Business records and accounts are important

Key Points:
There is now a rebuttable presumption of insolvency if, at the critical times, the bankrupt has not kept "books, accounts and records" of the required standard - or, having kept them, has not preserved them. The suggestion that the presumption should be based on failure to file a tax return was not adopted.

Amendments to the Commonwealth bankruptcy laws have now been enacted in response to the recommendations of the Joint Task Force Report on the use of Bankruptcy and Family Law Schemes to Avoid Payment of Tax. Many different proposals, and exposure drafts of legislation, were considered over a five year period with the aim of preventing bankruptcy from being used as a means of avoiding tax obligations, and of dealing generally with deficiencies exposed in the bankruptcy laws. The reforms have now been introduced by the Bankruptcy Legislation Amendment (Anti-avoidance) Act 2006, which received Royal Assent on 3 May 2006.

A feature of the amendments is that they are not restricted to taxation debts and instead strengthen the claw back provisions in the Bankruptcy Act 1966 in relation to debts generally. Although the main focus of the amendments is on improvements to, and expansion of, the existing property recovery powers of the trustee in bankruptcy, they also include important supplementary provisions. These provisions create a rebuttable presumption of insolvency if, at the critical times, the bankrupt has not kept "books, accounts and records" of the required standard - or, having kept them, has not preserved them.

The aim of the presumption is to make it easier for the bankruptcy trustee to prove his case relating to transfers of property at an undervalue, or transfers made to defeat creditors. The presumption links into the commencement of the claw back periods (referred to as the "examinable periods") prior to the commencement of a bankruptcy, with the possible effect of extending the claw back period that would otherwise apply.

In this article we’ll look at the main changes as they affect taxation, not the full package of reforms.

Reform of the recovery provisions

Amendments relating to undervalued transfers extend the claw back period for a transfer to a related entity from two years to four years before the commencement of the bankruptcy. In addition, special provisions have been introduced to apply to cases where property that has been transferred to, or acquired by, a natural person where the bankrupt has financially contributed to the ownership of the property by the natural person. A typical example occurs where a family home is owned by the spouse of a business proprietor who contributes financially towards the ownership of the home used by the business proprietor (for example, by meeting mortgage payments) and the business proprietor later becomes bankrupt.

In broad terms, the claw back period for court orders about recovering property held by related entities will run back four years before the commencement of the bankruptcy. If insolvency occurs in the year before the four year period, the claw back period can run from the first point of insolvency in the year five years before the commencement of the bankruptcy. Court orders for the recovery of property held by natural persons will be possible where the property was acquired during the claw back period as result of financial contributions made by the bankrupt (and the bankrupt obtained a benefit from the property during the period). Similarly, orders may be made where property held by a natural person increases in value during the claw back period as a result of financial contributions by the bankrupt (and the bankrupt obtains a benefit from the property).

The amendments also extend the recovery provisions to cases where a bankrupt has transferred property to another person who provided consideration for the transfer to a third party (rather than the bankrupt). The changes mean that the consideration will not be counted (unless the third party provided market value consideration to the bankrupt).

It is not relevant whether the bankrupt was solvent or insolvent when the property was acquired by the natural person, or when the financial contributions were made. It is also not relevant whether or not the natural person knew or suspected possible insolvency. The rebuttable presumption of insolvency in this context may assist in identifying an early commencement for the applicable claw back period (unless the presumption can be rebutted by production of the necessary books, accounts and records).

The rebuttable presumption of insolvency

The rebuttable presumption of insolvency arises in the context of each of the recovery provisions that relate to the transfer of property by the bankrupt at an undervalue or to defeat creditors. In each case a rebuttable presumption will arise that the transferor of the property was insolvent at the time of the transfer if it is shown that:

• the transferor had not, at that time, kept "such books, accounts and records as are usual and proper in relation to the business carried on by the transferor and as sufficiently disclose the transferor's business transactions and financial position"; or
• having kept such books, accounts and records, has not preserved them.

The presumption will have a particular role in relation to the provision relating to transfers where the transferor's main purpose was to defeat creditors. The wording of the amendments (in section 120(3A) and 121(4A) of the Bankruptcy Act) implies that in each case the presumption will generally operate only in relation to transferors who carry on a business.

During the course of the consideration of the proposed amendments, it was suggested (in a discussion paper) that a rebuttable presumption of insolvency could be introduced where a person who became bankrupt failed to file a tax return. That suggestion was not adopted. Failing to file a tax return in a timely manner, of course, continues to attract administrative penalties under the Tax Administration Act- as does failure to keep or retain required taxation law records.

Although the term "books" has a wide definition (that includes electronic records), the other terms are not defined. The relevant explanatory memorandum suggests that the standard is intended to reflect "usual commercial practice".

Comment

Only a small number of "high income professionals" (mainly NSW barristers) provoked the detailed scrutiny by the Task Force, and the resulting reforms to the bankruptcy legislation. However, one consequence of the amendments is that all persons engaged in business must not only have regard to the record-keeping requirements of the tax legislation and the Corporations Act, but must also keep in mind the indirect sanction posed by the presumption in the Bankruptcy Act.