallisation of a floating charge was an error, noting that at no point did the purchasers owe money to the mortgagees. Rather, the purchasers only ever owed money to the vendor and the vendor (and not the purchasers) only ever owed money to the mortgagees.
  • Referred to, but declined to adopt what were described as “more sophisticated” forms of argument put forward by counsel for the trustee which focused on whether the sale of the property by the vendor could be regarded as an unauthorised disposition which would give a mortgagee an equitable charge over the proceeds (on the basis of the English case of Barclays Bank plc v Buhr [2001] EWCA Civ 1223). These arguments were rejected primarily on procedural grounds because they were not covered by the Notice of Contention filed with the Court. Despite noting that subject to the procedural point, counsel for the Commissioner accepted that a mortgagee would have such a charge, the Court queried whether this was the case and suggested that such a charge crystallised only on receipt of the proceeds by the mortgagor. As the s 260-5 notice required the purchasers to pay the proceeds of sale of the property to the Commissioner, the charge (if any) over the proceeds never took effect.
  • Rejected a series of other arguments that “as a matter of construction, section 260-5 should not be understood as entitling the Commissioner to step in and take moneys promised to be paid to the vendor of a mortgaged property by him or her purchaser, at the expense of the mortgagee”. The Trustee made various arguments based on technical matters associated with the manner in which a s 260-5 notice operates and the process by which moneys are paid on settlement of a sale of real property under the Torrens System, as well as policy issues that arise if the Commissioner was paid in priority to a secured creditor of a taxpayer. The key proposition behind these arguments were summarised as follows by the Court:


“Each judgment for the Commissioner in a case such as the present would have the effect of turning the mortgagee into an unsecured creditor.”


The Court considered that there was no basis to construe s 260-5 as not applying where it would prevent repayment of a debt to a previously secured creditor. There was no policy reason for such a construction, in the view of the Court, where the discharge of the mortgages was entirely within the control of the mortgagors.


The respondent in the Full Federal Court case did not apply for special leave to appeal to the High Court. This is not surprising given that the amount at stake was less than $80,000 and the Tax Office funded the case up to Full Federal Court level, where it was successful.


Appointment of receiver vs mortgagee sale


If a secured lender appoints a receiver to the debtor company and the receiver sells the property that is the subject of the security, the receiver will be acting as the agent of the debtor company, not the secured lender, and so on the basis of Park’s case a purchaser on whom the Commissioner has served a s 260-5 notice would seem to be obliged to comply with that notice before paying the balance (if any) of the proceeds of sale to the receiver.


In contrast, it is clear that if the mortgagees in a situation similar to that which arose in Park’s case had exercised their power to sell the property in order to obtain repayment of the loans made to the bankrupt property owner, instead of agreeing that the trustee for the bankrupt property owner should sell the property, the proceeds of sale would have been owed (beneficially) to them, not to the property owner. Therefore, even if the Commissioner served a s 260-5 notice on the purchaser in relation to an amount owed by the vendor to the Commonwealth, it would not have been effective, as the debt owed by the purchaser would not be a debt owed to vendor.


Obligations of agents and trustees under s 254 of the Income Tax Assessment Act 1936


Section 254 of the Income Tax Assessment Act 1936 (the “ITAA 1936”) imposes certain obligations and liabilities on “agents” and “trustees”. A liquidator or receiver acts as “trustee” of a company in liquidation or receivership for the purposes of s 254: refer to the definition of “trustee” in s 6(1) of the ITAA 1936 and FCT v Barnes (1975) 133 CLR 483. A receiver will generally also, as a matter of law, be an agent of the company. A bankruptcy trustee acts as trustee of a bankrupt person.


Section 254 provides that an agent or trustee:


a) is answerable as taxpayer for the doing of all such things as are required to be done by virtue of this Act in respect of the income, or any profits or gains of a capital nature, derived by him or her in his or her representative capacity, or derived by the principal by virtue of his or her agency, and for the payment of tax thereon;

b) all in respect of that income, or those profits or gains, make the returns and be assessed thereon, but in his or her representative capacity only, and each return and assessment shall, except as otherwise provided by this Act, be separate and distinct from any other;

c) is hereby authorised and required to retain from time to time out of any money which comes to him or her in his or her representative capacity so much as is sufficient to pay tax which is or will become due in respect of the income, profits or gains; d) is hereby made personally liable for the tax payable in respect of the income, profits or gains to the extent of any amount that he or she has retained, or should have retained, under paragraph

(d); but he or she shall not be otherwise personally liable for the tax.


This provision does not create a tax liability; it is a collection provision: Fermanis v Cheshire Holdings Pty Ltd 90 ATC 4201. No obligation to pay tax arises until the tax has been assessed. Practically, though, an agent or trustee may seek to retain an estimate of a tax liability that is likely to be assessed in future, and the courts have supported trustees who seek to do so: Barkworth Olives Management Ltd v DFC of T 2010 ATC ¶20-172 and Bluebottle UK Limited v DFC of T 2007 ATC 5302.


Commissioner’s position


Draft Determination TD 2012/D7, issued on 19 September 2012, sets out the Commissioner’s views on the effect of s 254 on a receiver who sells an asset as agent of a debtor. Essentially, the Commissioner’s position is that:


  • s 254 gives him priority over other creditors for the purpose of collecting tax on a gain on the sale of the asset; and
  • the receiver is required to retain an amount equal to the tax on the entire gain, even if part or all of the gain relates to a period before the receiver was appointed.


In Draft Determination TD 2012/D6, also issued on 19 September 2012, the Commissioner’s position is that income tax does not need to have been assessed before an agent or trustee has an obligation under s 254 to retain sufficient money to pay tax which is or will become due as a result of their agency or trusteeship.


In relation to the priority question, TD 2012/D7 states:


17. The fact that the receiver is bound to apply the money received to meet secured debts does not constitute the receiver as trustee for the secured creditor in respect of the receipt of those moneys, nor as agent for the secured creditor. Therefore it is considered that the gross sale proceeds come to the receiver as agent for the debtor, and that is the money from which an amount sufficient to pay the tax liability must be retained.


The point that the proceeds of selling an asset of the company come to the receiver as agent for the debtor is relatively uncontroversial. The question to be addressed is whether the rights of the creditors in relation to the proceeds of sale of an asset of the debtor are subject to the obligations imposed on the receiver by s 254, or whether the amount that the agent or trustee is required to retain under s 254 is subject to the general law governing the priority of claims.


TD 2012/D7 does not appear to address this question. It continues:


18. As a consequence, an amount retained in compliance with paragraph 254(1)(d) of the ITAA 1936 takes precedence over the contractual right of the secured creditor to the proceeds from the disposal of the secured asset. This is the case irrespective of the arrangements made for the payment of sale proceeds – for example, the receiver does not avoid this obligation by directing the payment of sale proceeds directly to the secured creditor. The retention required by paragraph 254(1)(d) is a statutory requirement that takes precedence over other claims on the money. The obligation subsists despite other existing or potential claims over the retained amount.


Alternative view


The conclusion stated in paragraph 18 of TD 2012/D7 would seem to be contrary to the reasoning of the High Court in FCT v Receiver of E O Farley Limited (in liq) (1940) 63 CLR 278 (“Farley“) in relation to similar provisions which imposed an obligation to retain amounts for tax and which imposed a personal liability for the amount required to be retained for the tax.


In summary, the Commonwealth argued in Farley that the effect of similar provisions to s 254 was to give priority to the Commonwealth claims in respect of sales tax and income tax. The High Court rejected the Commissioner’s argument, holding that the relevant provisions did not operate to give priority in a winding up of a company to Commonwealth debts in respect of income tax and sales tax over New South Wales debts.


This is reinforced by the statutory removal of the prerogative of Crown priority and the Crown being bound by the provisions of the Corporations Act 2001 (Cth) concerning the external administration of companies (including the powers of receivers). Section 555 of the Corporations Act now establishes the general principle that all unsecured debts proved in a winding up rank equally and, if the company’s property is insufficient to meet them in full, they are to be paid proportionately.


Appointment of receiver vs mortgagee sale


TD 2012/D7 acknowledges that s 254 does not apply where an agent of the lender appoints an agent to sell an asset over which the lender has a mortgage. That is, an example in TD 2012/D7 accepts that section 254 does not apply where the lender takes possession of mortgaged land and an agent is appointed by the lender to sell the land pursuant to the mortgagee’s power of sale.


Practical considerations


Secured lenders should be aware that their position, as against claims by the Commissioner, may be considerably weaker if a trustee or agent of the debtor company (including a receiver) sells the mortgaged asset, rather than the lender itself (or an agent of the lender) taking possession of the asset and selling it to realise the security.


Even if the security documents give the secured party the ability to direct a receiver to act as the agent of the secured party rather than the grantor of the security, the income tax law will treat the receiver as a trustee in relation to the secured party (as noted above), and so the effect of s 254 will still need to be considered.


In relation to lenders that hold security interests covered by the Personal Property Securities Act 2009 (Cth) (“PPSA“), that regime will also need to be considered when determining the position of the Commissioner to make claims over the secured personal property. Given the infancy of the PPSA regime and its interaction with tax collection laws, developments in this area should be monitored.



For further information, please contact:


Paul O’Donnell, Partner, Ashurst

[email protected]


Ian Kellock, Partner, Ashurst

[email protected]


Ian Fullerton, Ashurst

[email protected]


Marcus Ryan, Ashurst

[email protected]


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