PCI knows bankruptcy – august 2019
Aug 15 2019
Who Pays The CGT?
Sometimes the Bankruptcy Act and the Income Tax Assessment Act (ITAA) just don’t gel the way they should. This month’s newsletter looks at who is responsible for the capital gains tax (CGT) that arises in the relatively rare circumstance where the Trustee sells a bankrupt’s property which then gives rise to a CGT liability. Sometimes the Bankruptcy Act and the Income Tax Assessment Act (ITAA) just don’t gel the way they should. This month’s newsletter looks at who is responsible for the capital gains tax (CGT) that arises in the relatively rare circumstance where the Trustee sells a bankrupt’s property which then gives rise to a CGT liability.
Surprisingly, the simple and largely uncontroversial answer is that the debtor is liable to declare any taxable profits on the sale of assets by a Trustee. However, it is the timing of that responsibility, and the fact that it is not a debt that is captured by the bankruptcy that gives rise to an outcome that would seem to be inconsistent with the concept that bankruptcy should provide a “fresh start” for the debtor.
Let’s consider how this circumstance comes about.
What does the legislation say?
We start by acknowledging that property owned by the bankrupt vests in the Trustee pursuant to Section 58 of the Bankruptcy Act. Next we look at the provisions of the ITAA that relate to capital gains tax and insolvency. Specifically, Section 106.30 provides that: -
1. The vesting of property in the Trustee in not a deemed asset disposal, and
2. Any action taken by the Trustee is deemed to be an act undertaken by the debtor
Therefore, it will be the responsibility of the debtor to disclose in their relevant tax return the capital gain that has been made, and on assessment be liable for any resulting liability. Section 102.5 of the ITAA operates to deny the bankrupt from taking advantage of any existing capital losses in the calculation of that liability.
Obviously, this liability is one which arises after bankruptcy / after appointment of the Trustee? and will not be a debt that is extinguished by the bankruptcy. This outcome will most likely leave the debtor considering the prospect of a second bankruptcy in order to achieve a “fresh start” which is surely not an intended outcome of the legislation.
What about a secured creditor?
Section 106.60 of the ITAA provides a similar exemption for the benefit of secured creditors. Firstly, the exercise of a security interest including the appointment of an agent or a receiver is not a deemed asset disposal, and secondly the actions taken by the security holder are held to be actions of the original asset owner.
And the liquidator?
Fortunately, Section 106.35 sets out a similar exemption for liquidators providing that the appointment is not an event that gives rise to a deemed disposal, and the actions of the Liquidator are taken to be actions of the debtor company.
However, it hasn’t always been so clear-cut. For a time it was argued (in a Ruling) by the ATO that Section 254 of the ITAA operated to require a Trustee (in the broad sense of the word, including Receivers and Liquidators) to retain out of sale proceeds sufficient funds to meet the tax arising on any profit. This argument, if correct, had the effect of granting the Commissioner a super-priority which would be at odds with the Commissioner’s ordinary priority under Section 556 of the Corporations Act, as well as creating an uncertain position for secured lenders.
After some unhelpful lower court decisions, common sense prevailed in a roundabout way in the High Court decision of Commissioner of Taxation v Australian Building Systems Pty Ltd (In Liquidation) 2015 (“ABS case”) which determined that the obligation of the liquidator to retain funds could only come about upon the issue of an assessment by the Commissioner which of course would be at some later point in time.
Accordingly, the ABS case confirmed that section 254 of the ITAA does not affect the operation of the Corporations Act such that the Commissioner enjoys a form of priority in winding up over the other unsecured creditors.
Lessons
So, what do we need to take away from this analysis? Firstly, if you are a Trustee who is in the position of having sold property of the bankrupt which may give rise to a capital gains tax liability, then it would be wise to provide the debtor with a full accounting of the process so that they can consider whether it is something that needs to be disclosed in their tax return.
The Trustee will not know the full details of the cost base and would not be in a position to undertake a proper calculation of the CGT liability, so best to just put the debtor on notice of their responsibilities and leave it at that.
If you are a debtor, or someone advising a debtor prebankruptcy, and an asset exists that could give rise to a capital gain, then it would be sensible to make all possible attempts to sell that asset prior to bankruptcy so as to crystallise the gain and avoid any postbankruptcy liability.