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NEWSLETTER WINTER 2006

01 06 2006

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This publication is produced by Foremans Business Advisors specifically focusing on insolvency issues relevant to accountancy practices. In this edition we consider the power of the Australia Taxation Office (“ATO”) to keep the tax refund of a bankrupt, what debts are not provable in a bankruptcy and other means by which a director may be personally liable for debts.

PROVABLE DEBTS IN BANKRUPTCY - WHY IS THE ATO ABLE TO OFFSET A TAX REFUND POST BANKRUPTCY?

On the bankruptcy of an individual one of the general intentions of the Bankruptcy Act 1966 is to free an insolvent person from his or her financial obligations arising from debts incurred prior to bankruptcy that they are unable to meet. Generally a creditor with a provable debt is prevented from continuing any recovery proceeding against a debtor upon their bankruptcy. There are very limited exceptions.

Debts owed to the ATO are provable so why is the ATO able to apply a credit against a debt that is provable in the bankruptcy? The ATO relies on Section 8AAZL of the Taxation Administration Act 1953 which allows the Commissioner to apply the credit entitlement in reduction of an amount due under a taxation law. Why should the ATO be in a better position then any other unsecured creditor in the bankruptcy? The ATO relies on the Full Federal Court decision in Taylor v DFC of T 87 ATC 4441 to allow the Commissioner to apply post bankruptcy credits against pre bankruptcy debts until:

  • the tax liability is extinguished; or
  • the bankrupt is discharged.

In that case the Court held that although a liability was provable under bankruptcy law, the process of dealing with the credit as provided for in the taxation law worked independent of the operation of the bankruptcy law.

If post bankruptcy credits can only be offset against pre bankruptcy debts by the ATO up to the date of discharge (normally a three year period) then a bankrupt due a refund but who only lodges the return post discharge would, based on the ATO’s position above, seemingly be entitled to retain the credit.

WHAT DEBTS ARE NOT PROVABLE IN BANKRUPTCY?

Some debts that are not provable in bankruptcy include:

  • unliquidated damages otherwise than by reason of breach of contract, promise or breach of trust are not provable in bankruptcy (eg. where a debtor has been involved in a motor vehicle accident and judgment has not been entered prior to bankruptcy, or there has been no legal acknowledgment of the liability).
  • penalties and fines imposed by a Court are not provable in bankruptcy however penalties imposed by the Australian Taxation Office for late payment or late lodgment of returns are provable in bankruptcy.
  • creditors' legal costs are not provable in bankruptcy unless they are allowed by a judgment obtained prior to bankruptcy or were allowed as part of the contractual obligation incurred prior to bankruptcy.
  • if a debt is not enforceable at law owing to a prohibition contained in a statute, the debt cannot be proved, (eg a debt due to a minor, an unlicensed bookmaker or a debt related to illegal purchases).
  • a Student Loan made pursuant to the Student and Youth Assistance Act 1973 and as from 1st July 1998, the Youth Allowance and Austudy Payment Schemes covered by the Social Security Act 1991, is a debt not provable in bankruptcy, pursuant to Section 12ZW of the Act. HECS-HELP, FEE-HELP or OS-HELP debts which arise after 1 January 2005, are not provable in bankruptcy. Consequential Act changes to existing accumulated HECS debts means they can be converted into new accumulated HELP debts. New accumulated HELP debts are not provable from 1 June 2006.

PERSONAL LIABILITY OF DIRECTORS

In the Autumn 2006 edition we considered the exposure by directors to personal liability arising out of Section 222AOE Notices under the Income Tax Assessment Act (or more commonly referred to as Director’s Penalty Notices.

Some other means by which a director may have personally liability arising from a winding up of a corporation are (not an exhaustive list):

  • Section 197 of the Corporations Act - Directors liable for debts and other obligations incurred by a corporation as Trustee;
  • Section 588M of the Corporations Act - Director liable for debts incurred through insolvent trading;
  • Section 588FGA of the Corporations Act - Director to indemnify Commissioner of Taxation if certain payments set aside by Liquidator;
  • personal guarantees; and
  • director’s loan accounts.