The enforcement of debt owed by a taxpayer

Introduction

Governments raise taxes to ensure the country can fund essential public services. Taxes are used to build and maintain public infrastructure such as roads and transport services and to provide education, a world class health care system as well as welfare assistance.

Paying taxes is part of our civic duty. Sometimes, however, taxpayers (whether individuals or companies) do not or cannot meet their obligations and it is necessary for steps to be taken by and on behalf of the Australian Taxation Office (ATO) to recover those taxes.

This paper discusses the various methods of enforcement that can be enlivened by the ATO.

Garnishee

Garnishee Notices can be issued as a means of collecting outstanding tax debts. Notices are issued pursuant to Section 206-5 of the Taxation Administration Act 1953.

Garnishee notices can be issued to:

• A bank or other financial institution, allowing possible access to current, savings or credit card accounts

• An employer, to access wages of the debtor

• Debtors of the taxpayer

• The taxpayer’s superannuation fund, although it will not be effective until the benefit is attached

• Life insurance policies, although not effective until moneys become payable

• A company in which the taxpayer holds shares, any payable dividends

• Sale proceeds of property, in respect of equity in the taxpayer’s property

In relation to a bankrupt, the Garnishee Notice must be served more than six months before the bankruptcy petition. A third party remains under a legal obligation to comply with the Garnishee Notice notwithstanding the appointment of an external administrator.

After a liquidator has been appointed to the Corporation, the power of the Commissioner to issue a Garnishee Notice is limited. In Bruton Holdings (in liq) v Federal Commissioner of Taxation (2009) 72 ATR 856, the High Court held that a Garnishee Notice could not be given to a liquidator in respect of a company’s pre-liquidation tax liabilities.

In Bell Group Limited (in liq) v Deputy Commissioner of Taxation (2015) ATC 20-528, the Federal Court quashed Garnishee Notices attempting to recover the tax liability of a company that was in liquidation.

Bankruptcy

A taxpayer debtor can become bankrupt as a result of a creditor presenting a Creditor’s Petition, however, this may only occur if the debtor has committed an ‘Act of Bankruptcy’, within the preceding six months and owes the petitioning creditor at least $5,000.

The Commissioner can exercise his right to use bankruptcy proceedings by either instituting such proceedings or supporting or substituting another creditor in those proceedings. In bankruptcy, the debtor’s property is vested in the Trustee of the debtor’s estate for the benefit of the creditors generally.

Alternatives to Bankruptcy

• Private arrangement with the taxpayer debtor, providing there is clear evidence that the debtor has sufficient liquid assets to enable all debts to be paid by their respective due dates.

• Agreements under Part IX and Part X of the Bankruptcy Act 1966.

Each of these alternatives provide relief to the debtor from the burden of having to immediately settle the debts in full. They can also assist a debtor to avoid the restrictions of bankruptcy. A debtor is required to provide the Commissioner and creditors with details of their financial situation so that an informed decision can be made as to whether an Agreement should be entered into. The benefits of Part IX are only available to debtors whose income assets and liabilities fall within the prescribed thresholds.

In the case of a business which is fundamentally viable, this option may provide an opportunity for the debtor to reorganise their affairs but at the same time enhancing the prospects of their creditors.

Compositions or Schemes of Arrangement Under Division 6 of Part IV of the Bankruptcy Act

This alternative provides a mechanism whereby a bankrupt can seek to have their existing bankruptcy annulled by entering into a Scheme or Composition; The bankrupt person, through their Trustee, may put a proposal to their creditors to satisfy the debts which, if accepted, would bring the bankruptcy to an end.

Liquidation

In the case of a corporate debtor owing more than $5,000, a creditor can seek to have the company wound up by serving a statutory demand for payment under the Corporations Act without obtaining a judgement against the company. If the statutory demand is not satisfied, the creditor can then file an application for winding up of the company with the court. 

A corporate debtor can voluntarily take steps to have a company wound up by calling meetings of members and creditors under Part 5.5 of the Corporations Act. The liquidator takes control of the company; property and assets are realised and distributed among the creditors.

Alternatives to Liquidation

The Commissioner or other creditors may consider entering into an agreement or arrangement under the Corporations Act as an alternative to liquidation proceedings. These agreements or arrangements are:-

Part 5.3A of the Corporations Act provides an opportunity for insolvent companies to reach an arrangement with their creditors which addresses the creditors’ debts and enables the company to continue trading. As it is not always possible for the company to continue, Part 5.3A also seeks to provide for the business, property and affairs of an insolvent company to be administered in a way that results in a greater return for the company’s creditors and members than would result from the liquidation of the company.

A Creditors’ Trust is an entity created under the terms of the Deed of a Company Arrangement. It is commonly used to accelerate a company’s exit from the external administration to facilitate the relisting of a public company on the Australian Stock Exchange.

In most cases, a Deed of Company Arrangement is finalised immediately upon the transfer of the company’s obligations under the Deed to a Creditors’ Trust.  The finalisation of that arrangement signifies the end of the company’s external administration. Under the arrangement, the company or a third party promises to make a payment or transfer of property to the trustee in satisfaction of the creditors’ claims against the company. The creditor’s become beneficiaries of the trust in return for having their rights against the company extinguished.

Factors to be Considered when Initiating (or supporting or substituting) Creditors in Bankruptcy or Liquidation Proceedings

1. The asset position of the debtor - Should there be no available assets that can be realised to satisfy the debt, bankruptcy or liquidation proceedings may not be appropriate. An alternative arrangement whereby payment of the debt is received over a period of time may be more viable.
2. Other creditors and the possibility of preference payments - Where there are other creditors with the prospect of their initiating bankruptcy or liquidation proceedings, it may not be prudent to enter into an arrangement whereby payment of the debt is agreed to be paid over a period of time. In this situation, should the debtor become bankrupt, or be placed into liquidation, any payments made during the relation back period may have to be repaid to the trustee in bankruptcy or a liquidator as a preference payment. With a company, the Commissioner may be the subject of a claim made by a liquidator with respect to a payment received by the ATO which may be declared void by a court because the company was insolvent at the time the payment was made.
3. The risks of receiving payment out of prior dispositions of property - Should the taxpayer debtor not be declared bankrupt or placed into liquidation, there is a risk that the Commissioner will not recover his debt. Conversely, should the Commissioner receive payment in respect of tax related liabilities during the relation back period of 6 months prior to bankruptcy, then such disposition could be declared void against the Trustee. Where the Commissioner has received payment from a tax related liability by reason of the sale of an asset for considerably less than the market value, there is the prospect that the transaction will be declared void as an “uncommercial transaction”. The Commissioner may also be the subject of a claim made by a liquidator with respect to a payment received by the ATO. Division 2 of Part 5.7B of the Corporations Act deals with the categories of voidable transactions that could impact on a prior payment made to the ATO including insolvent transactions, uncommercial transactions, unfair preferences and unfair loans to a company.
4. The advantage of an examination of the debtor’s affairs - The bankruptcy and liquidation processes enable the trustee or liquidator to conduct an examination of the debtor’s affairs. Where circumstances exists that prevent an assessment of the full financial position of the debtor, it may be appropriate to take bankruptcy or liquidation proceedings so that such an examination can occur.
5. Disputed debts - Where the debt is genuinely disputed it will normally be sufficient to prevent bankruptcy and liquidation occurring; however, where the debt comprises a combination of disputed and undisputed components, bankruptcy and liquidation action can still be commenced.
6. Debtor’s future financial position - The debtor may be able to show an ability to pay the debt over a reasonable period, particularly if their financial position can be substantiated by financial statements or other relevant reports. In those circumstances it may be appropriate for the debtor to consider accepting payment over a period of time.