Which trustee is liable for tax when there is a change of trustee?

Articles Written by Andy Milidoni (Partner)

Review of Practice Statement Law Administration PS LA 2012/2

The Commissioner issued Practice Statement Law Administration PS 2012/2 on 28 June 2012. PS LA 2012/2 sets out the Commissioner's approach to determining from which entity he will seek to recover income tax, GST liabilities and pay as you go (PAYG) withholding amounts of a trust where there has been a change of trustee of a trust. More specifically, PS LA 2012/2 also sets out:

a) the circumstances when the Commissioner will recover any unpaid tax from a former trustee and when he will join a subsequent trustee to any debt recovery action;
b) how notices of assessments will be issued and to whom they will be issued;
c) the Commissioner's approach to the issue of director penalty notices to directors of corporate trustees in respect of unpaid PAYG withholding amounts;
d) the circumstances in which the Commissioner may seek the grant of the remedy of subrogation.

The purpose of this paper is to examine PS LA 2012/2 and to conclude with some broad observations about the practical implications of the practice statement.

Overview

Under trust law, the trustee, as a legal person, incurs the legal obligations to pay debts and other liabilities arising from its administration of the affairs and activities of the trust. Trustees are personally liable for the debts of the trust, including tax debts assessed to them on behalf of the trust. To be able to meet the debts of the trust, trustees are usually entitled to be indemnified out of the trust's assets. However, such an indemnity may not cover all expenses especially where the trustee acts in bad faith or incurs debts in breach of the trust.

The Commissioner states that the entity which is the trustee at the end of a relevant income year (for income tax) or tax period (for GST) will be the liable party in respect of the tax liability arising for that period. This is examined in more detail in section 4 below.

In respect of other tax obligations, such as PAYG withholding obligations, the liable party will be the party who is the trustee at the time the tax obligation arises. This is examined in more detailed in section 5. In section 6, the Commissioner's approach to the issue of director penalty notices is examined.

Once the liability to tax has been properly attributed or assessed to the relevant trustee, the Commissioner will commence recovery proceedings in the normal course. In the first instance, the Commissioner will commence proceedings against liable trustee and seek a judgement against the Trustee's personal assets.

If the liable trustee's personal assets are insufficient to satisfy the tax liability, the Commissioner will then seek to be subrogated to the trustee's right of indemnity against the trust property. Recovery in this way will be initiated through a letter of demand to the former trustee with a copy served on the successor trustee. The Commissioner may appoint a receiver or provisional liquidator to the trustee for the purposes of protecting the trust assets.

This course of action relies on the following propositions:

a) a trustee has a right of indemnity against the trust's assets for debts incurred in administering the trust;
b) the right of indemnity is not extinguished where the trustee retires or is replaced;
c) the right of indemnity may be enforced by a liquidator of a corporate trustee or the trustee in bankruptcy in respect of a natural person trustee.

In respect of its rights of subrogation, we examine the Commissioner's approach in section 7.

When does a liability arise?

Liability to Income Tax

Division 6 of Part III of the Income Tax Assessment Act 1936 (Cth) (1936 Act) provides for taxation of the income of trusts. We note that the PS LA 2012/2 does not cover the position of a trustee in respect of a trust which is subject to taxation under Division 6B and 6C of Part III of the 1936 Act, which covers the taxation of certain unit trusts and public trading trusts. It is expected that the Commissioner would take a similar approach when there has been a change of trustee of a trust subject to taxation under these provisions. We also expect a similar approach to be taken in respect of trusts which are members of tax consolidated groups and GST groups and where joint and several liability applies in the event that a head company (in the case of tax consolidated groups) or representative member (in the case of GST groups) fails to pay the group's tax liability.

In respect of the application of Division 6, the trustee is only liable to pay tax in respect of 'net income' of a trust in cases when:

a) it is not assessed to a beneficiary (sections 99 and 99A of the 1936 Act);
b) the assessable beneficiary is under a legal disability or is a non-resident at the end of an income year (section 98 of the 1936 Act); or
c) the trust can be revoked or altered or the trust is for an unmarried minor (section 102 of the 1936 Act).

In each of the above cases, the Commissioner states that the obligation to pay income tax arises at the end of the income year (that is, on 30 June or on the last day of a substituted accounting period if one is applicable) as this is when the net income of the trust is determined and can be assessed. This is despite there being no amount due and payable and therefore enforceable as a debt at the end of the income year. An amount becomes due and payable when a notice of assessment issues and this can be some time later after the end of the relevant income year. In some cases, this can be up to 12 months after the end of the relevant income year.

Liability for GST

The sum of the GST payable on all taxable supplies attributable to a tax period is a component in working out the net amount which an entity has to pay to the Commonwealth where the net amount is greater than zero. Where it is less than zero, a refund is payable by the Commissioner.

The liability to pay GST does not arise at the time each taxable supply is made. Rather, it arises at the close of the relevant tax period. It is at this time that a 'net amount' is determined if GST on taxable supplies for the period exceeds input tax credits for the same period, an amount will be owing to the Commissioner. This is notwithstanding that the due date for payment is 28 days after the end of the tax period.

The Liable Party: Change of Trustee and Issue of Assessments

The issue and service of a notice of assessment does not give rise to the obligation to pay income tax. It simply makes the debt due to the Commonwealth and payable to the Commissioner on a due date.

The Commissioner's view is that there is no legislative basis to impose income tax or GST on the person who was not the trustee as at the liability date (that is, at the end of the income year for income tax or the end of a tax period for GST) notwithstanding that they later become the trustee when an income tax assessment issues or when the net amount for a BAS is due to be paid. The Commissioner considers that where a trustee retires and a new trustee is appointed, the former trustee is entitled to be indemnified out of the assets of the trust fund except where there has been a breach of the terms of the trust by the former trustee. The new trustee will often be required to acknowledge this indemnity.

A change in trustee does not give rise to an assumption by the new trustee of outstanding liabilities that have arisen in relation to the trust. The new trustee is not personally subject to the liabilities incurred by the former trustee and the Commissioner states that he will not seek to recover taxes arising from a prior income year from the new trustee.

The Commissioner's rights are not rights against the new trustee and he will proceed only by way of enforcement of or subrogation of the rights of the liable trustee. Those rights take the form of the indemnity out of the trust's assets. Accordingly, the Commissioner will:

a) issue an income tax assessment to an entity that was the trustee on 30 June (for the last day of a substituted accounting period); or
b) recover a net amount from an entity that was the trustee on the last day of the relevant tax period.

When issuing assessments, the Commissioner intends to address the assessment in the form 'Trustee of XXX Trust'. Where there has been a change of trustee after the end of an income year and the Commissioner is aware of both the identity of the former and successor trustee, the notice of assessment is to be addressed to the former trustee by name. The Commissioner also intends to serve a copy of any notice of assessment on the new trustee under cover of a letter advising that the original notice has been served on the former trustee. The purpose of this is to put the new trustee on notice that the former trustee may have a claim against trust property.

The same process as is used for income tax would be used for GST.

Liability to PAYG Withholding

Where there is a change of trustee during a tax period, it will be also be necessary to establish which trustee is liable for any PAYG Withholding (PAYGW) debt or any estimates of the amounts not remitted.

A PAYGW obligation arises in the instances set out in Schedule 1 to the Taxation Administration Act 1953 (TAA). Under these provisions, a taxpayer is liable to pay an amount to the Commissioner if it withholds an amount from a payment covered by the PAYGW provisions. These payments include the payments of salary, the payment of dividends, royalties and interest to non-residents, and in the case of residents, interest and other investment income for which the recipient has not quoted their tax file number.

Section 16-70 of Schedule 1 of the TAA provides that the person who is required to withhold an amount from a payment stipulated in Division 12 of Schedule 1 to the TAA is the party that is liable to pay the withheld amount to the Commissioner (referred to herein as the liable party). The due date for a PAYGW amount depends on whether the liable party is a small, medium or large withholder (and this depends on the quantum of the withheld amount).

This liability to pay the PAYGW amount does not arise under an assessment (unlike the collection of income tax). Where the liable party has not paid the PAYGW amount, the Commissioner may estimate the amount and issue the liable party a notice, the effect of which is to impose a liability equal to the estimated amount on the withholding party. This process is set out in Division 268 of Schedule 1 of the TAA. Accordingly, the Commissioner's position is that the entity which is the trustee of the trust on the date that a PAYGW obligation arises, and not when the withheld amount is due for payment, is liable for the payment of the unremitted PAYGW amount or the estimate of it.

Director Penalties

Under Division 269 of Schedule 1 to the TAA, the Commissioner can issue penalty notices against directors of companies for the purposes of imposing a duty on directors to either:

a) ensure that a company meets its obligations to remit amounts deducted under subdivision 16-B or pay estimates of those liabilities under section 268 of Schedule 1 to the TAA; or
b) appoint an administrator in the case of winding up.

This duty is enforced by penalties equal to the unpaid amounts of the company's obligations to the Commissioner. The Commissioner will issue such notices to the director(s) of the company who was the trustee at the date the withholding obligation arose and not the date the notices are issued.

In the case of a corporate trustee, any director who was in office at any time between the date of the withholding and the due date for payment of that amount and who fails to meet the requisite obligations would be liable for a penalty. This means that any new director appointed after the due date for payment of the PAYGW amounts withheld would also become liable for a penalty if they fail to remit those amounts within 14 days of their appointment. Person seeking appointment to the board of a corporate trustee should therefore make enquiries as to whether the trustee has any unpaid amounts owing to the Commissioner before accepting any directorship.

The Commissioner's Approach to Subrogation

The Commissioner will pursue the remedy of subrogation in the event that judgement against a trustee for unpaid tax would prove to be futile. This would need to be established after:

a) the Commissioner has demanded payment of the unpaid tax from the trustee and the trustee has not made that payment; and
b) the trustee's personal assets were insufficient to meet the tax debt.

Subrogation is an equitable remedy which, in the trust context, would allow a creditor to assume the position of the trustee and therefore exercise the trustee's indemnity out of the trust's assets. However, the creditor would have no higher rights against trust assets than the rights of the former trustee. Therefore, for example, where on a final account between the trustee and the beneficiary, the balance was in favour of the beneficiary, there may be no right of subrogation. Also, there may be no right of subrogation if the trustee did not incur the debt in course of the proper administration of the trust estate.

Where subrogation is available, the Commissioner would issue proceedings in his own name in the Equity Division of the relevant court against the former trustee seeking declaratory relief by way of subrogation. The current trustee, being the legal holder of the trust assets, would also be joined to the proceedings.

The Commissioner also states that it would be unnecessary to join the beneficiaries of the trust or other creditors unless, as the case requires, it would be appropriate to do so. This may occur where the final balance of account between trustee and beneficiary has not been ascertained. It is also expected that when an order for subrogation is made, and where there is more than one creditor, assets of the trust would be shared with the unsecured creditors. This would ensure that the Commissioner, or any other creditor for that matter commencing such proceedings, is not given a priority over other unsecured creditors.

In high risk cases, the Commissioner states that he may consider the appointment of a receiver or provisional liquidator to protect the trust assets.

Summary of the Commissioner's Approaches

The Commissioner's approach to the assessment of tax and the collection of unpaid taxes against a former trustee as set out in PS LA 2012/2 is summarised below.

Assessment of Income Tax

Where the net income of a trust estate is subject to income tax in the hands of the trustee, it is the entity which held the office of trustee at the end of the relevant income period which is the entity to be assessed and liable to pay tax. In most cases, this will be the trustee on 30 June. This is notwithstanding that there is a change of trustee between the end of the income year and the date of issue of the notice of assessment.

Collection of GST

The entity liable to pay the net amount in respect of a tax period is the entity which held the office of trustee at the end of the relevant tax period. This is notwithstanding that there is a change of trustee between the end of the tax period and the due date for payment of the net amount.

PAYG Withholding

The entity liable to pay a PAYG withheld amount is the entity which held the office of trustee at the time an amount was required to be withheld. This is notwithstanding that there is a change of trustee between the date of the withholding and the date that the withheld amount is required to be remitted to the Commissioner.

Director Penalty Notices

The Commissioner may issue a director penalty notice against the directors of a company which was the trustee of a trust at the time that an obligation to withhold an amount from a payment subject to the PAYGW provisions arose. If there is a change of trustee between the date of the withholding and the date of the director penalty notice, the directors of the company that was trustee at the date of the obligation to withhold will be served with the notice. Any new directors of the company appointed after the withholding date and before the date of the director penalty notice will also be liable to a penalty.

Concluding Remarks

PS LA 2012/2 raises the following practice points:

a) entities contemplating appointment as either a replacement trustee or an additional trustee during an income year should ensure that the trust's assets are sufficient to meet any income tax, GST or PAYGW amounts that may fall due. This is because, pursuant to the Commissioner's approach set out in , the entity that is the trustee at the end of or income tax or GST period will be the liable party. Therefore if prior to the appointment of the new trustee, the former trustee had distributed part or all of the trust fund to beneficiaries or otherwise incurred non-deductible expenditure, there may be insufficient assets left for the new trustee to pay the pending tax liability. Under PS LA 2012/2, the Commissioner will not apportion the liability between the outgoing trustee and the incoming trustee;
b) entities retiring as trustees need to ensure that the trust is in a position to pay, and actually pays tax liabilities which are not due or are unpaid at the time the trustee retires;
c) PS LA 2012/2 does not specifically cover the liable party for taxes raised under amended assessments. However, based on the analysis that a legal obligation to pay an income tax amount arises on the last day of the income year, it would following that this remains unchanged in respect income taxes raised under amendment assessments. This is because, in relation to the original assessment, the liability arises on the last day of the income year and not when an assessment issues. This would be no different for amendment assessments. It therefore follows that the entity that is the trustee on the last day of the income year should be the liable party and therefore it is expected that the Commissioner would issue an amended assessment to that entity;
d) as previously stated, directors should make enquiries as to the existence of any unpaid PAYGW amounts by a corporate trustee before accepting any appointment as a director of that company; and
e) the issue of when the Commissioner may seek to recover any unpaid tax amount from a beneficiary of a trust is not addressed in PS LA 2012/2. This, however, was not the purpose of PS LA 2012/2. Suffice to say, the Commissioner's right to recover any unpaid tax amounts from beneficiaries would be governed by the general law in the absence of any statutory right of recovery.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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