Unfair preferences and the Commissioner of Taxation: one less "defence" for the Commissioner

There is little doubt that the Commissioner of Taxation (the Commissioner) is the most common defendant to "unfair preference" claims by company liquidators. Recovery actions against the Commissioner are often the first such action to be pursued by a liquidator, hardly a surprising strategy in circumstances where the Commissioner is a solvent, well-resourced defendant and is subject to "model litigant" obligations.

Given the frequency with which the Commissioner is required to respond to such claims and the inability of the Commissioner to avail himself of the running account "defence" provided by s 588FA(3) of the Corporations Act 2001 (Cth) (the Act),¹ the Commissioner has understandably developed legal arguments designed to limit the Commissioner's exposure in relation to unfair preference claims.

One such argument has been to contend that the requirement in s 588FA(1)(b) — that, for a transaction to be an unfair preference, the creditor must have received more from that transaction than the creditor would have received had it proved for the debt in a winding up of the company — is to be assessed by reference to a hypothetical winding up conducted at the time of the relevant transaction, rather than the actual winding up in which the claim against the Commissioner is made. However, a recent decision of the Full Court of the Federal Court appears to confirm that this argument (presently enshrined in a Practice Statement of the Australian Taxation Office) will no longer be open to the Commissioner.

The statutory requirement of preferential effect and the Commissioner's interpretation

Section 588FA(1)(b) of the Act provides that a transaction between a company and a creditor of a company is only an unfair preference if:

"... the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company."

If assessed by reference to the actual winding up in which the unfair preference claim is made, this requirement is almost inevitably satisfied and, accordingly, offers creditors little or no prospect of resisting a liquidator's claim (unlike, for instance, a defence based upon s 588FG(2) of the Act, if its elements can be made out).

The Commissioner's position (perhaps more generally but certainly in relation to unfair preference claims arising from transactions that reduced or discharged an insolvent company's superannuation guarantee charge liability) has been that the preferential effect required by s 588FA(1)(b) is not assessed by reference to the actual winding up in which the claim against the Commissioner has been made. Rather, the Commissioner has contended that the preferential effect of a transaction is to be assessed having regard to the likely return to the Commissioner in a hypothetical winding-up conducted at the time of the impugned transaction(s).

This position was formalised in the Australian Taxation Office's Practice Statement PS LA 2011/16 as follows:

"If the liquidator is claiming that the Commissioner has received an unfair preference and the claim relates to payments made towards the SGC [being the superannuation guarantee charge], the Commissioner will only agree to repay those amounts to a liquidator without the need for a court order if the liquidator can establish preferential effect by providing evidence that at least one other creditor with the same statutory ranking existed at the time of the transaction and that that creditor remains a creditor in the winding up. This is on the basis that SGC is subject to a priority payment and must be paid in priority to all other unsecured debts and claims under paragraph 556(1)(e) of the Corporations Act.² [emphasis added]"

The Commissioner's recent practice has been to rely upon the Victorian Court of Appeal's decision in Walsh v Natra Pty Ltd³ as authority for the above proposition, including when requesting that liquidators provide further documentation to establish that there was an equal or higher ranking creditor in existence at the time of the impugned transaction(s). The Commissioner has adopted this position notwithstanding the court's observation in Walsh that:

"... s588FA(1)(b) does not require consideration of a hypothetical winding up as at the date of the payment which is impugned."⁴

The court went further in Walsh, stating that:

"I see no reason not to conclude that the best evidence of what a creditor would receive in "a winding up" is what unsecured creditors did (or were likely to) receive in the winding up that followed and which has given rise to the proceeding in which the transaction under scrutiny is impugned.

...

To my mind this case is quite straightforward. A winding up has followed; it is a relevant winding up by virtue of s 588FE and I see no reason why the liquidator cannot rely upon the probable return to the unsecured creditor in that winding up for the purpose of establishing the comparison required under s 588FA(1)(b)."⁵

Putting it to the test

The Commissioner's interpretation of s 588FA(1)(b) of the Act was subject to recent scrutiny in the Federal Court case of Kassem and Secatore v Commissioner of Taxation.⁶ In that case, the liquidators of Mortlake Hire Pty Ltd (Mortlake) sought to recover two payments totalling $70,000 made on behalf of Mortlake in respect of Mortlake's outstanding taxation liabilities, namely, its integrated client account. However, Mortlake was also indebted to the Commissioner in respect of superannuation guarantee charges. Some time after receiving payments on behalf of Mortlake in respect of its integrated client account, the Commissioner purported to reallocate those payments from Mortlake's integrated client account to its superannuation guarantee account in reduction of the superannuation guarantee charge owed by Mortlake.

The liquidators of Mortlake sought to recover these payments as unfair preferences pursuant to s 588FA(1) of the Act. The Commissioner defended the liquidators' claim on a number of grounds (only one of which is considered in this article), including that the Commissioner had not been preferred over other creditors (as required by s 588FA(1)(b)) because the payments were ultimately applied in respect of Mortlake's superannuation guarantee charge liability (a debt which, by reason of s 556(1)(e), had priority over all other unsecured debts in existence at the time the payments were made).⁷

In finding that the payments to the Commissioner were unfair preferences at first instance, Nicholas J was blunt in his assessment of the Commissioner's application of s 588FA(1)(b) based upon Walsh:

"... a fair reading of that decision does not support the Commissioner's argument. It was certainly argued in that case that the Court was required to consider what the unsecured creditor who received the impugned payments would have received in a hypothetical winding up undertaken at the date each such payment was made. However, it is clear that this argument was rejected by Phillips JA (at paras [31]-[33]) with whom Charles JA agreed (at para [56]). This case is authority for the proposition that the unsecured creditor's likelihood of recovery by way of a distribution in a winding up is to be assessed in the context of the actual winding up rather than a hypothetical winding up postulated to take place at the time of the impugned transaction."⁸

The Commissioner appealed the decision of Nicholas J, including on the ground that his Honour erred in his application of Walsh. In dismissing the appeal,⁹ the Full Court stated as follows in relation to this aspect:

"... the short answer to the Commissioner's contention is that s 588FA(1)(b) does not require consideration of a hypothetical winding up at the date of the impugned payment. It requires a comparison between the amount the creditor actually received and what it would receive in the actual winding up."¹⁰

The Full Court endorsed the assessment of Philips JA in Walsh that, while the subsection speaks of "a winding up", the "best evidence of what a creditor would receive is what unsecured creditors would receive (or are likely to receive) in the actual winding up".¹¹

Implications: no requirement to consider a "hypothetical winding up"

The decision of the Full Court of the Federal Court in the Mortlake case appears to close the door on the Commissioner's previously stated approach of requiring that the preferential nature of superannuation guarantee charge payments be assessed by reference to a hypothetical winding up at the time the payments were made. Based on the decision, liquidators are entitled to reject any assertion that they need look beyond the actual winding up in which the unfair preference claim is made in order to establish the preferential nature of the payments. This requirement will generally present liquidators will little or no difficulty. As noted above, the fact that such a claim is being pursued will almost certainly mean that the winding up will deliver to the defendant creditor less than the creditor received from the company in respect of the debt via the pre-appointment transaction that the liquidator seeks to unwind. Consequently, s 588FA(1)(b) of the Act appears increasingly unlikely to provide creditors with a basis to resist an unfair preference claim.

The article was first published in Insolvency Law Bulletin, October 2012.

¹ Sands & McDougall Wholesale Pty Ltd (in liq) v Commissioner of Taxation [1998] VSCA 76. ^{Back to article}

² Australian Government, Australian Taxation Office, Practice Statement Law Administration PS LA 2011/16 (2011) at 64. ^{Back to article}

³ Walsh v Natra Pty Ltd (2000) 1 VR 523; [2000] VSCA 60. ^{Back to article}

⁴ Above 533 (Phillips JA). (AQ – meaning of 533?) ^{Back to article}

⁵ Above. ^{Back to article}

⁶ Kassem and Secatore v Commissioner of Taxation [2010] FCA 152. ^{Back to article}

⁷ Above, at [40]. ^{Back to article}

⁸ Above, at [41]. ^{Back to article}

⁹ Commissioner of Taxation v Kassem [2012] FCAFC 124; BC201206588. ^{Back to article}

¹⁰ Above, at [80]. ^{Back to article}

¹¹ Above, at [83]. ^{Back to article}