Recent research has revealed that although the Australian Taxation Office (ATO) lost its priority in insolvencies in 1993, and was relegated to a pari passu standing along with other creditors, it has gradually regained that priority in other ad hoc ways with little coherent policy. A redrafting of s 555 of the Corporations Act, which states the para passu principle, is recommended, not to prevent tax priorities, but to at least require those seeking to interfere with insolvency’s pari passu approach to justify their case on sound policy grounds.
This is also relevant to the restoration of revenue priority in the UK, commencing in December 2020.
A basic principle of insolvency law is that creditors share equally – pari passu – in the remaining assets of the insolvent. Over time, policy decisions have been made that certain groups of creditors should have priority – employees in particular because of their special relationship with the business. That has now been reinforced because Australian law guarantees government financial support for employees of failed companies. The government then stands in the shoes of the employees with that priority.
In the past, the ATO was also accorded priority on the basis that it represents the collected community, putting it above the interests of the body of individual unsecured creditors.
The tax priority was removed in 1993 as being necessary to support the then new voluntary administration (VA) regime.[1] In exchange, the ATO was granted power to pursue directors personally for their company’s unremitted tax payments under the Director Penalty Notice (DPN) regime. As a consequence, it was thought that any loss of revenue from removing the ATO’s priority would be offset by the revenue recovered under the DPN regime.
While the law had never supported an ATO argument that such withholding taxes were held on trust by the company,[2] and thus not an asset of the company, it was those trust type tax debts that were the subject of the DPN regime.
That liability of directors has been enhanced and added to over time, most recently, for unpaid GST, such that tax law may now inhibit the VA regime.
Thesis
A recent doctoral thesis[3] by Dr Catherine Brown has examined the intersection of insolvency and tax law since 1993 and found the lack of a policy framework for resolving what she identifies as continued inconsistencies between the two areas of law. There are now many indirect priorities given to tax debts, in effect subverting the original policy intent.
These have arisen through provisions of tax law that were enacted after 1993 without due regard to insolvency law, and through the operation of latent provisions in pre-1993 tax law, which were not used until the ATO’s statutory priority was removed.
Dr Brown says that reviews of insolvency and tax laws following the 1993 Harmer Report changes largely ignored the question of the de facto priority of the ATO and as a consequence, she argues, taxation law has become increasingly inconsistent with the pari passu principle. Both insolvency and taxation law have been changed in a ‘piecemeal and ad hoc’ manner ‘arguably influenced by immediate political and social needs, rather than any clearly articulated coherent framework’.
Dr Brown’s thesis assists in providing a road map for reform.[4] A significant change needed is to amend s 555 of the Corporations Act, which enshrines the pari passu principle, but in qualified terms. It provides:
Except as otherwise provided by this Act, all debts and claims proved in a winding up rank equally and, if the property of the company is insufficient to meet them in full, they must be paid proportionately.
The hypothesis of the thesis is that the pari passu principle should prevail to form the basis upon which competing and inconsistent insolvency and taxation laws should be resolved. Any departure from that principle should be clearly justified according to accepted principles and not purely on the basis of policy preferences which are expressed by the ATO as being ‘for the better good of society’.[5]
The application of this general principle is recommended in relation to a range of taxes where inconsistency lies – PAYG, CGT, GST and more.
UK
The UK is also reviving its tax priority, but limited to our comparable withholding taxes, commencing 1 December 2020.[6] New law will grant the revenue authority a priority over all floating charge creditors and unsecured creditors but in respect mainly of VAT and PAYE income tax. It will not apply to corporate tax or employee national insurance contributions. Insolvency practitioners and fixed charge creditors retain their higher priority.
The UK policy is explained as giving priority to ‘taxes paid in good faith by [the insolvent business’s] employees and customers, and temporarily held by the business’ which ‘will go to fund public services rather than being distributed to other creditors.’ The policy review saw no significant economic impact and while it would affect financial institutions, the government does not expect it to have a material impact on lending.
The insolvency pari passu principle is always subject to society’s decision to allow some groups higher priority but as Dr Brown suggests, there should be a good policy explanation for the exception to be made and any potential negative consequences. The UK has offered that policy response and a decision has been made. IPs are to implement it and creditors and other can take whatever account is necessary in their lending or dealings. Others can assess whether the policy is correct.
Other impacts
In the intersection of tax and insolvency, both of which are susceptible to wayward compliance, regard should also be had to behavioral consequences. Although an impact on lending is often raised, lenders will merely factor this into their risk calculations. Unsecured creditors usually receive little or nothing. But changes like this can have more influence on business behavior, in particular of directors. The original Australian scheme sought to have directors prompted to face up to their company’s insolvency by the threat of personal liability under the DPN regime if they did not do so. Hence my article at the time that the ATO had the capacity to become the real insolvency regulator, given the prevalence of unpaid tax in any insolvency.[7]
Such laws can also impact revenue and regulatory behaviour, good and bad. One intended impact of the removal of the priority in Australia in 1993 was to cause the ATO to smarten up its own recovery actions, rather than sit back and rely on the priority.[8]
But the gradual intrusion of a de facto priority for the ATO in insolvency can also adversely impact the ATO’s behavior, as secured creditor’s right can influence their conduct. This may carry through in the ATO’s role at creditor meetings, its operation of panel liquidators and in using its ‘Commonwealth’ privileges. The same could apply to the Attorney-General’s Department in relation to the priority and influence it has in as a priority creditor in respect of employees. Fortunately, both agencies are held to high standards with their decisions reviewable beyond those of the usual self-interested commercial creditor.
Impact
No doubt Dr Brown’s research will be studied closely by those responsible for Australia’s tax and insolvency laws, and others overseas, and consider whether they need to go back to the legislative redrafting board.
Dr Catherine Brown is at catherine.brown@qut.edu.au
[1] Introduced under the Corporate Law Reform Act 1992 (Cth). In exchange for this loss of priority, the Insolvency (Tax Priorities) Legislation Amendment Act 1993 (Cth) also granted the ATO direct rights against directors.
[2] Sands & McDougall v Commissioner of Taxation [1998] VSCA 76.
[3] Revising the priority of taxation in corporate insolvency: An application of Dworkin’s Rights Thesis and Equality Theories, Catherine Brown, Doctor of Juridical Science, Queensland University of Technology, 2019.
[4] The thesis as Dr Brown explains examines the ATO’s position in the context of the recommendations of the Harmer Report, that pari passu should prevail, and of Dworkin’s rights and equality theses.
[5] Dworkin prioritizes the personal preferences of an individual over external preferences as being fundamental to achieving equality. Dr Brown agrees, arguing that any policy decision not grounded in the rights of the individual, such as the creditors in insolvency, but rather being for ‘the greater good of the community’, as argued by the ATO, is one based on external preferences and should be excluded.
[6] Policy paper – Introduction of changes to protect your tax in insolvency, 11 March 2020, HMRC.
[7] The ATO as an Insolvency Regulator? (2007) 19(3) Australian Insolvency Journal 24.
[8] Reminiscing the Taxation Priorities in Insolvency (2005) 1(2) Journal of the Australasian Tax Teachers Association 435, Symes.
