At the end of August 2012 the Full Federal Court handed down a decision granting the Commissioner of Taxation priority over a second mortgagee, meaning that the Commissioner was paid $75,508.64 and the second mortgagee received only $250,105.02 of a $430,200.00 debt that had been secured by a second mortgage.
The decision has created a lot of discussion. In the decision the Full Federal Court allowed the Commissioner to take priority over the mortgagee in circumstances where the Commissioner had issued a s260-5 notice to the purchaser of a property that was subject to a mortgage. A s260-5 notice is issued under schedule 1 of the Taxation Administration Act 1953 and operates in the same manner as a garnishee notice requiring a debtor to satisfy their obligations to a creditor by making payment to the Commissioner. The failure of the recipient to comply with such a notice is a criminal offence.
The taxpayer owed a debt to the Commissioner (Land Tax). The taxpayer entered into a contract of sale to sell the property, however the sale price was less than the amount needed to cover the payout of the two mortgages over the property. As such there was not going to be enough left to cover the debt owing to the Commissioner.
The taxpayer had filed for and had been declared a bankrupt in April 2010 (The contract was signed in January 2010 and the Commissioner’s notice was issued in February 2010). Mr Park, the defendant, was the Trustee of the Estate.
The majority of the Court found that under s 260-5, the instant moneys became owing by the purchasers to the taxpayer, the purchasers fell under the statutory obligation to pay those moneys to the Commissioner. At settlement, the purchasers came under a contractual obligation to pay the purchase price, including the $75,508.64 in question. That is, the money then became owing by the purchasers to the taxpayer. At that point, the purchasers’ obligation to pay to the Commissioner under s 260-5 became absolute.
What does this mean
In Bruton Holdings, the High Court found that the Commissioner could not use garnishee notices to take priority over secured creditors in the context of a liquidation. This was because specific rules exist which provide how the Commissioner can enforce pre-appointment tax debts against a liquidator and should preclude garnishee notices disrupting the obligations of a liquidator under the Corporations Act 2001 (Cth). In reaching its decision, the High Court observed that a garnishee notice issued by the Commissioner was similar to an ordinary garnishee notice obtained in respect of a debt.
In the opinion of Siopis J (dissenting) in this matter, this meant the Commissioner’s garnishee notice lost priority to the equitable charge held by the second mortgagee over the proceeds of the sale.
The position in Bruton Holdings may prevent the Commissioner from jumping the queue where a company has been put into liquidation. However, where a secured creditor permits the borrower to release the secured assets on a voluntary basis and is on notice of outstanding tax debts then vigilance is required. If either the first mortgagee or the Second Mortgagee had been acting as mortgagee-in-possession to facilitate the sale, then a different conclusion may have been reached. Under this scenario the relevant funds would never have become owing to the vendor by the purchaser, thereby potentially defeating the operation of the garnishee notice.
Similarly, if the relevant mortgage had included a clear security interest over the right to receive the proceeds of sale, or held other all asset security, the outcome may also have been different.
More generally, if a secured creditor releases its security in order to facilitate a sale without receiving payment there is a risk that the Commissioner may seek effective priority as against the proceeds through the use of a garnishee notice. As this case demonstrates, an undertaking to hold proceeds on trust pending resolution of the Commissioner’s s260-5 garnishee claim is a poor substitute.
This decision is a significant departure from the law as it stood previously and creates a significant risk to the priority previously held by a secured creditor. Given the strong dissenting judgment, Park may seek leave to appeal to the High Court.
Bruton Holdings Pty Ltd (in liq) v Commissioner of Taxation (2009) 258 ALR 612